DOD Financial Management: Integrated Approach, Accountability,	 
Transparency, and Incentives Are Keys to Effective Reform	 
(20-MAR-02, GAO-02-537T).					 
								 
the Department of Defense (DOD) financial management problems are
pervasive, complex, long-standing, and deeply rooted in virtually
all its business operations. DOD's financial management 	 
deficiencies, taken together, represent the single largest	 
obstacle to achieving an unqualified opinion on the U.S.	 
government's consolidated financial statements. To date, none of 
the military services or major DOD components have passed the	 
test of an independent financial audit because of financial	 
management systems, operations, and controls weaknesses. These	 
problems date back decades, and previous attempts at reform have 
been unsuccessful. DOD continues to rely on a far-flung, complex 
network of finance, logistics, personnel, acquisition, and other 
management information systems for financial data to support	 
day-to-day management and decision-making. This network has	 
evolved into an overly complex and error-prone operation that	 
exists today, including (1) little standardization across DOD	 
components, (2) multiple systems performing the same tasks, (3)  
the same data stored in multiple systems, (4) manual data entry  
into multiple systems, (5) and a large number of data		 
translations and interfaces, which combine to exacerbate problems
with data integrity. There are several key elements that	 
collectively will enable DOD to effectively address its 	 
long-standing financial management problems. Actions on many of  
the key areas central to successfully achieving desired financial
management and related business process transformation		 
goals--particularly those that rely on longer term systems	 
improvements--will take a number of years to fully implement.	 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-537T					        
    ACCNO:   A02931						        
  TITLE:     DOD Financial Management: Integrated Approach,	      
Accountability, Transparency, and Incentives Are Keys to	 
Effective Reform						 
     DATE:   03/20/2002 
  SUBJECT:   Accountability					 
	     Federal agency reorganization			 
	     Financial management				 
	     Financial management systems			 
	     Productivity in government 			 
	     Program management 				 
	     Accounting 					 
	     Best practices					 
	     Computer networks					 
	     Financial statements				 
	     Internal controls					 
	     Performance measures				 
	     Defense Business Operations Fund			 
	     DFAS Mechanization of Contract			 
	     Administration Services System			 
								 
	     DOD Corporate Information Management		 
	     Initiative 					 
								 
	     DOD Defense Reform Initiative			 
	     DOD Financial Management Improvement		 
	     Plan						 
								 
	     DOD Quadrennial Defense Review			 
	     DOD Standard Procurement System			 

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GAO-02-537T
     
United States General Accounting Office

GAO Testimony

Before the Subcommittee on Government Efficiency, Financial Management, and
Intergovernmental Relations, House Committee on Government Reform

For Release on Delivery Expected at 1 p.m. Wednesday, March 20, 2002

DOD FINANCIAL MANAGEMENT

Integrated Approach, Accountability, Transparency, and Incentives Are Keys
to Effective Reform

Statement of Gregory D. Kutz
Director, Financial Management and Assurance

                                      a

GAO-02-537T

Mr. Chairman and Members of the Subcommittee:

It is a pleasure to be here to discuss financial management at the
Department of Defense (DOD). Today, DOD faces financial management problems
that are pervasive, complex, long-standing, and deeply rooted in virtually
all business operations throughout the department. DOD's financial
management deficiencies, taken together, represent the single largest
obstacle to achieving an unqualified opinion on the U.S. government's
consolidated financial statements. To date, none of the military services or
major DOD components have passed the test of an independent financial audit
because of pervasive weaknesses in financial management systems, operations,
and controls.

Overhauling financial management represents a major management challenge
that goes far beyond financial accounting to the very fiber of the
department's range of business operations and management culture. Previous
administrations over the past several decades have tried to address these
problems in various ways but have largely been unsuccessful. In this regard,
on September 10, 2001, Secretary of Defense Rumsfeld announced a broad
initiative intended to "transform the way the department works and what it
works on" which he estimated could save 5 percent of DOD's budget-or an
estimated $15 to $18 billion annually. The Secretary recognized that
transformation would be difficult and expected the needed changes would take
8 or more years to complete.

The President's Management Agenda includes improved financial management
performance as one of his five governmentwide management goals. In addition,
in August 2001, the Principals of the Joint Financial Management Improvement
Program-the Secretary of the Treasury, the Director of the Office of
Management and Budget, the Director of the Office of Personnel Management,
and the Comptroller General-began a series of quarterly meetings that marked
the first time all four of the Principals had gathered together in over 10
years. To date, these sessions have resulted in substantive deliberations
and agreements focused on key issues such as better defining measures for
financial management success. These measures include being able to routinely
provide timely, reliable, and useful financial information and having no
material internal control weaknesses. Success on these measures will be a
significant challenge to DOD. The principals have invited Defense
Comptroller Zakheim to their upcoming April 2002 meeting to discuss the
department's transformation effort and to begin a constructive engagement
with DOD on this important initiative.

With the events of September 11, and the federal government's short-and
long-term budget challenges, it is more important than ever that DOD
effectively transform its business processes to ensure that it gets the most
from every dollar spent. The department must be able to effectively carry
out its stewardship responsibilities for the funding it receives and for the
vast amount of equipment and inventories used in support of military
operations. Even before the events of September 11, increased globalization,
changing security threats, and rapid technological advances were prompting
fundamental changes in the environment in which DOD operates. These trends
place a premium on increasing strategic planning, enhancing results
orientation, ensuring effective accountability, maintaining transparency,
and using integrated approaches. Six of the 22 areas on GAO's governmentwide
"high-risk" list are DOD program areas, and DOD shares responsibility for 2
other high-risk areas that are governmentwide in scope.1 Central to
effectively addressing DOD's financial management problems will be the
understanding that these eight areas are interrelated and cannot be
addressed in an isolated, stovepiped, or piecemeal fashion.

The recent success of our forces in Afghanistan has again demonstrated the
unparalleled excellence of our military forces. This same level of
excellence is not yet evident in the department's financial management and
other business processes. This is particularly problematic because effective
financial management operations are critical to achieving the department's
mission in a reasonably economical, efficient, and effective manner and to
providing reliable, timely financial information on a routine basis to
support management decision-making at all levels throughout DOD. This level
of excellence will also be critical in order to enhance overall transparency
and accountability. Success in this area will serve to freeup resources that
can be redeployed to enhance readiness, improve the quality of life for our
troops and their families, and reduce the gap between wants and available
funding in connection with major weapon systems.

Today, I will provide my perspectives on (1) how Defense got where it is
today and the underlying causes of the department's longstanding inability
to effectively reform its financial management and other business systems
and processes and (2) the keys to successfully carrying out the Secretary's
business process transformation and DOD's plans and actions to date. Last

1U.S. General Accounting Office, High-Risk Series: An Update, GAO-01-263
(Washington, D.C.: Jan. 2001).

summer, the Comptroller General shared with Secretary Rumsfeld and
Comptroller Zakheim a business transformation paper. This paper provided an
overview of GAO's views on the current challenges facing the department, the
keys to effective reform, and detailed one option for addressing these
challenges.

Long-Standing Financial Management Problems and Attempts at Reform

History is a good teacher. To solve the problems of today, it is instructive
to look to the past. The problems with the department's financial management
operations date back decades, and previous attempts at reform have largely
proven unsuccessful. These problems adversely affect DOD's ability to
control costs, ensure basic accountability, anticipate future costs and
claims on the budget (such as for health care, weapon systems, and
environmental liabilities), measure performance, maintain funds control,
prevent fraud, and address pressing management issues.

In this regard, I would like to briefly highlight three of our recent
products that exemplify the adverse impact of DOD's reliance on
fundamentally flawed financial management systems and processes and a weak
overall internal control environment.

* In a testimony before your subcommittee last week,2 we highlighted
continuing problems with internal controls over approximately $64 million in
fiscal year 2001 purchase card transactions involving two Navy activities.
Consistent with our testimony last July3 on fiscal year 2000 purchase card
transactions at these locations, our follow-up review demonstrated that
continuing control problems left these Navy activities vulnerable to
fraudulent, improper, and abusive purchases and theft and misuse of
government property. We are currently auditing purchase card usage across
the department.

* In a testimony before your Subcommittee in July 2001, we reported4 that
DOD did not have adequate systems, controls, and managerial attention

2U.S. General Accounting Office, Purchase Cards: Continued Control
Weaknesses Leave Two Navy Units Vulnerable to Fraud and Abuse, GAO-02-504T
(Washington, D.C.: Mar. 13, 2002).

3U.S. General Accounting Office, Purchase Cards: Control Weaknesses Leave
Two Navy Units Vulnerable to Fraud and Abuse, GAO-01-995T (Washington, D.C.:
July 30, 2001).

4U.S. General Accounting Office, Canceled DOD Appropriations: $615 Million
of Illegal or Otherwise Improper Adjustments, GAO-01-994T (Washington, D.C.:
July 26, 2001).

to ensure that $2.7 billion of adjustments to closed appropriations were
legal and otherwise proper. Our review of $2.2 billion of these adjustments
found that about $615 million of them should not have been made, including
about $146 million that were illegal.

* In June 2001, we reported5 that DOD's current financial systems could not
adequately track and report on whether the $1.1 billion in earmarked funds
that the Congress provided to DOD for spare parts and associated logistical
support were actually used for the intended purpose. The vast majority of
the funds-92 percent-were transferred to the military services operation and
maintenance accounts. We found that once these funds were transferred, DOD
lost its ability to assure the Congress that the funds it received for spare
parts purchases were used for, and only for, that purpose.

Problems with the department's financial management operations go far beyond
its accounting and finance systems and processes. The department continues
to rely on a far-flung, complex network of finance, logistics, personnel,
acquisition, and other management information systems- 80 percent of which
are not under the control of the DOD Comptroller-to gather the financial
data needed to support day-to-day management decisionmaking. This network
was not designed to be, but rather has evolved into, the overly complex and
error-prone operation that exists today, including (1) little
standardization across DOD components, (2) multiple systems performing the
same tasks, (3) the same data stored in multiple systems, (4) manual data
entry into multiple systems, and (5) a large number of data translations and
interfaces that combine to exacerbate problems with data integrity. DOD has
determined, for example, that efforts to reconcile a single contract
involving 162 payments resulted in an estimated 15,000 adjustments.

5U.S. General Accounting Office, Defense Inventory: Information on the Use
of Spare Parts Funding Is Lacking, GAO-01-472 (Washington, D.C.: June 11,
2001).

Many of the department's business processes in operation today are mired in
old, inefficient processes and legacy systems, some of which go back to the
1950s and 1960s. For example, while implemented in 1968, the department
still relies on the Mechanization of Contract Administration Services
(MOCAS) system to process a substantial portion of the contract payment
transactions for all DOD organizations. In fiscal year 2001, MOCAS processed
an estimated $78 billion in contract payments. Past efforts to replace MOCAS
have failed. Most recently, in 1994, DOD began acquiring the Standard
Procurement System (SPS) to replace the contract administration functions
currently performed by MOCAS. However, our July 2001 and February 2002
reporting6 on DOD's $3.7 billion investment in SPS showed that this
substantial investment was not economically justified and raised questions
as to whether further investment in SPS was justified. For the foreseeable
future, DOD will continue to be saddled with MOCAS.

Moving to the 1970s, we, the Defense Inspector General, and the military
service audit organizations, issued numerous reports detailing serious
problems with the department's financial management operations. For example,
between 1975 and 1981, we issued more than 75 reports documenting serious
problems with DOD's existing cost, property, fund control, and payroll
accounting systems. In the 1980s, we found that despite the billions of
dollars invested in individual systems, these efforts, too, fell far short
of the mark, with extensive schedule delays and cost overruns. For example,
in 1989, our report7 on eight major DOD system development efforts-including
two major accounting systems--under way at that time, showed that system
development cost estimates doubled, two of the eight efforts were abandoned,
and the remaining six efforts experienced delays of from 3 to 7 years.

Beginning in the 1990s, following passage of the Chief Financial Officers
(CFO) Act of 1990, there was a recognition in DOD that broad-based financial
management reform was needed. Over the past 12 years, the department has
initiated several departmentwide reform initiatives intended to
fundamentally reform its financial operations as well as other

6U.S. General Accounting Office, DOD Systems Modernization: Continued
Investment in the Standard Procurement System Has Not Been Justified,
GAO-01-682 (Washington, D.C.: July 31, 2001) and DOD's Standard Procurement
System: Continued Investment Has Yet to Be Justified, GAO-02-392T
(Washington, D.C.: Feb. 7, 2002).

7U.S. General Accounting Office, Automated Information Systems: Schedule
Delays and Cost Overruns Plague DOD Systems, GAO/IMTEC-89-36 (Washington,
D.C.: May 10, 1989).

key business support processes, including the Corporate Information
Management initiative, the Defense Business Operations Fund, and the Defense
Reform Initiative. These efforts, which I will highlight today, have proven
to be unsuccessful despite good intentions and significant effort. The
conditions that led to these previous attempts at reform remain largely
unchanged today.

Corporate Information Management. The Corporate Information Management
(CIM), initiative, begun in 1989, was expected to save billions of dollars
by streamlining operations and implementing standard information systems.
CIM was expected to reform all DOD's functional areas--including finance,
procurement, material management, and human resources--through
consolidating, standardizing, and integrating information systems. DOD also
expected CIM to replace approximately 2,000 duplicative systems. Over the
years, we have made numerous recommendations to improve CIM's management,
but these recommendations were largely not addressed. Instead, DOD spent
billions of dollars with little sound analytical justification. We reported
in 1997,8 that 8 years after beginning CIM, and spending about $20 billion
on the initiative, expected savings had yet to materialize. The initiative
was eventually abandoned.

Defense Business Operations Fund. In October 1991, DOD established a new
entity, the Defense Business Operations Fund by consolidating nine existing
industrial and stock funds and five other activities operated throughout
DOD. Through this consolidation, the fund was intended to bring greater
visibility and management to the overall cost of carrying out certain
critical DOD business operations. However, from its inception, the fund was
plagued by management problems. In 1996, DOD announced the fund's
elimination. In its place, DOD established four working capital funds. These
new working capital funds inherited their predecessor's operational and
financial reporting problems.

8U.S.  General Accounting  Office, High-Risk  Series: Information Management
and Technology, GAO/HR-97-9 (Washington, D.C.: Feb. 1997).

Defense Reform Initiative (DRI). In announcing the DRI program in November
1997, the then Secretary of Defense stated that his goal was "to ignite a
revolution in business affairs." DRI represented a set of proposed actions
aimed at improving the effectiveness and efficiency of DOD's business
operations, particularly in areas that have been long-standing
problems-including financial management. In July 2000, we reported9 that
while DRI got off to a good start and made progress in implementing many of
the component initiatives, it did not meet expected time frames and goals,
and the extent to which savings from these initiatives will be realized is
yet to be determined. GAO is currently examining the extent to which DRI
efforts begun under the previous administration are continuing.

The past has clearly taught us that addressing DOD's serious financial
management problems will not be easy. Early in his tenure, Secretary
Rumsfeld commissioned a new study of the department's financial management
operations. The report on the results of the study,

Transforming Department of Defense Financial Management: A Strategy for
Change, was issued on April 13, 2001. The report recognized that the
department will have to undergo "a radical financial management
transformation" and that it would take more than a decade to achieve. The
report concluded that many studies and interviews with current and former
leaders in DOD point to the same problems and frustrations, and that
repeated audit reports verify systemic problems illustrating the need for
radical transformation in order to achieve success. Secretary Rumsfeld
further confirmed the need for a fundamental transformation of DOD in his
"top-down" Quadrennial Defense Review. Specifically, his September 30, 2001,
Quadrennial Defense Review Report concluded that the department must
transform its outdated support structure, including decades-old financial
systems that are not well interconnected. The report summed up the challenge
well in stating: "While America's businesses have streamlined and adopted
new business models to react to fast-moving changes in markets and
technologies, the Defense Department has lagged behind without an
overarching strategy to improve its business practices."

9U.S. General Accounting Office, Defense Management: Actions Needed to
Sustain Reform Initiatives and Achieve Greater Results, GAO/NSIAD-00-72
(Washington, D.C.: July 25, 2000).

Underlying Causes of Financial and Related Business Process Reform
Challenges

As part of our constructive engagement approach with DOD, the Comptroller
General met with Secretary Rumsfeld last summer to provide our perspectives
on the underlying causes of the problems that have impeded past reform
efforts at the department and to discuss options for addressing these
challenges. There are four underlying causes

* a lack of sustained top-level leadership and management accountability for
correcting problems;

* deeply embedded cultural resistance to change, including military service
parochialism and stovepiped operations;

* a lack of results-oriented goals and performance measures and monitoring;
and

* inadequate incentives for seeking change.

Lack of Leadership and Accountability

Historically, DOD has not routinely assigned accountability for performance
to specific organizations or individuals that have sufficient authority to
accomplish desired goals. For example, under the CFO Act, it is the
responsibility of agency CFOs to establish the mission and vision for the
agency's future financial management. However, at DOD, the Comptroller-who
is by statute the department's CFO---has direct responsibility for only an
estimated 20 percent of the data relied on to carry out the department's
financial management operations. The department has learned through its
efforts to meet the Year 2000 computing challenge that to be successful,
major improvement initiatives must have the direct, active support and
involvement of the Secretary and Deputy Secretary of Defense. In the Year
2000 case, the then Deputy Secretary of Defense was personally and
substantially involved and played a major role in the department's success.
Such top-level support and attention helps ensure that daily activities
throughout the department remain focused on achieving shared, agencywide
outcomes. A central finding from our report on our survey of best practices
of world-class financial management organizations---Boeing; Chase Manhattan
Bank; General Electric; Pfizer; Hewlett-Packard; Owens Corning; and the
states of Massachusetts, Texas, and Virginia-was that clear, strong
executive leadership was essential to (1) making financial management an
entitywide priority, (2) redefining the

role of finance, (3) providing meaningful information to decisionmakers, and
(4) building a team of people that deliver results.10

DOD past experience has suggested that top management has not had a
proactive, consistent, and continuing role in building capacity, integrating
daily operations for achieving performance goals, and creating incentives.
Sustaining top management commitment to performance goals is a particular
challenge for DOD. In the past, the average 1.7--year tenure of the
department's top political appointees has served to hinder long-term
planning and follow-through.

Cultural Resistance and Parochialism

Cultural resistance to change and military service parochialism have also
played a significant role in impeding previous attempts to implement
broad-based management reforms at DOD. The department has acknowledged that
it confronts decades-old problems deeply grounded in the bureaucratic
history and operating practices of a complex, multifaceted organization, and
that many of these practices were developed piecemeal and evolved to
accommodate different organizations, each with its own policies and
procedures.

For example, as discussed in our July 2000 report,11 the department
encountered resistance to developing departmentwide solutions under the then
Secretary's broad-based DRI.12 In 1997, the department established a Defense
Management Council-including high-level representatives from each of the
military services and other senior executives in the Office of the Secretary
of Defense-which was intended to serve as the "board of directors" to help
break down organizational stovepipes and overcome cultural resistance to
changes called for under DRI. However, we found that the council's
effectiveness was impaired because members were not able to put their
individual military services' or DOD agencies' interests aside to focus on
department-wide approaches to long-standing problems.

10U.S. General Accounting Office, Executive Guide: Creating Value Through
World-class Financial Management, GAO/AIMD-00-134 (Washington, D.C.: Apr.
2000).

11GAO/NSIAD-00-72.

12Announced by the Secretary of Defense in 1997, DRI represents a set of
actions aimed at reforming the department's major business processes and
support operations.

We have also seen an inability to put aside parochial views. Cultural
resistance to change has impeded reforms not only in financial management,
but also in other business areas, such as weapon system acquisition and
inventory management. For example, as we reported13 last year, while the
individual military services conduct considerable analyses justifying major
acquisitions, these analyses can be narrowly focused and do not consider
joint acquisitions with the other services. In the inventory management
area, DOD's culture has supported buying and storing multiple layers of
inventory rather than managing with just the amount of stock needed.

Unclear Goals and Performance Measures

Further, DOD's past reform efforts have been handicapped by the lack of
clear, linked goals and performance measures. As a result, DOD managers lack
straightforward road maps showing how their work contributes to attaining
the department's strategic goals, and they risk operating autonomously
rather than collectively. In some cases, DOD had not yet developed
appropriate strategic goals, and in other cases, its strategic goals and
objectives were not linked to those of the military services and defense
agencies.

As part of our assessment of DOD's Fiscal Year 2000 Financial Management
Improvement Plan, we reported14 that, for the most part, the plan
represented the military services' and Defense components' stovepiped
approaches to reforming financial management and did not clearly articulate
how these various efforts would collectively result in an integrated
DOD-wide approach to financial management improvement. In addition, we
reported that the department's plan did not include performance measures
that could be used to assess DOD's progress in resolving its financial
management problems. DOD officials have informed us that they are now
working to revise the department's approach to this plan so that future
years' updates will reflect a more strategic, departmentwide vision and
provide a more effective tool for financial management reform.

13U.S.  General Accounting  Office, Major Management  Challenges and Program
Risks: Department of Defense, GAO-01-244 (Washington D.C.: Jan. 2001).

14U.S. General Accounting Office, Financial Management: DOD Improvement Plan
Needs Strategic Focus, GAO-01-764 (Washington D.C.: Aug. 17, 2001).

As it moves to modernize its systems, the department faces a formidable
challenge in responding to technological advances that are changing
traditional approaches to business management. For fiscal year 2001, DOD's
reported total information technology investments of almost $23 billion
supporting a wide range of military operations as well as DOD business
functions. As we have reported,15 while DOD plans to invest billions of
dollars in modernizing its financial management and other business support
systems, it does not yet have an overall blueprint-or enterprise
architecture-in place to guide and direct these investments. As we recently
testified,16 our review of practices at leading organizations showed they
were able to make sure their business systems addressed corporate-rather
than individual business unit-objectives by using enterprise architectures
to guide and constrain investments. Consistent with our recommendation, DOD
is now working to develop a financial management enterprise architecture,
which is a very positive development.

Lack of Incentives for Change

The final underlying cause of the department's long-standing inability to
carry out needed fundamental reform has been the lack of incentives for
making more than incremental change to existing "business-as-usual"
processes, systems, and structures. Traditionally, DOD has focused on
justifying its need for more funding rather than on the outcomes its
programs have produced. DOD generally measures its performance by the amount
of money spent, people employed, or number of tasks completed. Incentives
for its decision makers to implement changed behavior have been minimal or
nonexistent. Secretary Rumsfeld perhaps said it best in announcing his
planned transformation at DOD: "There will be real consequences from, and
real resistance to, fundamental change."

This lack of incentive has perhaps been most evident in the department's
acquisition area. In DOD's culture, the success of a manager's career has
depended more on moving programs and operations through the DOD process
rather than on achieving better program outcomes. The fact that a given
program may have cost more than estimated, taken longer to complete, and not
generated results or performed as promised was

15U.S. General Accounting Office, Information Technology: Architecture
Needed to Guide Modernization of DOD's Financial Operations, GAO-01-525
(Washington, D.C.: May 17, 2001).

16U.S. General Accounting Office, Defense Acquisitions: DOD Faces Challenges
in Implementing Best Practices, GAO-02-469T (Washington, D.C.: Feb. 27,
2002).

secondary to fielding a new program. To effect real change, actions are
needed to (1) break down parochialism and reward behaviors that meet
DOD-wide and congressional goals; (2) develop incentives that motivate
decisionmakers to initiate and implement efforts that are consistent with
better program outcomes, including saying "no" or pulling the plug on a
system or program that is failing; and (3) facilitate a congressional focus
on results-oriented management, particularly with respect to resource
allocation decisions.

Keys To Fundamental As we testified before your Subcommittee last May,17 our
experience has shown there are several key elements that, collectively would
enable the

DOD Financial department to effectively address the underlying causes of its
inability to

Management Reform resolve its long-standing financial management problems.
These elements, which are key to any successful approach to financial
management reform, include

* addressing the department's financial management challenges as part of a
comprehensive, integrated, DOD-wide business process reform;

* providing for sustained leadership by the Secretary of Defense and
resource control to implement needed financial management reforms;

* establishing clear lines of responsibility, authority, and accountability
for such reform tied to the Secretary;

* incorporating results-oriented performance measures and monitoring tied to
financial management reforms;

* providing appropriate incentives or consequences for action or inaction;

* establishing an enterprisewide system architecture to guide and direct
financial management modernization investments; and

* ensuring effective oversight and monitoring.

Actions on many of the key areas central to successfully achieving desired
financial management and related business process transformation goals
-particularly those that rely on longer term systems improvements-will take
a number of years to fully implement. Secretary Rumsfeld has estimated that
his envisioned transformation may take 8 or more years to complete.
Consequently, both long-term actions focused on the Secretary's envisioned
business transformation and short-term actions focused on

17U.S. General Accounting Office, DOD Financial Management: Integrated
Approach, Accountability, and Incentives Are Keys to Effective Reform,
GAO-01-681T (Washington, D.C.: May 8, 2001).

improvements within existing systems and processes will be critical going
forward. Short-term actions in particular will be critical if the department
is to achieve the greatest possible accountability over existing resources
and more reliable data for day-to-day decisionmaking while longer-term
systems and business process reengineering efforts are under way.

Beginning with the Secretary's recognition of a need for a fundamental
transformation of the department's business processes, and building on some
of the work begun under past administrations, DOD has taken a number of
positive steps in many of these key areas. At the same time, the challenges
remaining in each of these key areas are daunting.

Integrated Business Process Reform Strategy

As we have reported in the past,18 establishing the right goal is essential
for success. Central to effectively addressing DOD's financial management
problems will be the recognition that they cannot be addressed in an
isolated, stovepiped, or piecemeal fashion separate from the other high-risk
areas facing the department.19 Successfully reengineering the department's
processes supporting its financial management and other business support
operations will be critical if DOD is to effectively address the deep-rooted
organizational emphasis on maintaining business-as-usual across the
department.

18U.S. General Accounting Office, Department of Defense: Progress in
Financial Management Reform, GAO/T-AIMD/NSIAD-00-163 (Washington, D.C.: May
9, 2000).

19The eight interrelated high-risk areas that represent the greatest
challenge to DOD's developing world-class business operations supporting its
forces are: financial management, human capital, information security,
systems modernization, weapon system acquisition, contract management,
infrastructure management, and inventory management.

Financial management is a crosscutting issue that affects virtually all of
DOD's business areas. For example, improving its financial management
operations so that they can produce timely, reliable, and useful cost
information will be essential if the department is to effectively measure
its progress toward achieving many key outcomes and goals across virtually
the entire spectrum of DOD's business operations. At the same time, the
department's financial management problems-and, most importantly, the keys
to their resolution---are deeply rooted in and dependent upon developing
solutions to a wide variety of management problems across DOD's various
organizations and business areas. For example, we have reported20 that many
of DOD's financial management shortcomings were attributable in part to
human capital issues. The department does not yet have a strategy in place
for improving its financial management human capital. This is especially
critical in connection with DOD's civilian workforce, since DOD has
generally done a much better job in conjunction with human capital planning
for its military personnel. In addition, DOD's civilian personnel face a
variety of size, shape, skills, and succession-planning challenges that need
to be addressed.

As I mentioned earlier, and it bears repetition, the department has reported
that an estimated 80 percent of the data needed for sound financial
management comes from its other business operations, such as its acquisition
and logistics communities. DOD's vast array of costly, nonintegrated,
duplicative, and inefficient financial management systems is reflective of
its lack of an enterprisewide, integrated approach to addressing management
challenges. DOD has acknowledged that one of the reasons for the lack of
clarity in its reporting under the Government Performance and Results Act
has been that most of the program outcomes the department is striving to
achieve are interrelated, while its management systems are not integrated.

As I discussed previously, the Secretary of Defense has made the fundamental
transformation of business practices throughout the department a top
priority. In this context, the Secretary established a number of top-level
committees, councils, and boards, including the Senior Executive Committee,
Business Initiative Council, and Defense Business Practices Implementation
Board. The Senior Executive Committee was established to help guide efforts
across the department to improve its business practices. This
committee--chaired by the Secretary of Defense,

20GAO-01-244.

and with membership to include the Deputy Secretary, the military service
secretaries, and the Under Secretary of Defense for Acquisition, Logistics
and Technology-was established to function as the board of directors for the
department. The Business Initiative Council--comprising the military service
secretaries and headed by the Under Secretary of Defense for Acquisition,
Technology and Logistics--was established to encourage the military services
to explore new money saving business practices to help offset funding
requirements for transformation and other initiatives. The Secretary also
established the Defense Business Practices Implementation Board, composed of
business leaders from the private sector. The board is intended to tap
outside expertise to advise the department on its efforts to improve
business practices.

Active Leadership and Resource Control

The department's successful Year 2000 effort illustrated, and our survey of
leading financial management organizations21 captured, the importance of
strong leadership from top management. As we have stated many times before,
strong, sustained executive leadership is critical to changing a deeply
rooted corporate culture-such as the existing "business as usual" culture at
DOD-and to successfully implementing financial management reform. As I
mentioned earlier, the personal, active involvement of the Deputy Secretary
of Defense played a key role in building entitywide support and focus for
the department's Year 2000 initiatives. Given the long-standing and deeply
entrenched nature of the department's financial management
problems--combined with the numerous competing DOD organizations, each
operating with varying, often parochial views and incentives--such visible,
sustained top-level leadership will be critical.

21GAO/AIMD-00-134.

In discussing their April 2001 report to the Secretary of Defense on
transforming financial management,22 the authors stated that, "unlike
previous failed attempts to improve DOD's financial practices, there is a
new push by DOD leadership to make this issue a priority." With respect to
the key area of investment control, the Secretary took action to set aside
$100 million for financial modernization. Strong, sustained executive
leadership-over a number of years and administrations-will be key to
changing a deeply rooted culture. In addition, given that significant
investments in information systems and related processes have historically
occurred in a largely decentralized manner throughout the department,
additional actions will likely be required to implement a centralized IT
investment control strategy. For example, in our May 2001 report,23 we
recommended that DOD take action to establish centralized control over
transformation investments to ensure that funding is provided for only those
proposed investments in systems and business processes that are consistent
with the department's overall business process transformation strategy.

Clear Lines of Responsibility and Accountability

Last summer, when the Comptroller General met with Secretary Rumsfeld, he
stressed the importance of establishing clear lines of responsibility,
decision-making authority, and resource control for actions across the
department tied to the Secretary as a key to reform. As we previously
reported,24 such an accountability structure should emanate from the highest
levels and include the secretary of each of the military services as well as
heads of the department's various major business areas.

The Secretary of Defense has taken action to vest responsibility and
accountability for financial management modernization with the DOD
Comptroller. In October 2001, the DOD Comptroller established the Financial
Management Modernization Executive and Steering Committees as the governing
bodies that oversee the activities related to this modernization effort and
also established a supporting working group to provide day-to-day guidance
and direction in these efforts. DOD reports

22Department of Defense, Transforming Department of Defense Financial
Management: A Strategy for Change, (Washington, D.C.: Apr. 13, 2001).

23GAO-01-525.

24GAO/NSIAD-00-72.

that the executive and steering committees met for the first time in January
2002.

It is clear to us that the Comptroller has the full support of the Secretary
and that the Secretary is committed to making meaningful change. To make
this work, it is important that the Comptroller have sufficient authority to
bring about the full, effective participation of the military services and
business process owners across the department. The Comptroller has direct
control of 20 percent of the data needed for sound financial management and
has historically had limited ability to control information technology
investments across the department. Addressing issues such as centralization
of authority for information systems investments and continuity of
leadership are critical to successful business process transformation.

In addition to DOD, a number of other federal departments and agencies are
facing an array of interrelated business system management challenges for
which resolution is likely to require a number of years, challenges that
could span administrations. One option that may have merit would be the
establishment of chief operating officers, who could be appointed for a set
term of 5 to 7 years with the potential for reappointment. These individuals
should have a proven track record as a business process change agents for
large, diverse organizations and would spearhead business process
transformation across the department or agency.

Results-Oriented Performance

As discussed in our January 2001 report on DOD's major performance and
accountability challenges, 25 establishing a results orientation is another
key element of any approach to reform. Such an orientation should draw upon
results that could be achieved through commercial best practices, including
outsourcing and shared servicing concepts. Personnel throughout the
department must share the common goal of establishing financial management
operations that not only produce financial statements that can withstand the
test of an audit but, more importantly, routinely generate useful, reliable,
and timely financial information for day-to-day management purposes.

25GAO-01-244.

In addition, we have previously testified26 that DOD's financial management
improvement efforts should be measured against an overall goal of
effectively supporting DOD's basic business processes, including
appropriately considering related business process system
interrelationships, rather than determining system-by-system compliance.
Such a results-oriented focus is also consistent with an important lesson
learned from the department's Year 2000 experience. DOD's initial Year 2000
focus was geared toward ensuring compliance on a system-by-system basis and
did not appropriately consider the interrelationships of systems and
business areas across the department. It was not until the department, under
the direction of the then Deputy Secretary, shifted to a core mission and
function review approach that it was able to achieve the desired result of
greatly reducing its Year 2000 risk.

Since the Secretary has established an overall business process
transformation goal that will require a number of years to achieve, going
forward, it is especially critical for managers throughout the department to
focus on specific measurable metrics that, over time, collectively will
translate to achieving this overall goal. It is important for the department
to refocus its annual accountability reporting on this overall goal of
fundamentally transforming the department's financial management systems and
related business processes to include appropriate interim annual measures
for tracking progress toward this goal.

In the short term, it is important to focus on actions that can be taken
using existing systems and processes. It is critical to establish interim
measures to both track performance against the department's overall
transformation goals and facilitate near-term successes using existing
systems and processes. The department has established an initial set of
metrics intended to evaluate financial performance, and it reports that it
has seen improvements. For example, with respect to closed appropriation
accounts, DOD reported during the first 4 months of fiscal year 2002 a
reduction in the dollar value of adjustments to closed appropriation
accounts of about 51 percent from the same 4-month period in fiscal year
2001. Other existing metrics concern cash and funds management, contract and
vendor payments, and disbursement accounting. DOD also reported that it is
working to develop these metrics into higher-level measures more appropriate
for senior management. We agree with the

26GAO/T-AIMD/NSIAD-00-163.

department's efforts  to expand the use of  appropriate metrics to guide its
financial management reform efforts.

                        Incentives and Consequences

Another key to breaking down the parochial interests and stovepiped
approaches that have plagued previous reform efforts is establishing
mechanisms to reward organizations and individuals for behaviors that comply
with DOD-wide and congressional goals. Such mechanisms should be geared to
providing appropriate incentives and penalties to motivate decision makers
to initiate and implement efforts that result in fundamentally reformed
financial management and other business support operations.

In addition, such incentives and consequences are essential if DOD is to
break down the parochial interests that have plagued previous reform
efforts. Incentives driving traditional ways of doing business, for example,
must be changed, and cultural resistance to new approaches must be overcome.
Simply put, DOD must convince people throughout the department that they
must change from business-as-usual systems and practices or they are likely
to face serious consequences, organizationally and personally.

Enterprise Architecture Establishing and implementing an enterprisewide
financial management architecture is essential for the department to
effectively manage its large, complex system modernization effort now under
way. The Clinger-Cohen Act requires agencies to develop, implement, and
maintain an integrated system architecture. As we previously reported,27
such an architecture can help ensure that the department invests only in
integrated, enterprisewide business system solutions and, conversely, will
help move resources away from non-value-added legacy business systems and
nonintegrated business system development efforts. In addition, without an
architecture, DOD runs the serious risk that its system efforts will
perpetuate the existing system environment that suffers from systems
duplication, limited interoperability, and unnecessarily costly operations
and maintenance. In our May 2001 report,28 we pointed out that DOD lacks a
financial management enterprise architecture to guide and constrain the
billions of

27GAO/T-AIMD/NSIAD-00-163. 28GAO-01-525.

dollars it plans to spend to modernize its financial management operations
and systems.

DOD has reported that it is in the process of contracting for the
development of a DOD-wide financial management enterprise architecture to
"achieve the Secretary's vision of relevant, reliable and timely financial
information needed to support informed decision-making." Consistent with our
previous recommendations in this area, DOD has begun an extensive effort to
document the department's current as-is financial management architecture by
inventorying systems now relied on to carry out financial management
operations throughout the department. DOD has identified 674 top-level
systems and at least 997 associated interfaces thus far and estimates that
this inventory could include up to 1,000 systems when completed.

While DOD's beginning efforts at developing a financial management
enterprise architecture are off to a good start, the challenges yet
confronting the department in its efforts to fully develop, implement, and
maintain a DOD-wide financial management enterprise architecture are
unprecedented. Our May 2001 report29 details a series of recommended actions
directed at ensuring DOD employs recognized best practices for enterprise
architecture management. This effort will be further complicated as the
department strives to develop multiple enterprise architectures across its
various business areas. For example, in June 2001, we recommended30 that DOD
develop an enterprise architecture for its logistics operations. As I
discussed previously, an integrated reform strategy is critical. In this
context, it is essential that DOD closely coordinate and integrate the
development and implementation of these, as well as other, architectures. By
following this integrated approach and our previous recommendations, DOD
will be in the best position to avoid the serious risk that, after spending
billions of dollars on systems modernization, it will perpetuate the
existing systems environment that suffers from duplication of systems,
limited interoperability, and unnecessarily costly operations and
maintenance.

29GAO-01-525.

30U.S. General Accounting Office, Information Technology: DLA Should
Strengthen Business Systems Modernization Architecture and Investment
Activities, GAO-01-631 (Washington, D.C.: June 29, 2001).

Monitoring and Oversight Ensuring effective monitoring and oversight of
progress will also be a key to bringing about effective implementation of
the department's financial management and related business process reform.
We have previously testified31 that periodic reporting of status information
to department top management, the Office of Management and Budget (OMB), the
Congress, and the audit community is another key lesson learned from the
department's successful effort to address its Year 2000 challenge.

Previous submissions of its Financial Management Improvement Plan have
simply been compilations of data call information on the stovepiped
approaches to financial management improvements received from the various
DOD components. It is our understanding that DOD plans to change its
approach and anchor its plans in an enterprise architecture. If the
department's future plans are upgraded to provide a departmentwide strategic
view of the financial management challenges facing the department, along
with planned corrective actions, these plans can serve as an effective tool
not only to help guide and direct the department's financial management
reform efforts, but also to help maintain oversight of the department's
financial management operations. Going forward, this Subcommittee's annual
oversight hearings, as well the active interest and involvement of other
cognizant defense and oversight committees in the Congress, will continue to
be key to effectively achieving and sustaining DOD's financial management
and related business process reform milestones and goals.

Given the size, complexity, and deeply engrained nature of the financial
management problems facing DOD, heroic end-of-the year efforts relied on by
some agencies to develop auditable financial statement balances are not
feasible at DOD. Instead, a sustained focus on the underlying problems
impeding the development of reliable financial data throughout the
department will be necessary and is the best course of action. In this
context, the Congress recently enacted the fiscal year 2002 National Defense
Authorization Act, which contains provisions that will provide a framework
for redirecting the department's resources from the preparation and audit of
financial statements, which are acknowledged by DOD leadership to be
unauditable, to the improvement of DOD's financial management systems and
financial management policies, procedures, and internal controls. Under this
new legislation, the department will also be

31GAO-01-244.

required to report to the Congress on how resources have been redirected and
the progress that has been achieved. This reporting will provide an
important vehicle for the Congress to use in assessing whether DOD is using
its available resources to best bring about the development of timely and
reliable financial information for daily decision making and transform its
financial management as envisioned by the Secretary of Defense.

In conclusion, we support Secretary Rumsfeld's vision for transforming the
department's full range of business processes. Substantial personal
involvement by the Secretary and other DOD top executives will be essential
to change the DOD culture that has over time perpetuated the status quo and
been resistant to a transformation of the magnitude envisioned by the
Secretary. Comptroller Zakheim, as the Secretary's leader for financial
management modernization, will need to have the ability to make the tough
choices on systems, processes, and personnel, and to control spending for
new systems across the department, especially where new systems development
is involved. Processes will have to be reengineered, and hierarchical,
process-oriented, stovepiped, and internally focused approaches will have to
be put aside. The past has taught us that well-intentioned initiatives will
only succeed if there are the right incentives, transparency, and
accountability mechanisms in place.

The events of September 11 and other funding and asset accountability issues
associated with the war on terrorism, at least in the short term, may dilute
the focused attention and sustained action that are necessary to fully
realize the Secretary's transformation goal, which is understandable given
the circumstances. At the same time, the demand for increased Defense
spending, when combined with the government's long-range fiscal challenges,
means that solutions to DOD's business systems problems are even more
important. As the Secretary has noted, billions of dollars of resources
could be freed up for national defense priorities by eliminating waste and
inefficiencies in DOD's existing business processes. Only time will tell if
the Secretary's current transformation efforts will come to fruition. Others
have attempted well-intentioned reform efforts in the past. Today, the
momentum exists for reform. But, the real question remains, will this
momentum continue to exist tomorrow, next year, and throughout the years to
make the necessary cultural, systems, human capital, and other key changes a
reality? For our part, we will continue to work constructively with the
department and the Congress in this important area.

Mr. Chairman, this concludes  my statement. I would be pleased to answer any
questions you or other members of the Subcommittee may have at this time.

Contacts and  For  further information about this  testimony, please contact
Gregory D.  Kutz at (202) 512-9095 or  [email protected]. Other key contributors
to this

Acknowledgments testimony include Jack Brock, Geoffrey Frank, Randolph Hite,
Jeffrey Jacobson, Darby Smith, and David Warren.
*** End of document. ***