DOD Information Services: Improved Pricing and Financial Management
Practices Needed for Business Area (Chapter Report, 09/15/98,
GAO/AIMD-98-182).

Pursuant to a congressional request, GAO provided information on the
Defense Information Systems Agency's (DISA) price-setting process,
focusing on: (1) whether DISA is being reimbursed for the services
provided; and (2) the accuracy of DISA's financial management
information.

GAO noted that: (1) DISA has difficulty: (a) setting prices for
information technology services that result in the recovery of the full
cost of doing business; (b) getting reimbursed for the services it
provides; and (c) producing reliable financial information on the
Defense Information Services business area; (2) these weaknesses impair
the business area's ability to focus management attention on the full
costs of carrying out operations and managing those costs effectively;
(3) DISA is embarking upon a major effort to consolidate its Defense
megacenters (DMC) and increase their efficiency by allowing them to
specialize in mainframe processing and thereby lower their prices; (4)
by consolidating the mainframe processing from the current 16 DMC sites
to 6 and optimizing mainframe operations, DISA anticipates that planned
savings will be passed on to its customers through reduced prices; (5)
however, the reported cost of doing business varies considerably from
computer center to computer center; (6) an analysis of the cost
differences would provide management the opportunity to understand the
cases of the differences and thereby help identify inefficiencies and
make improvements in the services provided; (7) the DMCs have difficulty
estimating future workload; in fiscal year 1997, the Department of
Defense's (DOD) records showed that the estimated versus actual workload
varied from 15 percent to 174 percent for individual centers; (8)
because the DMCs underestimated the amount of work they would perform in
fiscal year 1997 for IBM and UNISYS mainframe services, they reported a
net profit of $90 million, which is 13 percent of the reported fiscal
year 1997 revenue of approximately $682 million; (9) in setting prices
for telecommunications services, the Communications Information Services
Activity did not incorporate about $137 million of costs related to
transitioning independent networks to DISA's new common-user network,
prior-year losses, and overhead expenses; (10) because these costs were
not included, the prices charged for services were not based on the full
costs incurred; (11) since business area costs were offset by
appropriations, its prices were further understated; (12) as of January
1998, DISA reports showed that 31 percent of the business area's
receivables, or about $173 million, had been outstanding for more than
60 days; and (13) weaknesses within DISA's internal control and
accounting systems have hindered the development of accurate financial
reports.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  AIMD-98-182
     TITLE:  DOD Information Services: Improved Pricing and Financial 
             Management Practices Needed for Business Area
      DATE:  09/15/98
   SUBJECT:  Federal agency accounting systems
             Accounts receivable
             Funds management
             Industrial funds
             Comparative analysis
             Financial management systems
             Mainframe computers
             Defense cost control
             Accounting procedures
             Information systems
IDENTIFIER:  DOD Working Capital Fund
             Army Working Capital Fund
             Navy Working Capital Fund
             Air Force Working Capital Fund
             DOD Automatic Digital Network
             DOD Defense Message System
             DOD WCF Capital Investment Program
             DOD Defense Property Accountability System
             Defense Business Operations Fund
             DBOF
             
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Cover
================================================================ COVER


Report to the Chairman, Subcommittee on Military Readiness, Committee
on National Security, House of Representatives

September 1998

DOD INFORMATION SERVICES -
IMPROVED PRICING AND FINANCIAL
MANAGEMENT PRACTICES NEEDED FOR
BUSINESS AREA

GAO/AIMD-98-182

DISA Pricing of Services

(511639)


Abbreviations
=============================================================== ABBREV

  ATM - Asychronous Transfer Mode
  AUTODIN - Automatic Digital Network
  CISA - Communications Information Services Activity
  CPU - central processing unit
  DBOF - Defense Business Operations Fund
  DCTF - DISA Continuity of Operations and Test Facility
  DFAS - Defense Finance and Accounting Service
  DII - Defense Information Infrastructure
  DISA - Defense Information Systems Agency
  DISN - Defense Information System Network
  DLA - Defense Logistics Agency
  DMC - Defense megacenter
  DMS - Defense Message System
  DOD - Department of Defense
  DODIG - Department of Defense Inspector General
  DPAS - Defense Property Accountability System
  DSCS - Defense Satellite Communications System
  FAA - Federal Aviation Administration
  FASAB - Federal Accounting Standards Advisory Board
  FMFIA - Federal Managers' Financial Integrity Act
  GAO - General Accounting Office
  JIEO - Joint Interoperability Engineering Organization
  IFAS - Industrial Fund Accounting System
  IT - information technology
  MICS - MVS Information Control System
  O&M - Operations and Maintenance
  SUPS - standard units of processing
  WCF - working capital fund

Letter
=============================================================== LETTER


B-278062

September 15, 1998

The Honorable Herbert H.  Bateman
Chairman, Subcommittee on Military Readiness
Committee on National Security
House of Representatives

Dear Mr.  Chairman: 

This report, one in a series\1 you requested on the financial
operations of the Department of Defense's (DOD) working capital funds
(WCF), addresses the Defense Information Services business area.  The
business area provides a wide range of information technology
products and services to DOD and other federal agencies, including
telecommunications services, mainframe data processing, and database
management.  It operates under the working capital concept, in which
customers are to be charged the full costs of services provided, and
is managed by the Defense Information Systems Agency (DISA).  For
fiscal year 1998, DOD estimated that the business area will have
reported revenue of about $2.7 billion. 

As you requested, this report discusses (1) DISA's price-setting
process, (2) DISA's reimbursement for services provided, and (3) the
accuracy of DISA's financial management information. 

We are sending copies of this report to the Ranking Minority Member
of your Subcommittee; the Chairmen and Ranking Minority Members of
the Senate Committee on Armed Services; the House Committee on
National Security; the Senate Committee on Appropriations,
Subcommittee on Defense; the House Committee on Appropriations,
Subcommittee on National Security; the Senate and House Committees on
the Budget; the Senate Committee on Governmental Affairs and House
Committee on Government Reform and Oversight; the Secretary of
Defense; the Director of the Defense Information Systems Agency; and
the Director of the Defense Finance and Accounting Service.  Copies
will also be made available to others upon request. 

Please contact me at (202) 512-6240 if you or your staff have any
questions concerning this report.  Major contributors to this report
are listed in appendix III. 

Sincerely yours,

Jack L.  Brock, Jr.
Director, Governmentwide and Defense
 Information Systems



--------------------
\1 Navy Ordnance:  Analysis of Business Area Price Increases and
Financial Losses (GAO/AIMD/NSIAD-97-74, March 14, 1997); Navy
Ordnance:  Analysis of Business Area Efforts to Streamline Operations
and Reduce Costs (GAO/AIMD/NSIAD-98-24, October 15, 1997); and Air
Force Supply Management:  Analysis of Activity Group's Financial
Reports, Prices, and Cash Management (GAO/AIMD/NSIAD-98-118, June 8,
1998). 


EXECUTIVE SUMMARY
============================================================ Chapter 0


   PURPOSE
---------------------------------------------------------- Chapter 0:1

Over the past several years, GAO reports and testimonies have
identified management problems with the Defense Working Capital Funds
(WCF) and have been used by the Congress in exercising its oversight
responsibility.  In view of the Defense Information Services business
area's importance to Department of Defense (DOD) operations, the
Chairman, Subcommittee on Military Readiness, House Committee on
National Security requested that GAO (1) evaluate the Defense
Information Systems Agency (DISA) price-setting process, (2)
ascertain if DISA is being reimbursed for the services provided, and
(3) ascertain the accuracy of DISA's financial management
information. 


   BACKGROUND
---------------------------------------------------------- Chapter 0:2

The Defense Information Services business area consists of two
components--the Defense megacenters (DMC) and the Communications
Information Services Activity (CISA).  The business area provides DOD
and other organizations a wide range of information services, such as
data processing, telecommunications services, and database
management, which are comparable to services found in the commercial
sector.  Data processing-related services are provided by the 16
DMCs, which are located throughout the United States. 
Telecommunications services are provided through CISA by numerous
offices located worldwide.  For fiscal year 1998, DOD estimates that
these two components will have a combined reported revenue of about
$2.7 billion.  As part of DOD's ongoing efforts to reduce
infrastructure cost, DISA has efforts underway to reduce the number
of megacenters.  Over the next 2 years, DISA plans to complete the
consolidation of its mainframe processing centers into six locations. 
DOD estimates that the planned consolidation will result in savings
over a 10-year period (fiscal years 1998 through 2007) of
approximately $1.5 billion. 

For financing purposes, the business area is part of the WCF, a
revolving fund that relies on sales revenue to finance operations,
much as sales revenues are used in commercial enterprises.  Defense
working capital funds are supposed to recover the full costs of
services performed and supplies acquired or used through the prices
charged to their customers. 

The business area generates revenue by billing customers at
predetermined prices as it performs agreed-upon work for those
customers.  The business area prices are based on the estimated costs
of providing services at a projected level of work.  In setting
prices, it is extremely important that the business area accurately
estimate the work it will perform and the cost of performing the
work.  However, this task is difficult because the process that
business areas use to develop prices is tied to the budget process,
which begins up to 2 years before the prices go into effect. 

Customers primarily use operations and maintenance appropriations to
pay for the requested services.  Payments are then used to finance
subsequent operations.  The business area is expected to operate
within the revenue it generates.  Conceptually, this provides an
incentive to control costs and maximize efficiency.  It is critical
that the working capital funds operate efficiently since every dollar
spent inefficiently results in fewer resources available for other
defense spending priorities, such as military readiness. 


   RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:3

DISA has difficulty (1) setting prices for information technology
services that result in the recovery of the full cost of doing
business, (2) getting reimbursed for the services it provides and (3)
producing reliable financial information on the Defense Information
Services business area.  These weaknesses impair the business area's
ability to focus management attention on the full costs of carrying
out operations and managing those costs effectively. 

DISA is embarking upon a major effort to consolidate its DMCs and
increase their efficiency by allowing them to specialize in mainframe
processing and thereby lower their prices.  By consolidating the
mainframe processing from the current 16 DMC sites to 6 and
optimizing mainframe operations, DISA anticipates that planned
savings will be passed on to its customers through reduced prices. 
The initiative is in concert with DOD's overall efforts to reduce its
infrastructure. 

However, the reported cost of doing business varies considerably from
computer center to computer center.  For example, the reported hourly
cost at the Columbus DMC is about 61 percent higher than that of the
St.  Louis DMC.  An analysis of the cost differences would provide
management the opportunity to understand the causes of the
differences and thereby help identify inefficiencies and make
improvements in the services provided. 

In addition, the DMCs have difficultly accurately estimating future
workload.  In fiscal year 1997, DOD's records showed that the
estimated versus actual workload varied from 15 percent to 174
percent for individual centers.  Because the DMCs underestimated the
amount of work they would perform in fiscal year 1997 for IBM and
UNISYS mainframe services, they reported a net profit of $90
million--which is 13 percent of the reported fiscal year 1997 revenue
of approximately $682 million.  Accurate workload projections are
essential to the business area in developing prices that enable it to
recover operating costs from its customers. 

In setting prices for telecommunications services, CISA did not
incorporate about $137 million of costs related to (1) transitioning
independent networks to DISA's new common-user network, (2)
prior-year losses, and (3) overhead expenses.  Because these costs
were not included, the prices charged for services were not based on
the full costs incurred.  Further, at least $231 million of DISA's
appropriations supported business area activities even though DOD
working capital fund business areas are supposed to recover the full
cost of operations through the prices charged customers.  Since the
Defense Information Systems business area costs were offset by
appropriations, its prices were further understated. 

Further, DISA has not been promptly reimbursed for its services.  As
of January 1998, DISA reports showed that 31 percent of the business
area's receivables, or about $173 million, had been outstanding for
more than 60 days.  The timely collection of amounts owed is
important to the financial stability of the business area.  Finally,
weaknesses within DISA's internal control and accounting systems have
hindered the development of accurate financial reports.  Meaningful
and reliable financial reports are essential to allow DISA to monitor
the financial results of operations and set realistic prices to
charge customers.  These weaknesses affect the reliability of
reported costs and revenue information for the business area. 


   PRINCIPAL FINDINGS
---------------------------------------------------------- Chapter 0:4


      DMC COSTS AND WORKLOAD
      WARRANT CONTINUED REVIEW
-------------------------------------------------------- Chapter 0:4.1

One of the basic goals of DOD working capital funds is to break even
over time.  To do so, funds should (1) set prices that accurately
reflect a specific activity's cost of doing business and (2)
accurately estimate future workload.  If prices represent an
individual activity's cost of doing business, the business area can
identify areas contributing to inefficient operations and use these
data to enhance performance.  If prices are based on accurate
workload estimates, they can help the business area ensure that it
does not incur excessive profits or losses. 

DISA anticipates that its major initiative to consolidate its DMCs
will enable it to be more efficient and lower its prices.  In
planning for the DMC consolidation, DISA identified the overall cost
of operations for the DMCs.  The cost data were one factor used to
decide which DMCs would continue to provide IBM and UNISYS mainframe
services to DISA's customers.  However, the reported cost of doing
business varied considerably from DMC to DMC.  For example, during
fiscal year 1998, the Denver DMC reported a cost of about $68 an hour
to provide UNISYS mainframe computer processing services, while the
reported cost at the San Antonio DMC was about $11 an hour to provide
the same service.  DISA stated that it had not undertaken a study of
the cost difference between DMCs providing the same or similar
services.  Taking the time now to analyze these differences would
give DISA management the opportunity to make fundamental improvements
in how the DMCs conduct business as DISA proceeds with the DMC
consolidation. 

GAO also found that the DMCs have not been able to develop accurate
estimates of their workload.  In fiscal year 1997, DISA's workload
execution reports for the 15 DMCs providing IBM mainframe services
showed that 7 overestimated their workload while 8 underestimated
their workload.  At 1 DMC, the reported usage was about 74 percent
more than the projected usage.  In addition, the reported level of
services at 5 of the 8 DMCs providing UNISYS mainframe services were
only 57 percent to 70 percent of their projected amounts used to
develop prices.  Reasonably accurate workload estimates are key to
developing realistic prices. 


      TELECOMMUNICATIONS PRICES DO
      NOT REFLECT THE FULL COST OF
      OPERATIONS
-------------------------------------------------------- Chapter 0:4.2

GAO found that DISA did not include in its prices approximately $77
million related to transitioning independent networks to the Defense
Information Systems Network (DISN).  Although DISA offset DISN
transition costs with anticipated collections or gains from a vendor,
its approach was not consistent with DOD's Financial Management
Regulation.  Realized gains are generally to be reflected in
offsetting adjustments to prices established in subsequent fiscal
years rather than offsetting anticipated gains against current year
prices.  DISA also excluded approximately $60 million in costs
related to a prior-year loss and overhead from its fiscal year 1998
telecommunications prices. 

DOD policy requires that the price charged the customer should
include all direct and indirect costs of doing business.  Excluding
applicable costs from the prices could result in the business area
failing to break even, resulting in higher prices in future years. 
Additionally, working capital funds are supposed to recover their
cost of operation through billings to customers and, therefore,
generally do not receive appropriated funds to finance day-to-day
operations.  However, at least $231 million of fiscal year 1998
appropriated funds are being used to support WCF operations, which
does not conform with the DOD WCF concept. 


      REIMBURSEMENT FOR SERVICES
      PROVIDED HAS BEEN SLOW AND
      INCOMPLETE
-------------------------------------------------------- Chapter 0:4.3

As of January 1998, a reported 31 percent of the business area's
accounts receivable, or about $173 million, had been outstanding more
than 60 days.  Since reimbursement for work performed is the
principal means through which the WCF receives funding, delays in
reimbursement could impact the WCF's financial stability.  The lack
of timely reimbursement is further compounded by DISA's failure to
bill customers for $115 million in services provided in fiscal years
1996 and 1997.  Part of the problem can be attributed to DISA being
directed to bill customers only up to the budgeted amount.  For
example, in fiscal year 1996, DISA billed approximately $101.6
million for services provided to the Defense Logistics Agency (DLA),
but the Office of the Secretary of Defense directed that DLA
reimburse DISA only $76 million--the amount DLA had budgeted.  As a
result, DISA was not reimbursed for $25.6 million in incurred cost. 


      EFFECTIVE MANAGEMENT
      REQUIRES ACCURATE FINANCIAL
      DATA
-------------------------------------------------------- Chapter 0:4.4

DISA, DOD, and the Congress have not received accurate information on
the financial operations of the Defense Information Services business
area.  This problem is not unique to the Defense Information Services
business area but rather symptomatic of the long-standing problems
DOD has encountered in preparing accurate financial reports on the
working capital funds.  GAO has reported on numerous occasions that
the financial reports on those funds were inaccurate and could not be
used by management to effectively monitor the operations.  DOD has
acknowledged that problems exist and has cited actions that were
being taken to resolve them.  However, GAO found that these actions
were not always effective and, as a result, the reporting problems
continued to exist.  Further, DFAS' fiscal year 1997 Chief Financial
Officers Act status report identified weaknesses with the Industrial
Fund Accounting System--which is used by the DMCs.  The report notes
that the system cannot provide financial data that are complete,
reliable, consistent, timely, and responsive to the needs of agency
management.  In addition, the Department of Defense Inspector General
(DOD IG) was unable to express an opinion on DISA's fiscal year 1997
financial statements. 


   RECOMMENDATIONS
---------------------------------------------------------- Chapter 0:5

GAO is recommending that the Director of the Defense Information
Systems Agency and the Under Secretary of Defense (Comptroller)
improve the operations, price-setting, and financial management
practices of the Defense Information Services business area by (1)
setting prices that include all costs incurred by the DMCs and CISA,
(2) promptly collecting amounts owed, and (3) recording amounts owed
in accordance with applicable accounting standards. 


   AGENCY COMMENTS AND OUR
   EVALUATION
---------------------------------------------------------- Chapter 0:6

The Office of the Secretary of Defense provided written comments on a
draft of this report.  DOD acknowledged that DISA was experiencing
difficulty in being reimbursed for all services provided.  DOD also
agreed that the amounts owed to DISA were not always recorded in
accordance with applicable accounting standards.  Accordingly, DOD
agreed with the recommendations made to the Under Secretary of
Defense (Comptroller) related to collecting and improving the quality
of accounting data for amounts owed. 

However, DOD disagreed with the findings, conclusions, and
recommendations made to the Director of DISA that are aimed at
improving the price setting practices of the business area.  DOD
stated that GAO's report misstates, misinterprets, and misrepresents
much of what DISA has done to control the cost of operations and
manage funds.  DOD further stated that the report does not adequately
acknowledge past and current actions DISA has taken to address the
conditions reported by GAO.  GAO disagrees.  The report was based on
analyses of DISA costs, workload data, pricing documentation, and
accounting and budgetary information.  These data were provided by
and discussed with responsible DISA management officials and other
DOD offices throughout GAO's audit.  For example, GAO's analyses of
the information related to the (1) $11 million in overhead, (2) $49
million loss, and (3) $77 million in DISN transition costs were
corroborated by DISA and Defense officials as not being included in
telecommunication prices.  Further, the report identifies the
progress DISA has made in consolidating 194 processing centers into
the current 16 centers.  The report also discusses DISA's efforts to
further consolidate its DMCs and develop more accurate workload
estimates. 

DOD also disagreed with GAO's recommendation to provide the Congress
more detailed information on the use of appropriated funds supporting
WCF activities.  This information will enable the Congress to decide
whether to continue funding DISA services, where applicable, through
both appropriations and the WCF.  In this regard, House Report
105-532, dated May 12, 1998, on the National Defense Authorization
Act for Fiscal Year 1999, directs the Secretary of Defense, beginning
with the fiscal year 2000 budget request, to more appropriately
reflect and justify the DISA non-WCF budget request.  Satisfying the
language in the House Report will meet the intent of GAO's
recommendation. 

DOD's specific comments and GAO's evaluation of the comments are
discussed in detail at the end of chapters 2 through 5. 


INTRODUCTION
============================================================ Chapter 1

The Defense Information Systems Agency (DISA) is responsible for
managing the Defense Information Services business area.  This
business area provides a wide range of services relating to computer
center operations and voice, data, and video telecommunications.  For
fiscal year 1998, DISA estimated that the business area will have
revenues of about $2.7 billion.  Business area operations are
financed as part of the Defense-wide Working Capital Fund, which was
formerly called the Defense Business Operations Fund (DBOF).  In
December 1996, the Under Secretary of Defense (Comptroller) dissolved
DBOF and created four working capital funds\1 (WCF) to clearly
establish the military services' and DOD components' responsibilities
for managing the functional and financial aspects of their respective
business areas.  As currently specified in the Department of
Defense's (DOD) Financial Management Regulation, Volume 11B,
Reimbursable Operations, Policy and Procedures-Defense Business
Operations Fund, the funds are to charge customers the full costs of
providing goods and services. 

The primary goal of the working capital fund is to focus management's
attention on the full costs of carrying out certain critical DOD
business operations and the management of those costs.  Unlike a
private sector enterprise, which has a profit motive, the working
capital funds are to operate on a break-even basis over time by
recovering the full costs incurred in conducting business operations. 
Accomplishing this requires DOD managers to become more conscious of
operating costs and to make fundamental improvements in how DOD
conducts business.  It is critical for the working capital funds to
operate efficiently since every dollar spent inefficiently results in
fewer resources available for other defense spending priorities. 


--------------------
\1 The four are the Army, Navy, Air Force, and Defense-wide Working
Capital Funds. 


   BACKGROUND
---------------------------------------------------------- Chapter 1:1

The Defense Information Services business area consists of two
components--the Defense megacenters (DMC) and the Communications
Information Services Activity (CISA).  The DMCs' primary mission is
to provide computer processing services to DOD and other federal
government agencies.  The primary mission of CISA is to provide
telecommunications services to DOD and non-Defense customers.  These
two entities differ markedly in mission, as highlighted in the
following sections. 


      DEFENSE MEGACENTERS
-------------------------------------------------------- Chapter 1:1.1

Mainframe processing comprises the core of the DMC services.  DISA
refers to them collectively as A-Goal services, and they include data
processing on IBM and UNISYS mainframe computers, data transfers
between computers, and data storage.  DMCs provide a variety of other
services to their customers, referred to collectively as C-Goal
services, which include mainframe processing on computers made by
other manufacturers (such as Burroughs), telecommunications, and
database management. 

Table 1.1 summarizes the DMCs' reported revenues, cost of operations,
and the net operating results for fiscal years 1995 through 1997. 



                               Table 1.1
                
                DMCs' Reported Results of Operations for
                     Fiscal Years 1995 Through 1997

                         (Dollars in thousands)

                                        Fiscal year
                                ----------------------------
                                    1995      1996      1997     Total
------------------------------  --------  --------  --------  ========
Revenues                        $681,212  $693,596  $681,914  $2,056,7
                                                                    22
Cost of operations\a             713,221   646,204   645,439  $2,004,8
                                                                    64
Net operating results\b         ($32,009   $47,392   $36,475   $51,858
                                       )
----------------------------------------------------------------------
\a The cost of operations represents the cost incurred by the DMCs in
providing services to their customers. 

\b The net operating results represent the difference between the
revenue and the cost of operations for that particular fiscal year. 

Source:  DISA's financial statements for fiscal years 1995 through
1997.  GAO did not independently verify the information.  The DOD IG
was unable to render an opinion on DISA's financial statements for
fiscal year 1997 when performing the audit required by the Chief
Financial Officers Act. 

Currently, there are 16 megacenters located throughout the Unites
States.\2 DISA has designated DISA Western Hemisphere as the
responsible entity for managing the DMCs.  As part of DOD's ongoing
efforts to reduce infrastructure cost, DISA has efforts underway to
further reduce the number of megacenters.  Over the next 2 years DISA
plans to complete the consolidation of its mainframe processing
centers from 16 to 6\3 and at the same time introduce Regional
Information Services.\4 This is a continuation of DOD efforts to
consolidate its computer center operations.  Between fiscal years
1990 and 1996, DOD consolidated workload and equipment from 194
computer centers to 16 DISA DMCs. 

While the remaining DMCs will provide mainframe processing services,
the Regional Information Services will concentrate on nonmainframe
services, such as local area network support and personal computer
operations and maintenance.  According to DISA's Defense Megacenter
Business Strategy, dated October 1997, DOD estimates that the planned
consolidation will result in savings over a 10-year period (fiscal
years 1998 through 2007) of approximately $1.5 billion.  Of the $1.5
billion, approximately $1 billion will accrue after fiscal year 2002. 


--------------------
\2 The 16 Defense megacenters are located in Chambersburg,
Pennsylvania; Columbus, Ohio; Dayton, Ohio; Denver, Colorado;
Huntsville, Alabama; Jacksonville, Florida; Mechanicsburg,
Pennsylvania; Montgomery, Alabama; Ogden, Utah; Oklahoma City,
Oklahoma; Rock Island, Illinois; Sacramento, California; San Antonio,
Texas; San Diego, California; St.  Louis, Missouri; and Warner
Robins, Georgia.  The Sacramento DMC is scheduled to close as a
result of the Base Realignment and Closure Commission of 1995. 

\3 The six remaining centers will be located in Columbus, Ohio;
Mechanicsburg, Pennsylvania; Ogden, Utah; Oklahoma City, Oklahoma;
San Antonio, Texas; and St.  Louis, Missouri. 

\4 Regional Information Services will be located at the 15 locations
remaining after the closure of the Sacramento DMC. 


      COMMUNICATION INFORMATION
      SERVICE ACTIVITY
-------------------------------------------------------- Chapter 1:1.2

CISA is responsible for acquiring services that connect base-level
and deployed telecommunications networks within and between the
continental United States, Europe, Pacific, and the Caribbean.  These
services are provided within the United States primarily through
leased telecommunications lines and overseas by a mixture of
government-owned and leased lines.  Table 1.2 provides information on
CISA's reported revenues, cost of operations, and net operating
results for fiscal years 1995 through 1997. 



                               Table 1.2
                
                 CISA's Reported Results of Operations
                   for Fiscal Years 1995 Through 1997

                         (Dollars in thousands)

                                        Fiscal year
                                ----------------------------
                                    1995      1996      1997     Total
------------------------------  --------  --------  --------  ========
Revenues                        $1,805,0  $2,102,3  $1,996,1  $5,903,5
                                      93        46        14        53
Cost of operations              1,820,18  2,150,53  2,014,64  $5,985,3
                                       1         4         4        59
Net operating results           ($15,088  ($48,188  ($18,530  ($81,806
                                       )         )         )         )
----------------------------------------------------------------------
Source:  DISA's financial statements for fiscal years 1995 through
1997.  GAO did not independently verify the information.  The DOD IG
was unable to render an opinion on DISA's financial statements for
fiscal year 1997 when performing the audit required by the Chief
Financial Officers Act. 

CISA can provide its customers--DOD and other federal entities, such
as the Federal Aviation Administration--all forms of secure and
nonsecure voice, data, video, and bulk transmission
telecommunications.  If CISA is unable to provide the requested
services directly, it will contract, on behalf of the requesting
activity, with the commercial sector or another federal entity to
provide the services.  For example, some voice services are provided
by the General Services Administration under its FTS-2000 contract
for services not available through CISA. 


   OBJECTIVES, SCOPE, AND
   METHODOLOGY
---------------------------------------------------------- Chapter 1:2

The objectives of our review were to (1) evaluate DISA's processes
for establishing the prices DMCs and CISA charge for the services
provided to customers of the Defense Information Services business
area, (2) ascertain if DISA is being reimbursed for all services
provided, and (3) ascertain the accuracy of DISA's financial
management information. 

To evaluate the price-setting process for the DMCs and CISA, we
reviewed the policies and procedures DOD established for setting
prices.  We identified the cost elements included in the prices and
determined whether these elements are in conformance with the
guidance set forth in DOD's Financial Management Regulation, Volume
11B, Reimbursable Operations, Policy and Procedures-Defense Business
Operations Fund.  We also collected and analyzed workload data
obtained from DISA-WESTHEM.  We discussed the reliability of this
data on DMC operations with DISA-WESTHEM and determined the
difference between the projected and actual workload for IBM and
UNISYS mainframe services for fiscal year 1997.  In addition, we
obtained and reviewed a study performed by a private contractor
related to CISA's pricing of services. 

To determine if the information service business area is being
reimbursed for all services provided, we collected, reviewed, and
analyzed selected financial information related to collections,
disbursements, and accounts receivable.  We determined whether DISA
pursued collection of accounts receivable in accordance with the
guidance set forth in DOD's Financial Management Regulation.  We also
contacted DISA customers to discuss amounts they owed DISA for
services provided.  In addition, through our discussion with DISA
personnel, review of the financial reports, and review of relevant
federal accounting standards,\5 we determined whether amounts owed
DISA were being properly recorded. 

To evaluate the accuracy of DISA's financial management information
we (1) obtained and analyzed the Defense Working Capital Fund
Accounting Reports and (2) DISA's Chief Financial Officer Annual
Financial Statement for FY 1996.  We also reviewed the DOD IG's audit
report on the business area financial statements for fiscal year
1997, to identify any problems they found with the business area's
financial information.  We also reviewed DOD's fiscal year 1997
Federal Managers' Financial Integrity Act (FMFIA) report and the
Defense Finance and Accounting Service (DFAS) Chief Financial
Officer's Financial Management Status Report and Five Year Plan
1997-2001 to identify any accounting and reporting weaknesses related
to DISA. 

The quantitative financial information used in this report was
produced by DOD's systems, which have long been reported to generate
unreliable data.  We did not independently verify the data.  The DOD
IG was unable to render an opinion on DISA's financial statements for
fiscal year 1997. 

We performed our work at the Office of the Under Secretary of Defense
(Comptroller), Washington, D.C.; DISA Headquarters, Arlington,
Virginia; DFAS Headquarters, Crystal City, Virginia; DISA-WESTHEM,
Denver, Colorado; Defense Logistics Agency, Ft.  Belvior, Virginia;
Federal Aviation Administration, Washington, D.C.; and the Department
of State, Washington, D.C..  Our work was performed from August 1997
through August 1998, in accordance with generally accepted government
auditing standards.  We requested comments on a draft of this report
from the Secretary of Defense.  The Office of the Secretary of
Defense provided written comments on a draft of this report that are
discussed in chapters 2, 3, 4, and 5 and are reprinted in appendix I. 
DOD also provided technical comments on the draft report, which we
have incorporated where appropriate, but have not included. 

Chapter 2 of this report discusses pricing issues related to the
Defense megacenters.  Chapter 3 discusses issues primarily related to
pricing telecommunications services offered by CISA.  Chapter 4
discusses DISA's ability to be reimbursed in a timely manner for
services provided and the nonreimbursement for services provided to
customers.  Chapter 5 discusses the accuracy and reliability of
DISA's financial management information. 


--------------------
\5 In October 1990, the Federal Accounting Standards Advisory Board
(FASAB) was established by the Secretary of the Treasury, the
Director of the Office of Management and Budget (OMB), and the
Comptroller General of the United States to consider and recommend
accounting standards to address the financial and budgetary
information needs of the Congress, executive agencies, and other uses
of federal financial information.  Once FASAB recommends accounting
standards, the Secretary of the Treasury, the Director of OMB, and
the Comptroller General decide whether to adopt the recommended
standards.  The Standards that are adopted are published as
Statements of Federal Financial Accounting Standards by OMB and GAO. 


DMCS' COSTS AND WORKLOAD WARRANT
CONTINUED REVIEW
============================================================ Chapter 2

One of the goals of the working capital fund is to break even over
time.  To achieve this, prices are supposed to include all direct and
indirect costs incurred in providing services to the customers.  To
ensure that customers have sufficient funds to pay for the requested
services, prices are to be established before the start of the fiscal
year and remain in effect for the entire year.  In order to set
prices that will enable the business area to operate on a break-even
basis, it is extremely important that the business area accurately
estimate the work it will perform and the cost of performing that
work.  This task is made more difficult because the process that
business areas use to develop prices begins up to 2 years before the
prices go into effect. 

In developing prices for mainframe processing services, each DMC
collects cost data on direct labor, depreciation, contracts,
software, and the indirect cost incurred by the DMC and headquarters
(such as base support costs and centralized contract administration)
to arrive at the activity's estimated cost of doing business.  The
workload data are derived through discussions with customers and
utilization data collected by DISA.  Once the cost and workload data
are accumulated, the individual DMC price is determined by allocating
the estimated total cost over the estimated workload to arrive at a
cost per hour.  Currently the DMCs use a uniform price structure
which results in all customers being charged the same price
regardless of where the work is performed.  Our review disclosed that
the cost of doing business varied considerably from DMC to DMC.  As
DISA proceeds with its consolidation effort, analyzing the cost
differences between the DMCs should enable managers to seek ways to
become more efficient and effective, thereby reducing the cost of
operations and lowering prices charged to the customers. 

We also found that the DMCs had difficulty developing accurate
workload estimates.  For example, at the Columbus DMC, the actual
reported workload was about 74 percent more than the projected
workload, while at the Warner Robins DMC, the actual reported
workload was approximately 81 percent of the projected workload. 
While DISA has put into place mechanisms to better identify the
current workload, additional efforts are needed to ensure that DISA
receives accurate estimates on new workload requirements. 


   DIFFERENCES IN REPORTED COSTS
   OF OPERATIONS BETWEEN DMCS
   WARRANT FURTHER ANALYSIS
---------------------------------------------------------- Chapter 2:1

DOD has recognized that its computer centers have been operating
inefficiently and that they need to adopt new technologies in order
to continue supporting DOD's large and complex information
infrastructure.  The planned DMC consolidation is aimed at reducing
DOD's infrastructure costs, thereby lowering the price charged to
customers for IBM and UNISYS mainframe services.  The House
Appropriation Committee report 104-208, directed the Under Secretary
of Defense (Comptroller) to determine the feasibility of outsourcing
DOD's megacenters.  A cost analysis was completed in February 1996
that detailed the overall cost of operating the DMCs.\1 Although the
analysis was used as a factor in evaluating which DMCs would continue
to provide mainframe services, it did not identify the specific costs
of operating each DMC. 

Our analysis of the reported cost of doing business disclosed that
the cost varied considerably from DMC to DMC for both IBM and UNISYS
work.  The IBM costs, for example, ranged from a low of $40 per hour
at the Ogden DMC to a high of $275 per hour at the San Diego DMC. 
Table 2.1 shows the reported fiscal year 1998 cost per central
processing unit (CPU) hour for IBM and UNISYS platforms at individual
DMCs. 



                               Table 2.1
                
                 Reported Fiscal Year 1998 Cost Per CPU
                 Hour for IBM and UNISYS at Individual
                                  DMCs

                                              Estimated Cost Per CPU
                                                       Hour
                                            --------------------------
DMC                                                  IBM        UNISYS
------------------------------------------  ------------  ------------
Chambersburg                                      $97.16            \b
Columbus                                           83.76            \b
Dayton                                            220.38            \b
Denver                                            105.72        $67.53
Huntsville                                         90.43            \b
Jacksonville                                      184.01         28.71
Mechanicsburg                                      59.83            \b
Montgomery                                            \a         11.60
Ogden                                              40.35         22.20
Oklahoma City                                     126.05         22.14
Rock Island                                       150.64            \b
Sacramento                                        129.05            \b
San Antonio                                        79.00         10.59
San Diego                                         274.55         22.91
St. Louis                                          51.96            \b
Warner Robins                                     106.73         17.97
----------------------------------------------------------------------
\a Montgomery does not operate IBM platforms. 

\b These DMCs do not operate UNISYS platforms. 

Source:  Defense Information Systems Agency.  We did not
independently verify this information. 

The primary goal of the WCF financial structure is to focus the
attention of all levels of management on the full costs of carrying
out certain critical DOD business operations and the management of
those costs.  Analysis of the reported cost differences would be in
accordance with this goal.  However, DISA personnel stated that a
formal analysis has not been conducted to determine the causes of DMC
cost differences. 

This analysis is especially critical for the six centers that are
supposed to remain after the consolidation effort.  These centers
report wide variances in the cost per CPU hour.  For instance, at the
Ogden DMC, the IBM cost per CPU hour is approximately $40; at the
Oklahoma City DMC, it is $126, over three times higher.  By taking
time now to analyze the cost differences at these and the other four
remaining facilities, DISA managers can assess the causes of such
variances and thereby identify inefficient operations and make
fundamental improvements in how the centers conduct business before
consolidation efforts are completed. 


--------------------
\1 Strategy for Defense Information Services, February 9, 1996. 


   ACCURATE WORKLOAD ESTIMATES ARE
   A KEY ELEMENT IN SETTING PRICES
---------------------------------------------------------- Chapter 2:2

Projecting workload accurately is a key element in setting prices
that will help a business area to break even over time.  Too high a
workload estimate could result in the business area operating at a
loss.  Conversely, if the workload estimate is too low, the business
area could have a profit.  Although DISA has initiated efforts over
the past several years to develop accurate workload estimates, it
continues to struggle.  For example, at the Columbus DMC, the
reported actual workload was about 74 percent more than the projected
workload, while at the Warner Robins DMC, the actual reported
workload was approximately 19 percent less than the projected
workload.  The establishment of accurate workload estimates was one
of the issues discussed in DOD's September 1997 plan to improve the
operations of the WCFs.  \2 The improvement plan notes that
synchronizing customer funding and workload estimates is critical to
ensure that WCF prices are based on realistic workload estimates and
customer purchases are adequately funded.  The plan noted that this
does not always occur. 


--------------------
\2 A Plan to Improve the Management and Performance of the Department
of Defense Working Capital Funds, September 1997. 


      MORE ACCURATE WORKLOAD
      ESTIMATES ARE NEEDED
-------------------------------------------------------- Chapter 2:2.1

In fiscal year 1994, DISA began identifying system utilization and
developing projections of future customer workload requirements based
on information provided by DMCs.  However, according to DISA, this
information has frequently been misclassified because clear
definitions for customer identification codes--which identify the
workload below the major command level--are lacking.  In order to
improve the reliability of customer projections, DISA validated
customer identification codes for DMC customers in fiscal year 1997. 
DISA also took steps to capture the utilization data by installing
measurement systems on IBM, UNISYS, and other hardware platforms. 
Data from these systems are fed to the MVS Information Control System
(MICS), which now serves as DISA's workload reporting and invoicing
system. 

DISA has also gathered information from DMC staff on conditions that
could have an impact on future requirements, such as missing data,
changes in customer codes, and differences between historical and
future volumes caused by workload migrations.  However, despite these
efforts, the inability to reasonably estimate the volume of services
was the primary reason the mainframe services--IBM and UNISYS--had a
reported net profit of approximately $90 million for fiscal year
1997.  This profit was approximately 13 percent of the DMCs' reported
revenue of about $682 million. 

Our analysis of DISA's workload execution reports showed that 7 of
the 15 DMCs providing IBM mainframe services overestimated their CPU
hour usage during fiscal year 1997, while 8 underestimated usage. 
For example, at the Columbus DMC, the actual usage was about 74
percent more than the projected usage.  Further, our analysis of
UNISYS workload reports also showed that actual processing at 5 of
the 8 DMCs providing UNISYS\3 mainframe services was 57 percent to 70
percent of projected amounts.  At one of the DMCs, however, the
actual reported workload was almost 66 percent more than projected. 
Tables 2.2 and 2.3 show the projected and actual amounts of
processing for IBM and UNISYS systems in fiscal year 1997. 



                                    Table 2.2
                     
                     Projected and Reported Usage of IBM CPU
                        Hours by DMC for Fiscal Year 1997

                                      Reported                        Percent of
                                         usage                            actual
                 Projected IBM      of IBM CPU                      to projected
DMC                  CPU hours           hours      Difference             usage
--------------  --------------  --------------  --------------  ----------------
Chambersburg           152,598         137,198        (15,400)             89.91
Columbus               237,598         412,421         174,823            173.58
Dayton                  56,211          53,984         (2,227)             96.04
Denver                 135,913         171,894          35,981            126.47
Huntsville             126,656         110,102        (16,554)             86.93
Jacksonville            15,483          20,413           4,930            131.84
Mechanicsburg          501,228         524,799          23,571            104.70
Ogden                  257,676         172,186        (85,490)             66.82
Oklahoma City           98,838         149,155          50,317            150.91
Rock Island             84,639         140,382          55,743            165.86
Sacramento              41,853           6,469        (35,384)             15.46
San Antonio             81,512          66,036        (15,476)             81.01
San Diego               11,976          20,177           8,201            168.48
St. Louis              250,118         274,937          24,819            109.92
Warner Robins           56,264          45,420        (10,844)             80.73
--------------------------------------------------------------------------------
Source:  Budget Execution and Monitoring System Industrial Fund
Workload Execution Reports for fiscal year 1997.  We did not
independently verify this information. 



                                    Table 2.3
                     
                      Projected and Reported Usage of UNISYS
                      Standard Units of Processing (SUPS) by
                             DMC for Fiscal Year 1997

                       Projected  Reported usage
                          UNISYS              of
DMC                         SUPS     UNISYS SUPS      Difference         Percent
----------------  --------------  --------------  --------------  --------------
Denver                    79,428          50,671        (28,757)           63.79
Jacksonville             268,875         446,097         177,222          165.91
Montgomery               915,960         602,740       (313,220)           65.80
Ogden                    486,096         402,170        (83,926)           82.73
Oklahoma City            452,278         406,147        (46,131)           89.80
San Antonio            1,197,204         797,753       (399,451)           66.63
San Diego                163,779         114,106        (49,673)           69.67
Warner Robins            569,292         322,545       (246,747)           56.66
--------------------------------------------------------------------------------
Source:  Budget Execution and Monitoring System Industrial Fund
Workload Execution Report for fiscal year 1997.  We did not
independently verify the information. 

In discussing the workload fluctuations with DISA-WESTHEM personnel,
we were informed that although they are responsible for estimating
future requirements for DMC services, the accuracy of these estimates
depends heavily on information provided by DISA customers.  According
to DISA-WESTHEM personnel, systems have been installed which enable
DISA to determine the amount of services actually provided to DMC
customers.  However, DISA-WESTHEM cannot easily identify all of the
factors that could cause a change in future customer needs.  For
example, the current DOD initiatives to standardize systems have led
to widespread migration of workloads from numerous older systems to
new systems.  Central Design Activities are responsible for
maintaining existing systems and for working with customers on the
development of replacement systems.  Decisions concerning the types
of data to be maintained by the new systems and specific program
operations affect the types and amounts of DMC services required,
such as data storage and the number of input/output operations that
will occur during program execution.  In addition, the actual pace of
progress made in developing, testing, installing, and implementing
the new systems affects the volume of processing that will continue
to be done on the legacy systems.  For example, the Chief of the
Resource Management Branch in the Denver DMC Business Management
Division stated that the CPU hours for the Defense Civilian Pay
System were 46 percent higher than projected in fiscal year 1997
because of an increase in accounts migrated from legacy systems
requiring mainframe processing services. 

DISA-WESTHEM officials also confirmed that this issue is continuing
to hinder their ability to develop accurate workload estimates.  For
example, DISA-WESTHEM was recently notified that the planned
migration of the Base Level Personnel System workload from DISA to
Randolph Air Force Base on September 30, 1998, has been delayed until
fiscal year 2000.  As a result, DISA will be providing about $7
million in services during fiscal year 1999 that were not included in
its customer projections or factored into DISA's prices for the
fiscal year.  DISA-WESTHEM officials further noted that the workload
for the Defense Transportation Reporting System is now four times the
fiscal year 1997 projected level.  DISA only received 30 days notice
of the increased workload.  Because of the long lead time to develop
prices, which is tied to preparing the budget, this additional
workload will not be reflected in the fiscal year 1999 prices.  All
these factors impact the DMCs' ability to accurately estimate their
workload.  Without sound workload estimates, the credibility of the
prices being charged is questionable. 


--------------------
\3 UNISYS workload is measured in standard units of processing
(SUPS).  SUPS include CPU processing time and the amount of time
taken for data input/output transfer functions.  In contrast, IBM
workload is measured in CPU hours alone and does not include transfer
time. 


      DOD IMPROVEMENT PLAN
      RECOGNIZES IMPORTANCE OF
      ACCURATE WORKLOAD ESTIMATES
-------------------------------------------------------- Chapter 2:2.2

In response to the National Defense Authorization Act for Fiscal Year
1997, DOD developed a plan to improve the operation of the WCFs.  One
of the issues discussed in the plan was the importance of accurate
workload estimates and the potential effect of inaccurate estimates
on the results of operations.  The plan points out that revolving
fund activity workload and customer funding should be synchronized. 
This synchronization is critical to ensure that prices are based on
realistic workload estimates and expected purchases are adequately
funded.  The plan points out that this does not always occur.  In the
case of the DMCs, the higher than anticipated workload in fiscal year
1997 was a primary reason the IBM and UNISYS mainframe services
reported a net profit of $90 million in fiscal year 1997. 

Within DOD, the Office of the Comptroller is the one entity that
should have, or be able to obtain, information on the workload
estimates contained in customers' budget request and the revolving
fund activity estimates of workload to be performed for customers. 
As part of its program budget review process, in which the prices are
finalized, the Comptroller's office could use the information to
review and resolve workload differences between DISA and its
customers.  A more accurate workload estimate should help reduce the
problem of customers not being able to pay for all services provided,
which is discussed in further detail in chapter 4. 


   CONCLUSIONS
---------------------------------------------------------- Chapter 2:3

DOD has recognized the need to continue reducing the cost of its
computer centers' operations through consolidations.  Over the next 2
years, DISA plans to complete the consolidation of its mainframe
processing centers from 16 to 6 locations.  In planning the
consolidation effort, DISA identified the cost of operating the DMCs
and used these data in the decision making process.  However, by not
analyzing significant differences between the reported cost of
operations at the DMCs that will remain after the consolidation is
completed, DOD is forgoing an opportunity to further enhance the
efficiency of DMC operations and make fundamental improvements in the
services provided.  Further, until DOD improves its workload
projections, it will continue to experience difficulty in setting
accurate prices and, in turn, ensuring that the DMCs do not incur
excessive profits or losses. 


   RECOMMENDATIONS
---------------------------------------------------------- Chapter 2:4

We recommend that the Director of DISA

  -- analyze the cost differences in the estimated cost per CPU hour
     at the DMCs as part of the consolidation effort and identify
     improvements needed in how they conduct business and

  -- compare forecasted workload estimates to actual work received
     and consider these trends in developing the workload estimates
     and prices to charge customers for the services provided. 

We also recommend that as part of the price-setting process, the
Under Secretary of Defense (Comptroller) ensure the workload
estimates in DISA and customer budgets agree. 


   AGENCY COMMENTS AND OUR
   EVALUATION
---------------------------------------------------------- Chapter 2:5

DOD did not agree with our recommendations that DISA (1) analyze the
cost differences at the DMCs and identify improvements needed in how
they conduct business and (2) compare forecasted workload estimates
to actual work received and consider these trends in developing the
workload estimates and prices to charge customers for the services
provided.  DOD agreed with our recommendation that the Under
Secretary of Defense (Comptroller), as part of the price-setting
process, ensure the workload estimates in DISA and customer budgets
agree. 

In its response, DOD stated that analyses of cost differences have
been made and provided to DISA management and that along with other
analyses they were used to plan the ongoing consolidation of the
DMCs.  Our report fully recognizes the efforts DISA put forth in
planning the consolidation and the importance the February 1996 cost
analysis played in the decision-making process.  However, our
analysis disclosed that there were considerable differences in the
reported cost of doing business between the DMCs.  Our conclusion
that opportunities for savings exist is based in part on the
magnitude of the DMC operating cost differences which now exist--the
reported variance per CPU hour is $40.35 to $274.55.  Further, in an
August 1998 meeting, the Acting Deputy Comptroller and the Resource
Manager, Operations Directorate, stated that DISA has not formally
analyzed the reasons for the cost differences between the DMCs. 
Furthermore, a DISA official acknowledged that DISA had not studied
the differences in costs between DMCs providing the same or similar
service.  This evidence clearly indicates to us that despite earlier
analyses, a more rigorous study of costs is warranted to determine
and correct the underlying causes of these differences. 

DOD also disagreed with our characterization of the need for
improvements in the estimation of the workload performed by the DMCs. 
DOD noted that given the changes brought on by the consolidation
effort, it is difficult to develop accurate workload estimates.  DOD
also noted that as discussed in the report, the process of developing
workload starts 2 years before the prices go into effect.  DOD
further stated that regardless of the quality of the estimated
workload, the customers will inevitably change workload requirements
to meet their current situation. 

The report recognizes the efforts that DISA has undertaken to improve
the accuracy and reliability of its workload estimates, the obstacles
it faces in doing so, and the difficulty involved in precisely
estimating the workload to be performed.  Indeed, there will always
be some variance between the estimated workload and the actual work
performed by the DMCs.  However, the extent of the reported workload
variance for IBM CPU hours (from about 74 percent more than the
projected workload at Columbus DMC to about 19 percent less than the
projected workload at the Warner Robins DMC) is much greater than
would normally be expected.  The DMCs posted a $90 million net profit
for mainframe services in fiscal year 1997 primarily because workload
volumes were substantially higher than anticipated. 

Since the volume of workload is one factor in determining the CPU
hourly price, the accuracy and reliability of the workload estimate
is critical in establishing an hourly CPU price.  Conceptually, the
larger the volume of work to be performed the lower the price because
the cost of operations can be spread across more CPU hours. 
Therefore, for fiscal year 1997, a more accurate workload estimate
for the DMCs would have resulted in a lower CPU hourly price for IBM
mainframe services and a higher hourly price for UNISYS mainframe
service.  A lower hourly IBM mainframe price may have afforded some
customers, such as DFAS, the opportunity to pay for more of the
services DISA provided. 

Further, as discussed in the report, DISA personnel developing
mainframe projections stated that they rely heavily on data gathered
on past workload levels and that these data do not necessarily
reflect future requirements.  They emphasized that outside customers,
such as the Central Design Activities, should have the most immediate
knowledge of application systems run at the DMCs and the times when
workloads will be moved from one platform to another. 


TELECOMMUNICATIONS PRICES DO NOT
REFLECT THE FULL COST OF
OPERATIONS
============================================================ Chapter 3

In addition to the DMC pricing concerns discussed in chapter 2, our
analysis of the Defense Information Services business area also
disclosed that DISA was not recovering the full costs incurred in
providing telecommunications services.  Recovering the full cost of
operations is one of the basic underpinnings of the working capital
fund (WCF).  Not including the full cost of operations in developing
prices understates the prices charged customers for the services
provided.  Our review disclosed that DISA did not include in its
prices approximately $77 million related to transitioning independent
networks to the Defense Information Systems Network (DISN) in
accordance with DOD's Financial Management Regulation.  Further, we
found approximately $60 million of costs that were not incorporated
in DISA's computation of its fiscal year 1998 telecommunications
prices. 

In addition, while reviewing DISA's fiscal year 1998
telecommunications prices, we identified at least $231 million in
appropriated funds that supported WCF activities.  However, based
upon our review of DISA's fiscal year 1998 budgetary request, the
rationale for financing WCF-related costs through the use of
appropriations was not clear.  Normally, costs are recovered through
customer billings and, in most instances, the WCF generally does not
receive appropriations for financing day-to-day operations.  Since
the Defense Information Services business area prices do not take
into consideration the use of appropriated funds, this further
understates the prices charged for services offered by DISA. 
Furthermore, a recent pricing study\1 performed by a private
contractor concluded that while overall workload estimates were
accurate for existing services, DISA's telecommunications costs were
supported by appropriations and thus were excluded from its
telecommunications prices. 


--------------------
\1 DISN Business Process, Cost, and Methodology Review (Price
Waterhouse, January 29, 1998). 


   SOME COSTS NOT INCLUDED IN
   TELECOMMUNICATIONS PRICES
---------------------------------------------------------- Chapter 3:1

DOD policy requires business activities to identify the direct and
indirect costs of doing business and to incorporate these costs into
their prices.  To ensure that WCF customers have enough funds to pay
for the services they need to sustain their readiness, DOD policy
requires that prices be established before the start of the fiscal
year and remain in effect for the entire year.  The process for
establishing telecommunications prices generally is finalized about
10 months before the prices go into effect with CISA developing
workload projections for each service offered for the budget year
based on customer input. 

In establishing CISA prices, cost data are collected related to (1)
network operations, (2) network management, (3) provisioning, (4)
systems development, (5) network transition, (6) equipment, and (7)
prior year profits or losses.  The prices charged customers vary
based on service offering, data versus voice usage, calling area,
precedence capability, bandwidth, and usage.  In instances where
usage data are not available, DISA may allocate the cost based on the
average cost of using the service or attempt to establish prices that
are competitive with the commercial sector or other federal entities. 
In addition, DISA adds a surcharge to each customer's bill to recover
general and administrative overhead expenses.  Although DISA went
through this process, our analysis disclosed that CISA's
telecommunications prices did not always include the total costs. 
For example, $77 million for transitioning telecommunications
networks was not recognized in the prices charged customers. 
Further, for fiscal year 1998, we found that $49 million for a prior
year loss and $11 million of overhead were not included. 


      TRANSITION COSTS NOT
      INCLUDED IN
      TELECOMMUNICATIONS PRICES
-------------------------------------------------------- Chapter 3:1.1

To improve the effectiveness and efficiency of its military
communications services, DOD began in 1991 to plan and implement DISN
to serve as the department's worldwide telecommunications and
information transfer network to support national security and defense
operations.  DOD's strategy focuses on replacing its older data
communications systems using emerging technologies and cost-effective
strategies that provide secure and interoperable voice, data, video,
and imagery communications services in support of military
operations.  DISN is a subset of the Defense Information
Infrastructure (DII), which is a combination of communication
networks, computers, software, databases, and other services.  As
stated in the WCF FY 1999 Amended Budget Estimates, dated February
1998, DISA is responsible for the pricing of DISN through the CISA
business activity.  According to DISA's WCF charter, the
responsibilities of the WCF expanded with the formulation of DII in
order to create a seamless, transparent, and protected end-to-end
information transfer capability. 

Although DISA is responsible for the pricing of DISN through CISA, it
excluded approximately $77 million related to transitioning
independent networks to DISN from its telecommunications prices.\2
According to the Chief of the Revolving Funds Division, transition
costs were expected to be offset by revenues generated from new
customers, contract savings, discounts and DISA appropriations.\3 For
example, in developing the prices for fiscal year 1998, transition
costs were reduced by the amount of the collections that DISA
anticipated receiving from a contractor because of savings and volume
discounts.  DISA's offsetting of costs in this manner is not in
accordance with the DOD's Financial Management Regulation,\4 which
states that realized gains are generally reflected in offsetting
adjustments to prices established in subsequent fiscal years. 

In addition, this method of accounting for costs and revenue
understates the actual cost incurred in providing services to the
customer.  If the full costs are not identified, the primary goal of
the WCF financial structure--focusing attention on the full costs of
operations and on managing those costs--cannot be met and management
is not in a position to act.  Further, WCF prices should recover
operating expenses (full costs) to be incurred in the applicable
fiscal year unless an exception is granted by the Under Secretary of
Defense (Comptroller). 

In discussing this matter with the Office of the Under Secretary of
Defense (Comptroller), we were informed that the office was not aware
that the transition costs had increased to $127 million.  The office
also believed that DISA's method of accounting for the costs and
revenues was inappropriate and that all costs, other than a one-time
$50 million cost exclusion, should have been included within the
appropriate year's price computation. 


--------------------
\2 Initially, we were informed that the transition costs--costs due
to DISN implementation delays and running dual networks--were
approximately $117 million.  In August 1998, DISA officials stated
that the transition costs had increased to $127 million.  On November
25, 1996, the Under Secretary of Defense (Comptroller) had approved
the exclusion of $50 million in transition costs from future year
prices. 

\3 During fiscal years 1996 and 1997, DISA paid approximately $10
million of DISN transition costs from its appropriations. 

\4 DOD Financial Management Regulation, Volume 11B, Chapters 50, 61,
and 62. 


      FISCAL YEAR 1996
      TELECOMMUNICATIONS LOSS NOT
      INCLUDED IN PRICES
-------------------------------------------------------- Chapter 3:1.2

Our review of CISA's fiscal year 1998 telecommunications prices
disclosed that losses from telecommunications operations were not
recovered in accordance with DOD policy.  In keeping with DOD's
policy, the reported accumulated operating loss at the end of fiscal
year 1996--$49 million--should have been included in fiscal year 1998
prices, but it was not.  In discussions with DISA and the Office of
the Under Secretary of Defense (Comptroller), we pointed out that the
$49 million was reported in DOD's financial reports at the end of
fiscal year 1996 and therefore should have been considered in
developing the prices for fiscal year 1998.  While the Comptroller's
office agreed, it was unable to explain why the $49 million loss from
fiscal year 1996 had not been incorporated into the fiscal year 1998
prices.  We verified that the financial results of operation for
fiscal year 1997 had been incorporated into prices for fiscal year
1999. 


      OVERHEAD COSTS NOT INCLUDED
      IN TELECOMMUNICATIONS PRICES
-------------------------------------------------------- Chapter 3:1.3

Normally, WCF prices should recoup all costs of doing business,
including overhead costs.  In this regard, DOD WCF requirements allow
for surcharges to be used to recover general and administrative
costs.  To recoup its telecommunications overhead cost, CISA applies
a 2 percent surcharge to the total cost of each customer's bill. 
According to the revolving fund manager, the percentage factor is
applied because it is less complicated than determining the actual
amount of overhead cost related to each specific service. 

For fiscal year 1998, we found that the 2 percent surcharge will
generate $44 million in revenue, which is $11 million less than the
estimated overhead costs of $55 million.  This shortfall is the
result of not including all overhead costs when the fiscal year 1998
prices were developed.  According to the Chief of the Revolving Fund
Division, DISA is establishing additional surcharges to recover all
overhead costs for the various services CISA offers.  It is
anticipated that these additional surcharges will be effective for
fiscal year 2000. 


   APPROPRIATED FUNDS USED TO PAY
   FOR SOME COSTS
---------------------------------------------------------- Chapter 3:2

DOD's WCF statute requires that the full costs of services or work
performed be recovered through prices charged customers and
recognizes that the fund may also receive appropriations for the
purpose of providing capital as have been specifically authorized by
law.\5 Our review of DISA's information technology (IT) budget for
fiscal year 1998 identified many instances in which the Congress
appropriated non-WCF funds that can be used to subsidize the cost of
the Defense Information Services business area.  DISA's fiscal year
1998 budgetary request did not clearly delineate the rationale for
using appropriated funds to finance WCF-related services.  Since DISA
does not include the costs paid for by appropriations within the
prices, customers are not charged the full cost of services offered. 

As the central manager for the Defense Information Infrastructure,
DISA annually receives appropriations for (1) Operations and
Maintenance (O&M), (2) Procurement, and (3) Research, Develop, Test
and Evaluation, along with authority for its working capital budgets. 
DISA's appropriations may be spent for various purposes, including
(1) establishing new services, (2) paying for program and technical
activities, and (3) maintaining the communications and computer
infrastructure.  Our analysis of the budget request showed that at
least $231 million of fiscal year 1998 appropriations support the
WCF, including the following.  Appendix II provides additional
details regarding DISA IT appropriated funding being used to support
WCF activities. 

  -- Approximately $87 million of DISA's fiscal year 1998 O&M and $19
     million of Procurement authority were used to enhance DISA's
     information systems security.  The information systems security
     program was established to reduce the vulnerability of DOD's
     existing telecommunications networks and data processing
     centers, including the systems operated as part of the WCF, to
     intrusion.  DISA estimates that approximately 25 percent of its
     information systems security appropriations is used for
     improving the security of systems under the working capital
     fund. 

  -- Approximately $34 million of O&M and $43 million of Procurement
     authority were used to cover the cost of replacing the current
     messaging service, the Automatic Digital Network (AUTODIN), with
     the Defense Message System (DMS).  The objectives of DMS are to
     reduce cost, reduce staffing requirements, improve security, and
     improve DOD messaging services.  For fiscal year 1998, the costs
     for AUTODIN and the network management and operational costs for
     DMS were funded through the CISA activity. 

  -- Approximately $60 million of O&M authority was provided to DISA
     for implementing DISN, which as discussed previously, is
     replacing legacy telecommunications systems.  Although DISA's
     information infrastructure plan states that DISN operates on a
     fee-for-service or working capital basis, only the long haul
     component is currently paid for through the WCF. 

Further, our analysis of DISA's O&M fiscal year 1998 budget
identified the following instances in which appropriated funding was
provided to organizational components supporting WCF activities. 

  -- Approximately $138 million of DISA's fiscal year 1998 O&M
     appropriation was designated for the Joint Interoperability and
     Engineering Organization (JIEO).  JIEO's mission is to ensure
     the interoperability of the Defense Information Infrastructure
     which includes those systems that are funded through DISA's WCF. 
     In addition, JIEO provides engineering support for all
     information transfer and network control systems managed by
     DISA.  For example, the JIEO's Center for Application
     Engineering is responsible for message handling for both DMS and
     AUTODIN--current components of the WCF.  According to the Deputy
     Director for Strategic Plans and Policy, at least $6 million of
     the $138 million could be transferred from the O&M appropriation
     to the WCF. 

  -- The DISN Service Center (DSC) mission is to manage provisioning,
     implementation, and operational control of telecommunications
     services under CISA.  However, according to the Resource Manager
     for DISA operations, DSC is funded for fiscal year 1998
     operations through the working capital fund and DISA's O&M
     appropriation.  For fiscal year 1998, DSC received approximately
     $7.7 million in O&M funds to cover mission support and customer
     service activity.  Mission support and customer service costs
     include civilian salaries, rents, utilities, travel, and
     training. 

  -- Approximately $7 million of DISA's fiscal year 1998 O&M
     authority was used to cover the cost of operating DISA-Western
     Hemisphere, which is responsible for overseeing the operations
     of the DMCs.  In addition, approximately $17 million and $5
     million of DISA's fiscal year 1998 O&M and Procurement
     authority, respectively, were used for the DISA Continuity of
     Operations and Test Facility (DCTF).  DCTF provides innovative
     and integrated services for the DMCs, including disaster
     contingency planning.  The DMCs are part of the WCF. 

  -- After conducting a review of civilian salaries paid from its O&M
     appropriation, DISA identified at least $12 million of the $172
     million authorized for fiscal year 1998 that could be
     transferred to the WCF.  In addition, DISA stated that a portion
     of the $21 million authorized for travel would also need to be
     adjusted for those civilians who could be realigned to the WCF. 

According to DISA's Acting Deputy Comptroller and the Chief of the
Revolving Funds Division, the development of new DISA services has
traditionally been paid for with appropriated funds.  New services
are not incorporated into the WCF until they are operational and a
customer base has been identified.  However, according to DOD working
capital regulations,\6 reinvestment in the infrastructure of business
areas in order to improve product and service quality and timeliness,
reduce costs, and foster comparable and competitive business
operations is the primary goal of the WCF Capital Investment Program,
whose use applies to all activities or groups of activities within
the defense agencies, including DISA. 

We also noted that DISA was using military departments'
telecommunications components to supplement its telecommunications
architecture.  Because the military departments pay for these
components, they were not included in DISA's prices.  For example,
the Defense Satellite Communication System (DSCS) is owned, operated,
and paid for by the Air Force and Army but used by CISA--more
specifically, DISN--in providing services to its customers. 
According to DISA, though some telecommunications traffic does pass
over the DSCS, DOD has kept both operation and life-cycle replacement
of DSCS, as well as other military satellite communication systems,
out of the WCF by policy.  For fiscal year 1998, DISA estimated that
its DSCS usage would cost approximately $46 million annually if
procured from the commercial sector. 

Further, a recent study\7 performed by a private contractor at DISA's
request concluded that while the overall workload estimates for
existing services are accurate, DISA's telecommunications prices were
supported by appropriated funds which were excluded from the prices
charged customers.  The study states that excluding costs understates
the true costs of operations.  For example, the study stated that
DISA's Asychronous Transfer Mode (ATM) prices were considered more
competitive than commercial prices.  However, our review showed that
DISA's ATM price excluded the cost for base support, such as floor
space and power.  The study also found that the WCF paid for some
unique military capabilities.  In commenting on the study, DISA's
Deputy Director for Strategic Plans and Policy acknowledged that in
some instances appropriated funds are supporting the WCF.  He further
stated that DISA was reviewing its pricing structure to identify
those costs that should be part of the WCF. 


--------------------
\5 10 U.S.C.  2208.  DOD'S working capital fund regulations note that
occasionally the funds will receive funding from an appropriation or
transfer to cover a loss.  (DOD Financial Management Regulation,
Volume 11B, 50.A.1.h and 52.C). 

\6 DOD Financial Management Regulation, Volume 11B, Chapter 58. 

\7 See footnote 1. 


   CONCLUSIONS
---------------------------------------------------------- Chapter 3:3

Working capital funds can break even over time by ensuring that all
direct and indirect costs of conducting business are incorporated
into their prices.  Yet, DISA has been excluding from its
telecommunications prices millions of dollars related to
transitioning independent networks to the new common-user network,
prior-year losses, and overhead expenses.  In addition, significant
costs associated with providing data processing and
telecommunications services through the WCF are not being recovered
through the prices charged, but rather, are paid for by
appropriations.  DISA's budgetary request does not clearly state why
appropriated funds are necessary to finance WCF-related services. 
Using appropriated funds further understates DISA's WCF prices and
undermines business area managers' abilities to focus on their
operating costs and to make fundamental improvements in their
operations. 


   RECOMMENDATIONS
---------------------------------------------------------- Chapter 3:4

We recommend that the Director, DISA,

  -- ensure that transition costs and revenues are considered when
     computing telecommunications prices, in accordance with the
     criteria set forth in DOD's Financial Management Regulation, and

  -- as part of DISA's fiscal year 2000 budget, identify (1) all
     appropriations used in support of WCF activities and (2) the
     specific reason(s) the appropriated funds are being used to
     support the activities of the WCF. 


   AGENCY COMMENTS AND OUR
   EVALUATION
---------------------------------------------------------- Chapter 3:5

DOD did not concur with our recommendations to ensure that transition
costs and revenues are considered within the computation of
telecommunications prices in accordance with the criteria set forth
in DOD's Financial Management Regulation.  DOD also disagreed with
our recommendation that DISA, as part of its fiscal year 2000 budget,
identify (1) all appropriations used in support of WCF activities and
(2) the specific reason(s) the appropriated funds are being used to
support the activities of the WCF.  DOD further commented that all
costs--more specifically the $137 million discussed in the
report--related to the telecommunications services have been
considered in developing the prices charged customers. 

DISA may have considered these costs in the development of the
prices, but the $137 million was either (1) not included in the
fiscal year 1998 prices or (2) not considered within the framework of
DOD's Financial Management Regulation.  For example, in a July 30,
1998, meeting with DOD and DISA officials, a DISA representative told
us that the $11 million in overhead costs were not included within
the prices for fiscal year 1998.  This statement supports our
analysis of the fiscal year 1998 price computation, which disclosed
that the $11 million was not included.  Our review showed that the
revenue was approximately $44 million, whereas the cost was $55
million.  Further, as discussed in the report, the Chief of the
Revolving Fund Division acknowledged that there was an overhead
shortfall in fiscal year 1998.  To recover these costs, additional
surcharges will be used starting in fiscal year 2000.  In addition,
according to the Office of the Under Secretary of Defense
(Comptroller), although the $49 million loss discussed in the report
should have been included within the prices for fiscal year 1998, it
was not.  Therefore, there is much evidence to indicate that $60
million of the $137 million was not included in the fiscal year 1998
prices charged customers. 

Further, as stated in the report, DISA's methodology for accounting
for the $77 million in transition costs is inconsistent with DOD's
Financial Management Regulation.  The regulation clearly states that
all estimated costs of providing the customer with goods and services
should be included in the prices charged customers.  It also
stipulates that any realized gains should be used to offset the
estimated costs in subsequent fiscal years.  In addition, the Office
of the Under Secretary of Defense (Comptroller) stated that it is DOD
policy to treat transition costs as operating expenses and,
therefore, these costs should be included in the price charged
customers.  However, as discussed previously, DISA did not adhere to
this prescribed policy, thus understating the full cost of operations
in a given fiscal year. 

We disagree with DOD's position that it is not necessary to provide
the Congress more detailed information on the use of appropriated
funds in support of the WCF.  Our review of DISA's fiscal year 1998
budgetary request found that it did not delineate the rationale for
using appropriated funds to finance WCF-related services. 
Significant costs associated with providing data processing and
telecommunications services through the WCF are being subsidized by
appropriations.  Using appropriated funds further understates DISA's
WCF prices.  The intent of our recommendation is to provide the
Congress with information that will enable it to decide whether to
continue funding DISA services, where applicable, through both
appropriations and the WCF.  In this regard, House Report 105-532,
dated May 12, 1998, on the National Defense Authorization Act for
Fiscal Year 1999, directs the Secretary of Defense, beginning with
the fiscal year 2000 budget request, to more appropriately reflect
and justify the DISA non-WCF budget request.  Satisfying the language
in the House Report will meet the intent of our recommendation. 


DISA NOT REIMBURSED FOR SERVICES
PROVIDED
============================================================ Chapter 4

WCF activities rely on prompt reimbursement to be financially stable. 
Customer payments are used to finance subsequent operations, much as
sales revenues are used in commercial enterprises.  However, we found
that DISA customers were not promptly paying for services provided. 
Additionally, in fiscal years 1996 and 1997, the DMCs did not bill
customers $115 million for services provided.\1 Further, these
amounts were not recorded in DISA's accounting records in accordance
with federal accounting standards. 


--------------------
\1 This information was provided by DISA.  It comes from the Budget
Formulation and Execution Monitoring System and the MVS Information
Control System.  We did not independently verify the accuracy of
these data. 


   ACCOUNTS RECEIVABLE NOT
   COLLECTED IN A TIMELY MANNER
---------------------------------------------------------- Chapter 4:1

DOD Financial Management Regulation, Volume 4, provides that
"procedures shall be established for the routine aging of all amounts
overdue so that appropriate actions can be taken to affect their
collection.  The aggressive and efficient management of receivables
in the Department of Defense is an important element of DOD
stewardship over public funds."

Our review of DISA WCF accounts receivable showed that DISA was not
being promptly reimbursed millions of dollars for services it
provided.  As of January 1998, 31 percent of the reported accounts
receivable, or about $173 million, was reported outstanding for over
60 days.  Of the $173 million in receivables, $19.3 million was
related to the DMCs and $154 million to CISA.  The DMC accounts
receivables were generally due from DOD customers, while CISA's
accounts receivables were generally due from other federal government
entities.  The following table provides aging information on DISA's
accounts receivable over 60 days old. 



                               Table 4.1
                
                 Reported Accounts Receivable More Than
                     60 Days Old as of January 1998

                         (Dollars in thousands)

                                Aging of accounts receivable (in days)
                                --------------------------------------
Business activity                  61-90    91-120  Over 120     Total
------------------------------  --------  --------  --------  ========
DMC                              $14,806      $156    $4,046   $19,008
 DOD customers
Other federal customers                0         0       322       322
Public                                 0         0         0         0
======================================================================
Subtotal                         $14,806      $156    $4,368   $19,330
CISA                             $16,720   $16,576   $24,711   $58,007
 DOD Customers
Other federal customer            18,368    17,726    59,472    95,566
Public                                12        11       322       345
======================================================================
Subtotal                         $35,100   $34,313   $84,505  $153,918
======================================================================
Total                            $49,906   $34,469   $88,873  $173,248
----------------------------------------------------------------------
Source:  Data provided by DISA and DFAS.  We did not independently
verify this information. 

Examples of the information service business area receivables that
have not been promptly reimbursed follow. 

  -- As of January 1998, the Federal Aviation Agency (FAA) had not
     reimbursed DISA approximately $50 million for telecommunications
     services.  The entire $50 million was over 60 days old, with $16
     million over 120 days old.  According to FAA personnel, there is
     an approximately 2-month cycle for billing and paying for DISA
     telecommunications services.  DISA's Acting Comptroller and FAA
     personnel stated that they are discussing the use of electronic
     payments in order to reimburse DISA in a more timely manner. 

  -- As of January 1998, DISA had not been reimbursed approximately
     $12 million for telecommunications services provided to the
     Department of State.  Approximately $11 million was over 120
     days old.  Although DISA had routinely sent out past due notices
     for amounts owed, it had not inquired why State had not paid. 
     Officials within State's Office of the Comptroller acknowledged
     that the amounts were owed to DISA. 

  -- A July 10, 1996, memo from the Director, Resource Management,
     DFAS-Denver Center, stated that DFAS-Headquarters had directed
     it to hold data processing costs constant by not reimbursing the
     DMCs for fiscal year 1996 data processing services beyond the
     amount paid in fiscal year 1995.  As a result, the DMCs were not
     reimbursed approximately $3 million in fiscal year 1996 for data
     processing services. 

  -- DISA had not reimbursed itself for approximately $11 million in
     DMC services and $9 million in telecommunications services as of
     January 1998.  Both amounts were over 60 days old.  According to
     DISA DMC officials, at a minimum, it takes 2 months to process a
     payment voucher, ask DFAS to make the transfer, and liquidate
     the internal receivable.  DISA is currently working with DFAS to
     shorten its internal funds transfer process.  In addition,
     according to DISA telecommunications officials, DISA had not
     collected amounts owed by its internal customers because these
     customers had failed to provide correct funding information. 

Since most of the receivables are from government entities and
constitute the primary source of revenue for the WCF, these amounts
should be collected. 


   DMCS CLASSIFY SOME UNPAID
   AMOUNTS AS UNBILLED
---------------------------------------------------------- Chapter 4:2

Our review of DISA documentation indicated that the DMCs performed
approximately $115 million of billable work during fiscal years 1996
and 1997 for which they were not reimbursed.  This represents about 8
percent of the DMC revenues for the 2 fiscal years.  DISA performed
this work without receiving the required funding document from its
customers.  DOD Financial Management Regulation, Volume 11B, Chapter
61, states that as a general rule, no work or services should be
performed by a business activity unless a reimbursable order is
received and accepted.  Such orders constitute obligations of federal
government ordering activities or advances from nonfederal government
entities.  Further, DISA's method of accounting for the $115 million
was not in accordance with federal accounting standards. 

Based upon information provided by DISA, as of November 1997, DFAS
had not reimbursed DISA $11.7 million and $32.3 million in fiscal
years 1996 and 1997, respectively, for work performed.  According to
the DOD Comptroller's office, DFAS did not reimburse DISA for all
service provided in fiscal year 1996 because the amount DFAS budgeted
was less than the cost incurred.  DFAS stated that the primary cause
for nonpayment in fiscal year 1997 was that work had been
reclassified into a different category which resulted in a higher
price for the service.  DFAS noted that this occurred after its
fiscal year 1997 budget had been set and its level of funding
approved.  In discussing this issue with the Office of the Under
Secretary of Defense (Comptroller), we were informed that discussions
are being held with DFAS and DISA to determine the most appropriate
means to resolve the nonpayment issues. 

Under DOD's policy, prices are set at the beginning of the fiscal
year and are to remain in effect for the entire year.  Similarly,
customer budgets are to include sufficient funds to pay for the
services requested.  This process should result in the WCF breaking
even.  However, during fiscal year 1997, DISA initiated efforts to
better define the cost associated with its IBM and UNISYS mainframe
processing.  The specific services that DISA determined not to be
related to mainframe processing were placed in another category. 
According to DFAS personnel, DFAS was charged a higher price for work
as a result of the reclassification, and these higher prices were not
anticipated when its fiscal year 1997 budget was developed, about 2
years prior to the start of the fiscal year. 

DISA's efforts to reclassify its work is consistent with the WCF
concept because it will result in more costs being aligned with the
appropriate customers.  Further, this effort should provide for a
more accurate accumulation of DISA's cost of operations and thereby
enable DISA to develop more realistic prices for its services. 
However, DISA's efforts were not coordinated with the overall WCF
budget-setting process.  As a result of reclassifying of the work to
a higher cost category, the DFAS budget approved by the Office of the
Secretary of Defense (Comptroller) was not sufficient to pay for the
higher cost incurred. 

We also found other instances in which DISA was not reimbursed for
all services provided. 

  -- According to information provided by the Defense Logistics
     Agency (DLA), it did not reimburse DISA approximately $25.6
     million during fiscal year 1996 for services provided.  For
     fiscal year 1996, DISA billed DLA approximately $101.6 million,
     but DLA had only budgeted $76 million to reimburse DISA. 
     According to DLA, the Office of the Secretary of Defense decided
     that DLA would have to reimburse DISA only the budgeted amount
     and DISA would have to absorb the $25.6 million shortfall.  A
     similar shortfall occurred during fiscal year 1997.  In an
     August 7, 1997, memo, signed by DISA's Acting Comptroller and
     DLA's Comptroller, it was agreed that DLA's billing for fiscal
     year 1997 would be capped at $82 million--the maximum amount DLA
     would have to pay for the services DISA provided.  According to
     DLA, the billings from DISA would have been about $108 million
     if the cap had not been in place.  In addition, the funding
     shortages can be attributed to (1) workload projections not
     being available when the fiscal years 1996 and 1997 budgets were
     developed and (2) DLA's approved funding not being commensurate
     with prices charged by DISA. 

  -- The Marine Corps did not reimburse DISA $1 million in fiscal
     year 1996 and $6 million in fiscal year 1997.  According to the
     Marine Corps official responsible for the information technology
     budget, DISA formally agreed to bill the Marine Corps up to the
     amount budgeted for each fiscal year.  However, for each fiscal
     year, DISA's actual cost incurred in providing services to the
     Marines Corps exceeded the budgeted amount.  As a result of the
     agreement, DISA was not reimbursed for total costs it incurred. 

Further, DOD's Financial Management Regulation prohibits the
recognition of revenue and the corresponding recording of accounts
receivable in the absence of the requesting activity having funding
authority.\2 Therefore, DISA did not report the $115 million for
unbilled work for fiscal years 1996 and 1997 as part of its accounts
receivable.  Instead, DISA reported the $115 million through a
work-in-process account.  Federal accounting standards require that
accounts receivable be established when a federal entity establishes
a claim based on goods or services provided.\3


--------------------
\2 DOD Financial Management Regulation, Volume 11B, Chapter 61,
Section A.  7a. 

\3 FASAB Volume I Original Statements:  Statements of Federal
Financial Accounting Concepts and Standards (GAO/AIMD 21.1.1 March
1997). 


   CONCLUSIONS
---------------------------------------------------------- Chapter 4:3

Being reimbursed for work performed is essential to the Defense
Information Services business area's financial stability since this
is the principal means through which it receives the funds needed to
cover operating expenses.  Since virtually all of the receivables are
from government activities, it seems reasonable to expect that they
should be collected.  Nevertheless, about one-third of the business
area's accounts receivable have been outstanding for more than 60
days.  While the lack of prompt reimbursement is a concern, the
failure to be reimbursed for services provided is a more pressing
issue to be addressed. 


   RECOMMENDATIONS
---------------------------------------------------------- Chapter 4:4

We recommend that the Under Secretary of Defense (Comptroller) direct

  -- DOD activities to follow existing DOD Financial Management
     Regulation by providing funding documents to DISA for the amount
     of services being requested before DISA begins work,

  -- DOD activities to reimburse DISA for the full amount of services
     provided, and

  -- DISA to record amounts it is owed for services provided in
     accordance with federal accounting standards. 


   AGENCY COMMENTS AND OUR
   EVALUATION
---------------------------------------------------------- Chapter 4:5

DOD agreed with our recommendations to direct (1) DOD activities to
provide DISA funding documents for the amount of services requested
prior to work beginning, (2) DOD activities to reimburse DISA for the
full amount of services provided, and (3) DISA to record amounts it
is owed for services provided in accordance with federal accounting
standards. 

However, DOD stated that we did not recognize DISA's progress in
obtaining quicker reimbursement for the services provided by
aggressively following up on outstanding amounts and using electronic
payments.  In July 1998, we contacted FAA to inquire about the
progress being made in establishing an electronic payment process
with DISA.  A FAA representative stated that although discussions had
been held with DISA concerning this matter, nothing had been
finalized.  Further, DISA-WESTHEM informed us that as of July 1998,
it was estimating that DFAS will not reimburse DISA approximately $40
million for services provided in fiscal year 1998.  Based upon these
representations, it is not clear how much progress has actually been
made. 


EFFECTIVE MANAGEMENT REQUIRES
ACCURATE FINANCIAL DATA
============================================================ Chapter 5

Meaningful and reliable financial reports are essential to allow DISA
to monitor the financial results of operations and set realistic
prices to charge the customer.  Reliable financial reports are also
necessary to enable the Congress to exercise its oversight
responsibility.  However, weaknesses within DISA's internal control
and accounting systems have hindered the development of accurate
financial reports.  The primary cause of these weaknesses is the
Industrial Fund Accounting System (IFAS), which is used by the DMCs. 

As noted in DOD's Chief Financial Officer's status report for fiscal
year 1997,\1 IFAS cannot provide financial data that are complete,
reliable, consistent, timely, and responsive to the needs of agency
management.  Because of these weaknesses, the DOD IG was unable to
express an opinion on DISA's fiscal year 1997 financial statements. 

These problems are not unique to DISA.  Since the concept of DBOF was
put forth in February 1991, we have continually reported that DOD has
experienced difficulty with accurately reporting on the results of
operations for the WCFs.\2 Because the financial reporting problems
and other inefficiencies in the operations of the WCFs, the National
Defense Authorization Act for Fiscal Year 1997 required DOD to
develop an improvement plan by September 30, 1997.  In its response,
DOD acknowledged that "[s]ystem deficiencies are a major reason for
unreliable and unsupported accounting information."\3


--------------------
\1 Chief Financial Officer's Financial Management Status Report and
Five-Year Plan 1997-2001, Defense Finance and Accounting Service,
Fiscal Year 1997. 

\2 Air Force Supply Management:  Analysis of the Activity Group's
Financial Reports, Prices, and Cash Management
(GAO/AIMD/NSIAD-98-118, June 8, 1998); Defense Business Operations
Fund:  Management Issues Challenge Fund Implementation
(GAO/AIMD-95-79, March 1, 1995); Defense Business Operations Fund: 
Improved Pricing Practices and Financial Reports Are Needed to Set
Accurate Prices (GAO/AIMD-94-132, June 22, 1994); and Financial
Management:  Status of the Defense Business Operations Fund
(GAO/AIMD-94-80, March 9, 1994). 

\3 A Plan to Improve the Management and Performance of the Department
of Defense Working Capital Funds, September 1997. 


   DOD IG ISSUES DISCLAIMER OF
   OPINION ON DISA FINANCIAL
   STATEMENTS
---------------------------------------------------------- Chapter 5:1

Because of system deficiencies that resulted in unverifiable account
balances and inadequate audit trails, the DOD IG was unable to render
an opinion on DISA's financial statements for fiscal year 1997.  The
DOD IG found that (1) undistributed collections and disbursements
were posted to accounts receivable and payable, respectively, and
could not be verified and (2) beginning and ending balances for
property, plant, and equipment could not be reconciled. 

Conceptually, collections and disbursements are considered
undistributed when they have been made and reported to the Treasury
but not recorded in DOD's accounting records.  Therefore, DOD adjusts
the (1) accounts receivable balances based on the difference between
the collections recorded in the accounting system's general ledger
and the collections reported to the Treasury and (2) accounts payable
balance based on the difference between the disbursements recorded in
the accounting system's general ledger and the disbursements reported
to the Treasury. 

In accordance with DOD guidance--Financial Management Regulation,
Volume 11B, Chapter 54--the DMCs' undistributed collections and
disbursements were transferred to accounts receivable and payable and
reported in the financial statements at the end of fiscal year 1997. 
These transfers resulted in accounts receivable and payable being
reduced by $98 million and $337 million, respectively.  In conducting
its audit of DISA's financial statements for fiscal year 1997, the
DOD IG was unable to verify the accuracy and reliability of these
adjustments.  Furthermore, in the case of accounts payable, the
reduction resulted in an abnormal debit balance of $50 million. 
Although DFAS and DISA are aware of the problem, they have not
identified the specific cause.  Moreover, federal accounting
standards do not provide for offsetting undistributed transactions to
accounts receivable and payable. 

Further, because of system interface problems between IFAS and the
Defense Property Accountability System (DPAS), the DOD IG was unable
to audit the property, plant, and equipment line item.  These
problems resulted in incorrect postings to depreciation and fixed
asset accounts.  In addition, regular periodic reconciliations were
not performed to correct the errors.  The amount reported for DMC
property, plant, and equipment ($198.7 million) in DISA's Statement
of Financial Position represents 23 percent of total assets. 

Our September 1997 report\4 identified similar problems between IFAS
and DPAS.  We identified over $100 million in differences between
property and accounting records and found that procedures were not
adequate to control rejected transactions and ensure that
discrepancies were corrected promptly.  This situation occurred
because the required reconciliations were not performed. 

The inability to accurately account for property, plant, and
equipment could affect the accuracy of DMC prices because
depreciation is a major cost element included in the prices.  For
fiscal year 1998, the amount of depreciation included in DMC prices
was 14 percent for IBM and 8 percent for UNISYS.  Given the myriad of
problems discussed above, there is no assurance that the amount for
depreciation is accurate.  If the accuracy of a major cost element is
questionable, the accuracy of the price being charged is
questionable. 


--------------------
\4 Financial Management:  DOD's Approach to Financial Control Over
Property Needs Structure (GAO/AIMD-97-150, September 30, 1997). 


   RELIABLE REVENUE AND COST DATA
   ESSENTIAL TO SETTING ACCURATE
   PRICES
---------------------------------------------------------- Chapter 5:2

Our analysis of DISA's fiscal year 1997 financial data disclosed
numerous instances in which the revenue and cost for nonmainframe
services were not accurately reported.  Overall, we identified (1) 11
DMCs that reported revenues without any corresponding cost for 19
C-Goal categories of service and (2) 12 DMCs that reported cost
without any related revenue for 20 categories of service.  Revenue
without corresponding cost totaled approximately $5 million, while
cost for which no corresponding revenue was recorded totaled about $3
million.  Examples of each condition are as follows. 

  -- Ogden DMC reported revenues with no costs, including
     approximately $1.5 million in revenue for Direct Customer
     Support, $169,000 for Network Control, and $58,000 for services
     provided to a specific customer. 

  -- Montgomery DMC reported no costs for four of the five categories
     of service with revenues totaling $823,000. 

  -- Chambersburg DMC reported costs with no revenues for four of the
     eight services, including about $627,000 for Defense Information
     Integrated Engineering, $96,000 for Information Systems Support,
     $91,000 for Output Distribution, and $69 for Network and Program
     Management. 

DISA-WESTHEM officials acknowledged that the accounting for DMC
revenues and costs has been unreliable.  They further stated that
DISA has focused much of its attention on the management of the
mainframe processing workload and has little overall visibility over
the other types of services the DMCs were providing to their
customers.  These services included computer repair and local area
network operations that are not associated with mainframe operations. 
As part of DISA's DMC consolidations, these services will be offered
by the Regional Information Services locations. 

DISA has initiated efforts to improve its oversight over C-Goal
services.  For example, the Resource Management Branch has developed
new unit identification codes to reduce the risk of misclassifying
revenue and cost and new budgeting and accounting procedures manuals,
including guidance for pricing nonmainframe services.  DISA-WESTHEM
also appointed a project manager who has begun efforts to standardize
categories of services being offered.  Standardizing services is an
important first step in gaining visibility and oversight of the
various services being offered.  The outcome of these efforts should
improve DISA's ability to develop accurate projections of operating
costs and prices and to evaluate operating results. 

Additionally, the accurate recording of revenues and costs is
important to the successful operations of the Regional Information
Services locations which are a part of DISA's overall plan to further
consolidate its megacenter operations.  According to DISA's
consolidation plan, each regional location must be self-sustaining as
required by the WCF.  Further, an official within the Office of the
Under Secretary of Defense (Comptroller) stated that locations
operating at a loss will be closed. 


   DOD EFFORTS TO IMPROVE ACCURACY
   OF FINANCIAL DATA
---------------------------------------------------------- Chapter 5:3

The types of problems identified by the DOD IG and discussed in DOD's
fiscal year 1997 Federal Managers' Financial Integrity Act (FMFIA)
report, and the DFAS Status Report are not unique to DISA.  Since the
concept of DBOF was put forth in February 1991, we have repeatedly
identified weaknesses with the accuracy and reliability of the
financial reports prepared on the results of operations.  DOD itself
has also recognized the inadequacies in financial reports--in the
Acting Comptroller's February 2, 1993, letter to the congressional
Defense committees; the September 24, 1993, Defense Business
Operations Fund improvement plan; and DOD's February 2, 1994,
response to our October 1993 letter on concerns we had with the
Defense Business Operations Fund improvement plan.  Further, DOD's
fiscal year 1997 FMFIA report noted deficiencies with WCF accounting
and reporting.  More specifically, DOD's CFO Status Report notes that
IFAS cannot provide financial data that are complete, reliable,
consistent, timely, and responsive to the needs of agency management. 
To resolve these problems, DOD stated that it has undertaken an
alternative analysis to determine the most cost effective means of
implementing a compliant system.  However, DOD has not specified a
date for completion of the analysis. 

Because of congressional concern over DOD's inability to resolve
these long-standing problems, the National Defense Authorization Act
for Fiscal Year 1997 directed DOD to prepare a plan to improve the
management and operations of the WCFs.  Among other things, the act
specifically required DOD to address the issue involving financial
reporting.  As discussed in our recent report,\5 DOD's September 30,
1997, response clearly articulated the problems hindering accurate
financial reporting and discussed the decisions made to resolve the
problems.  However, the plan does not (1) identify the specific tasks
that need to be performed, (2) establish accountability for ensuring
that the tasks are completed when more than one DOD organizational
entity is involved, and (3) establish milestones for ensuring that
the tasks are completed promptly.  Our report recommended that DOD
develop a detailed implementation plan that (1) identifies the
specific actions that need to be taken, (2) establishes milestones,
and (3) clearly delineates responsibilities for performing the
specific tasks.  In his May 14, 1998, response to our report, the
Under Secretary of Defense (Comptroller) concurred with the overall
findings and recommendations.  The Comptroller noted that the Office
of the Secretary of Defense Revolving Fund Directorate has
established three working groups that will develop specific
implementation and execution plans and procedures for financial
reporting. 


--------------------
\5 GAO/AIMD/NSIAD-98-118, June 8, 1998. 


   CONCLUSIONS
---------------------------------------------------------- Chapter 5:4

Accurate and credible financial data are essential for DISA managers
to ascertain if realistic prices are being established.  Reliable
financial information is also necessary to enable the Congress to
exercise its oversight responsibilities.  Although DOD has
acknowledged accounting and reporting problems and developed various
improvement plans, the financial reporting problems confronting the
WCF today are essentially the same as they were since their
inception.  Until the accuracy and reliability of the financial
reports improve, DISA will continue to be in the untenable position
of attempting to manage and fulfill its fiduciary responsibility
based on questionable data. 


   AGENCY COMMENTS AND OUR
   EVALUATION
---------------------------------------------------------- Chapter 5:5

DOD expressed concern that our findings related to DISA and that the
report does not recognize the systemic nature of the deficiencies in
DOD.  We disagree.  The report states that these problems were not
unique to DISA and that since the concept of DBOF was put forth in
February 1991, we have continually reported on DOD's difficulties in
reporting accurately on the results of operations for the working
capital funds.  Further, the report also recognizes that the
responsibility for resolving these problems rests with DOD, not DISA. 

In addition, some of the financial reporting weaknesses discussed
above are the result of DISA personnel not following procedures in
the recording of revenue and cost at the DMCs.  As noted in our
report, the DMCs have experienced difficulty in accurately recording
revenues and costs.  DISA management needs to ensure that such
weaknesses do not continue and contribute to overall weaknesses
within DOD's accounting systems. 




(See figure in printed edition.)Appendix I
COMMENTS FROM THE DEPARTMENT OF
DEFENSE
============================================================ Chapter 5



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)


The following is GAO's comment on the Department of Defense's letter
dated September 2, 1998. 

GAO COMMENT

1.  Discussed in "Agency Comments and Our Evaluation" sections of
chapters 2 through 5. 


FISCAL YEAR 1998 APPROPRIATED
FUNDS SUPPORTING WORKING CAPITAL
FUND ACTIVITIES
========================================================== Appendix II

                              (Dollars in thousands)

                                                Appropriated
                                                 amounts for        Appropriated
                                              WCF activities             amounts
                                                        with      supporting WCF
                                           existing customer             related
DISA PROGRAM                                            base          activities
----------------------------------------  ------------------  ------------------
Operations & Maintenance (IT Budget)
--------------------------------------------------------------------------------
The Defense Message System is replacing              $34,110             $34,110
 the legacy messaging service, AUTODIN.
 AUTODIN costs are recovered by the
 working capital fund.
The information security program was                 $21,635             $21,635
 established to secure DOD networks
 including those funded by the WCF from
 intrusion. DISA estimates that 25
 percent of its $86.5 million annual
 appropriated amount relates to systems
 under the working capital fund.
The Defense Information System Network               $60,077             $60,077
 includes the base, long-haul, and
 deployed blocks. DISA is responsible
 for (1) operational management,
 (2) system design, (3) performance
 standards, (4) interoperable interface
 standards, (5) connection requirements,
 (6) approval for DISN procurement, (7)
 test and evaluation, (8) billings
 through the WCF, and
 (9) security measures.
The DISA Continuity of Operations and                $16,978             $16,978
 Test Facility mission includes
 providing continuity of operations
 support to the megacenters and testing
 Defense Information Infrastructure
 components such as DISN.
Engineering Standards encompasses                    Portion             $18,847
 exchange standards necessary for vital           pertaining
 command and control functions,               to megacenters
 including voice and data communication                  and
 systems that are components of the WCF.        DISN unknown
IT core computing includes programs that             Portion             $28,482
 will deliver and implement Defense               pertaining
 Information Infrastructure building          to megacenters
 block components. Specific projects                 unknown
 include IT core DMC engineering. DMCs
 operate under the WCF.
================================================================================
Subtotal                                            $132,800            $180,129

Procurement
--------------------------------------------------------------------------------
Mobile Satellite System Technologies is               $9,769              $9,769
 an emerging technology with the
 capability to support low rate voice
 and data services. Current voice and
 data services are funded through the
 working capital fund.
The information security program was                 $19,151             $19,151
 established to secure DOD networks
 including those funded by the WCF from
 intrusion. Budget justification
 generally relate fund usage to WCF
 components.
Continuity of Operations funds are to                 $4,534              $4,534
 establish a state of the art lab at
 DISA's Continuity of Operations and
 Test Facility. This lab provides
 integrated services to the DMCs. DMCs
 are funded by the WCF.
The Defense Message System is replacing              $43,485             $43,485
 the legacy messaging service AUTODIN.
 AUTODIN costs are recovered by the WCF.
================================================================================
Subtotal                                             $76,939             $76,939

Research, Development, Test and Evaluation
--------------------------------------------------------------------------------
Interoperability provides test and                    $5,942              $5,942
 evaluation of major DOD programs, such
 as DMS and DISN, by certifying that
 critical requirements are supported by
 interoperable functionalities.
Defense Information Infrastructure                    $1,388              $1,388
 engineering and integration services
 and tools support key DISA programs and
 initiatives such as DMS, DISN, ATM, and
 information security.
Long-haul communications program funds               $13,693             $13,693
 system engineering and test and
 evaluation for DISN.
================================================================================
Subtotal                                             $21,023             $21,023
================================================================================
Total                                               $230,762            $278,091
--------------------------------------------------------------------------------

MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix III


   ACCOUNTING AND INFORMATION
   MANAGEMENT DIVISION WASHINGTON,
   D.C. 
------------------------------------------------------- Appendix III:1

Darby W.  Smith, Assistant Director
Miguel A.  Castillo, Senior Information Systems Analyst
Cristina Chaplain, Communications Analyst


   DENVER FIELD OFFICE
------------------------------------------------------- Appendix III:2

Peggy A.  Hegg, Senior Information Systems Analyst


*** End of document. ***