    Defense Budget: Improved Reviews Needed to Ensure Better
    Management of Obligated Funds (30-JAN-03, GAO-03-275).

    As of September 30, 2001, the Navy's operating appropriations had
    $2.1 billion in unliquidated--or unpaid--funds that were
    obligated during fiscal years 1997-99. Unliquidated obligations
    that are no longer needed to pay for goods and services tie up
    funds that could be used for other permissible purposes. In
    addition, inaccurate obligation data result in misstatement of
    budgetary information. Because of the large dollar value, we
    examined the Navy's management of unliquidated obligations.
    Specifically, we reviewed a statistically representative sample
    of the Navy's $1.4 billion in unliquidated operating obligations
    valued at $50,000 or more for fiscal years 1997-99 to determine
    whether these obligations were (1) properly accounted for and (2)
    reviewed in accordance with DOD regulations.
    -------------------------Indexing Terms-------------------------
    REPORTNUM:   GAO-03-275
        ACCNO:   A05980
      TITLE:     Defense Budget: Improved Reviews Needed to Ensure Better
    Management of Obligated Funds
         DATE:   01/30/2003
      SUBJECT:   Budget obligations
    	     Defense budgets
    	     Financial management
    	     Funds management
    	     Appropriated funds
    	     Obligated budget balances
    	     Accounting errors

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    GAO-03-275

    Report to the Secretary of Defense

    United States General Accounting Office

    GAO

    January 2003 DEFENSE BUDGET Improved Reviews Needed to Ensure Better
    Management of Obligated Funds

    GAO- 03- 275

    We estimated that $929 million of the $1.4 billion in unliquidated
    operating obligations valued at $50,000 or more for fiscal years 1997- 99
    was not properly accounted for (see table). Specifically, the Navy failed
    to deobligate $452 million of unliquidated operating obligations that was
    no

    longer needed and potentially available for other permissible purposes,
    such as contract modifications. In addition, $147 million of unliquidated
    operating obligations was inaccurately recorded because of problem
    disbursements* payments not properly matched to the correct obligation. A
    further $330 million was inaccurately recorded due to unresolved errors,
    such as bills that were not processed properly. The remaining $489 million
    in unliquidated operating obligations was properly accounted for and still
    needed for the original purpose.

    An estimated two- thirds of the unliquidated operating obligations over
    $50,000 were not properly accounted for as a result of the Navy*s failure
    to review such obligations three times each year as required by DOD
    regulations. In addition, the Navy did not fully adhere to the regulation
    that unliquidated operating obligations of any value be reviewed at least
    once each year. Consequently, the Navy did not know how much money was
    tied up in unliquidated operating obligations that could potentially be
    used for other appropriate needs, and its budgetary reports to Congress
    and financial statements were inaccurate. Navy fund managers chose to
    selectively review their operating obligations, citing obstacles such as
    difficulties in obtaining accurate payment and billing data and the
    extensive length of time needed to review large numbers of obligations.
    Further, the Navy did not apply existing internal control activities to
    ensure that fund managers performed obligation reviews in accordance with
    DOD regulations, nor did it hold fund managers accountable for the
    accuracy and completeness of the reviews. Estimate of Navy*s Unliquidated
    Operating Obligations Valued at $50,000 or More for Fiscal

    Years 1997- 99, as of September 30, 2001

    Dollars in millions Category Estimated total Percentage of total

    Still needed for original purpose $489 35 Not properly accounted for: No
    longer needed for original purpose 452 32

    Problem disbursements 147 10 Unresolved errors 330 23 Subtotal not
    properly accounted for: 929 65

    Total $1,419 a 100

    Source: DOD. Note: GAO analysis of DOD data. a Amounts do not add to total
    due to rounding. DEFENSE BUDGET

    Improved Reviews Needed to Ensure Better Management of Obligated Funds

    www. gao. gov/ cgi- bin/ getrpt? GAO- 03- 275. To view the full report,
    including the scope and methodology, click on the link above. For more
    information, contact Sharon Pickup at (202) 512- 9619 or pickups@ gao.
    gov. Highlights of GAO- 03- 275, a report to the

    Secretary of Defense

    January 2003

    As of September 30, 2001, the Navy*s operating appropriations had $2. 1
    billion in unliquidated* or unpaid* funds that were obligated during
    fiscal years 1997- 99. Unliquidated obligations that are no longer needed
    to pay for goods

    and services tie up funds that could be used for other permissible
    purposes. In addition, inaccurate obligation data result in misstatement
    of budgetary information.

    Because of the large dollar value, we examined the Navy*s management of
    unliquidated obligations. Specifically, we reviewed a statistically
    representative sample of the Navy*s

    $1. 4 billion in unliquidated operating obligations valued at $50, 000 or
    more for fiscal years 1997- 99 to determine whether these obligations were
    (1) properly

    accounted for and (2) reviewed in accordance with DOD regulations. We are
    recommending that the Navy adhere to obligation review regulations and
    better apply existing internal controls to ensure fund managers adhere to
    these

    regulations and are accountable for accuracy and completeness. The Navy
    partially concurred, but

    stated that it prioritizes obligation reviews to enable it to also pursue
    other efforts to improve financial reporting. We note that DOD regulations
    require review of all unliquidated obligations and do not

    allow for prioritization.

    Page i GAO- 03- 275 Defense Budget Letter 1 Results in Brief 2 Background
    4 Navy Did Not Properly Account for Large Portion of Unliquidated

    Operating Obligations 6 Navy Did Not Fully Adhere to DOD Review
    Regulations 9 Conclusions 11 Recommendations for Executive Action 12
    Agency Comments and Our Evaluation 12 Appendix I Scope and Methodology 16

    Appendix II Agency Comments 19

    Appendix III GAO Contacts and Staff Acknowledgments 21

    Tables

    Table 1: Estimate of Navy*s Unliquidated Operating Obligations for Fiscal
    Years 1997- 99, as of September 30, 2001 7 Table 2: Dollar Value
    Distribution of Fiscal Year 1997- 99

    Obligations Reviewed in the GAO Sample, as of September 30, 2001 17
    Abbreviations

    DOD Department of Defense FMR Financial Management Regulations Contents

    Page 1 GAO- 03- 275 Defense Budget

    January 30, 2003 The Honorable Donald H. Rumsfeld Secretary of Defense

    Dear Mr. Secretary: The Department of Defense (DOD) confronts pervasive
    and complex financial management problems that can seriously diminish the
    efficiency of the military services* support operations. Recent audits of
    DOD*s

    financial statements highlight ongoing financial management challenges
    that affect the development of accurate and complete financial
    information. Among the challenges facing DOD is the lack of accurate
    obligation data needed for effective budget management and reliable
    financial reporting.

    To ensure accuracy, it is important for the services to liquidate
    obligations if funds are no longer needed as originally planned and adjust
    their financial records accordingly. Unliquidated obligations are those
    that have not yet been paid. The unliquidated obligations that are no
    longer needed to pay for goods and services tie up funds that could be
    used for other

    permissible purposes. Inaccurate obligation data result in misstatement of
    budgetary information on federal financial statements and in the
    President*s budget and contribute to the failure to provide basic
    financial accountability. 1 DOD has recognized the need for the services
    to identify and reduce the

    number and amount of unliquidated obligations by requiring that fund
    managers review these obligations. In 1996, the DOD Office of the Under
    Secretary of Defense (Comptroller) issued a memorandum directing DOD

    components to review three times each year the accuracy of unliquidated
    operating obligations valued at $50,000 or more. DOD also directed
    agencies to review all other unliquidated operating obligations at least
    once a year. In reviewing service obligation data, we noted that the Navy
    has significantly large amounts of unliquidated obligations. As of

    1 *Providing basic financial accountability* has been identified by GAO as
    a governmentwide high- risk area in need of attention. See U. S. General
    Accounting Office,

    High- Risk Series: An Update, GAO- 01- 263 (Washington, D. C.: Jan. 2001).

    United States General Accounting Office Washington, DC 20548

    Page 2 GAO- 03- 275 Defense Budget

    September 30, 2001, the Navy*s operating appropriations 2 had $2.1 billion
    in unliquidated funds that were obligated during fiscal years 1997- 99, of
    which $1.4 billion (67 percent) represented unliquidated operating
    obligations of $50,000 or more. 3 Also, in 1999 and 2000, Navy auditors
    reported inaccuracies in the Navy*s obligation data and found that fund
    managers were not fully complying with DOD review regulations.

    Because of the large dollar value of unliquidated obligations and Navy
    audit findings, we reviewed the Navy*s management of its unliquidated
    operating obligations. More specifically, we determined whether these
    unliquidated operating obligations were (1) properly accounted for and (2)
    periodically reviewed in accordance with DOD regulations. We reviewed a
    statistically representative sample of the Navy*s unliquidated operating
    obligations of $50,000 or more for fiscal years 1997- 99. We also analyzed
    documentation related to DOD*s obligation review regulations and the
    Navy*s guidance to adhere to the regulations, and interviewed Navy
    officials. A more detailed description of our scope and methodology is
    included in appendix I. On the basis of our sample, we estimated that $929
    million of the

    $1.4 billion in unliquidated operating obligations valued at $50,000 or
    more for fiscal years 1997- 99 was not properly accounted for.
    Specifically, the Navy failed to deobligate $452 million of unliquidated
    operating obligations that was no longer needed and potentially available
    for other

    permissible purposes, such as contract cost overruns or contract
    modifications. In addition, $477 million of unliquidated operating
    obligations was not properly accounted for due to billing and recording
    errors. For example, payments were made and recorded on behalf of the
    wrong obligation, or payments were not made because bills were not
    processed properly. In addition to tying up funds unnecessarily, these
    obligation errors resulted in inaccurate reporting in the Navy*s budgetary
    reports and in its financial statements. The remaining $489 million in
    unliquidated operating obligations was properly accounted for and still
    needed for the original purpose.

    2 *Operating* appropriations include the Operation and Maintenance (O& M),
    Defense- wide, and Defense Health Program appropriations. 3 The Navy
    obligated a total of $25.6 billion in operating funds during fiscal years
    1997- 99, as reported in its Standard Accounting and Reporting System,
    which maintains approximately 90 percent of all operating appropriation
    obligations. Results in Brief

    Page 3 GAO- 03- 275 Defense Budget

    An estimated two- thirds of the unliquidated operating obligations over
    $50,000 were not properly accounted for as a result of the Navy*s failure
    to review such obligations three times each year as required by DOD
    regulations. In addition, the Navy did not fully adhere to the regulation
    that unliquidated operating obligations of any value be reviewed at least
    once each year. Consequently, the Navy did not know how much money was
    tied up in unliquidated operating obligations that could potentially be
    used for other permissible needs, and its budgetary reports to Congress

    and financial statements were inaccurate. Navy fund managers chose to
    selectively review their operating obligations, citing obstacles such as
    difficulties in obtaining accurate payment and billing data and the
    extensive length of time needed to review large numbers of obligations.
    Further, the Navy did not apply existing internal control activities to
    ensure that fund managers performed obligation reviews in accordance with
    DOD regulations, nor did it hold fund managers accountable for the
    accuracy and completeness of the reviews.

    Accordingly, we are recommending that the Navy adhere to its obligation
    review regulations and apply existing internal controls to ensure fund
    manager adherence to these regulations. The Navy partially concurred with
    our recommendations, acknowledging that more thorough efforts dedicated to
    the review of obligations would increase the accuracy and reliability of
    financial reports. The Navy, however, noted that because

    numerous factors contribute to problems in financial reports, it has to
    prioritize its remedial efforts and therefore focus on reviewing
    unliquidated obligations in available appropriations, correcting systemic
    problems, and pursuing broad improvements in financial management. When
    appropriate requirements have arisen, the Navy commented that encumbrances
    for unliquidated obligations have not been an impediment to obtaining
    necessary funds. While we agree focusing on systemic issues offers
    opportunities to improve the Navy*s financial information, we note DOD*s
    obligation review regulations are in fact designed to minimize systemic
    problems and do not allow for prioritization. Furthermore, the ability of
    the Navy to gain access to funds when needs arise does not relieve it of
    the responsibility to adhere to existing laws and regulations governing
    sound financial management. We therefore are making no changes to the
    recommendations in our report.

    Page 4 GAO- 03- 275 Defense Budget

    Obligations are recorded when an authorized agent of the federal
    government enters into a legally binding agreement to purchase specific
    goods or services. 4 As bills are received and payments are made, the
    recorded obligation is reduced by the amount of the payments made. When
    all services or goods have been received and paid for, the obligation is
    considered *liquidated,* and any remaining amount of the unliquidated
    (unpaid) obligation should be deobligated and reduced to zero. 5 Operating
    funds must be obligated in the fiscal year for which they are
    appropriated.

    However, obligated funds may be spent over a period of 5 additional years,
    as bills for goods and services are received and paid. 6 If the goods and
    services are received and paid for in the first year of the obligation,
    the remaining unliquidated obligation can be reused for other needs
    consistent with the source appropriation. If the goods and services are
    received and paid for in the subsequent 5 years, the remaining
    unliquidated obligation

    can still be used, if permissible, to modify contracts or to increase
    existing obligations that might need more funds.

    Accurate obligation information is essential for reliable budgeting
    reports to Congress, agency financial statements, performance
    measurements, and funds control. Inaccurate obligation data misstates the
    amount of funds available from the appropriation, contributes to
    inaccuracies in the Navy*s budget and financial reports, and subsequently
    leads to inaccuracies in

    federal financial statements. For example, the Navy*s unliquidated
    obligations are reported in the Navy Statement of Budgetary Resources,
    which are in turn incorporated in other DOD and federal budget reports and
    financial statements.

    We have documented weaknesses in DOD*s accounting practices and Navy
    auditors have documented inaccuracies in the Navy*s obligations data. In
    our 2001 Performance and Accountability Series report, we stated that

    because of weaknesses in DOD*s budget execution accounting, the department
    does not know with certainty the amount of funding it has

    4 31 U. S. C. 1501; DOD Financial Management Regulation (FMR) volume 3,
    chapter 8, section 080301. 5 DOD FMR volume 3, chapter 8, section 080405
    A, requires all deobligations, adjustments or corrections to be documented
    and processed within 10 working days of their identification.

    6 31 U. S. C. 1552. Background

    Page 5 GAO- 03- 275 Defense Budget

    available. 7 Naval Audit Service reports published in February 1999 8 and
    January 2000 9 reported that Navy fund managers were not complying with
    obligation review regulations and documented inaccuracies in the Navy*s
    obligation data. In July 2000 we reported that such inaccuracies in
    obligation data not only hamper DOD*s ability to produce timely and
    accurate financial information, but also significantly impair efforts to

    improve the economy and efficiency of its operations. 10 To ensure that
    obligation data are tracked and accurately reported, the DOD Financial
    Management Regulations (FMR) require that the services, including the
    Navy, review their unliquidated operating obligations valued $50,000 or
    more three times a year to ensure that they are accurate and that the
    funds are still needed. 11 All unliquidated operating obligations,

    regardless of dollar value, must be reviewed at least once a year. 12
    Also, Congress specifically established in chapter 15 of title 31, United
    States Code, a framework for reviewing, adjusting, certifying to, and
    reporting on, among other items, the status and amounts of unliquidated
    obligations. 13 In addition, for many interagency obligations entered
    under specific statutory authority, such as the Economy Act, 14 the
    authorizing

    7 U. S. General Accounting Office, High Risk Series: An Update, GAO- 01-
    263 (Washington, D. C.: Jan. 1, 2001). 8 Naval Audit Service, Obligations
    Associated Primarily with Indefinite Delivery Contracts and Basic Ordering
    Agreements (Falls Church, Va.: February 18, 1999). 9 Naval Audit Service,
    Validation of Selected Work Request Obligations in the Standard Accounting
    and Reporting System (Washington, D. C.: Jan. 28, 2000).

    10 U. S. General Accounting Office, Department of Defense: Implications of
    Financial Management Issues, GAO/ T- AIMD/ NSIAD- 00- 264 (Washington, D.
    C.: July 20, 2000). 11 DOD FMR volume 3, chapter 8, section 080403 B. DOD
    first implemented this requirement in May 1996 via a memorandum issued by
    the Office of the Under Secretary of Defense to all military services,
    including the Navy. DOD formally added the requirement to volume 3,
    chapter 8 of the FMR in November 2000.

    12 DOD FMR volume 3, chapter 8, section 080403 E. 13 31 U. S. C., chapter
    15, subchapter IV. 31 U. S. C. S: 1554( b) specifically directs heads of
    agencies to report to the President and the Secretary of the Treasury, and
    to certify to those reports, regarding unliquidated obligations and other
    balances and adjustments. Section 1554( c) directs agencies to establish
    controls to assure that an adequate review of obligated balances is
    performed.

    14 31 U. S. C. S: 1535.

    Page 6 GAO- 03- 275 Defense Budget

    statute may mandate the deobligation of appropriations at specific times
    or when certain conditions arise. 15 The DOD regulation also directs the
    services to implement effective

    internal controls to ensure that the required reviews are completed and
    that identified corrective actions are completed in a timely manner. 16
    Further, the Federal Managers* Financial Integrity Act of 1982 17 requires
    that agencies* controls reasonably ensure that (1) obligations and costs
    comply with applicable law and (2) revenues and expenditures applicable to
    agency operations are properly recorded and accounted for so that agency
    accounts and reliable financial and statistical reports may be prepared
    and the accountability of assets may be maintained. 18 An estimated two-
    thirds of the Navy*s unliquidated operating obligations

    valued at $50,000 or more from the fiscal years 1997- 99 operating
    appropriations was not properly accounted for. Specifically, we estimated
    that $929 million of the $1.4 billion in unliquidated operating
    obligations was not properly accounted for. As shown in table 1, $452
    million of the unliquidated operating obligations was no longer needed for
    its original purpose. These funds could have been used for other
    permissible purposes of the same appropriation and fiscal year, such as
    contract modifications. In addition, $477 million was not properly
    accounted for due to billing and

    recording errors, including $147 million in problem disbursements and $330
    million in unresolved accounting and recording errors. Finally, $489
    million in unliquidated operating obligations was properly accounted for
    and still needed for the original purpose.

    15 Section 1535( d) of the Economy Act, for example, requires deobligation
    of funds at the end of their period of availability if the performing
    agency has not performed or otherwise made authorized contracts.

    16 DOD FMR volume 3, chapter 8, section 080404. 17 P. L. 97- 255, S: 2, 96
    Stat. 814, September 8, 1982 (codified at 31 U. S. C. S: 3512( b) and
    (c)), and is commonly called the Federal Managers* Financial Integrity Act
    of 1982. 18 31 U. S. C. S: 3512( c)( 1). Navy Did Not

    Properly Account for Large Portion of Unliquidated Operating Obligations

    Page 7 GAO- 03- 275 Defense Budget

    Table 1: Estimate of Navy*s Unliquidated Operating Obligations for Fiscal
    Years 1997- 99, as of September 30, 2001

    Dollars in millions

    Category Estimated total Percentage of total

    Still needed for original purpose $489 35 Not properly accounted for: No
    longer needed for original purpose 452 32

    Problem disbursements 147 10 Unresolved errors 330 23 Subtotal not
    properly accounted for: 929 65

    Total $1,419 a 100

    Source: DOD. Note: GAO analysis of DOD data. a Amounts do not add to total
    due to rounding.

    The Navy failed to deobligate an estimated $452 million that was no longer
    needed for the original obligated purpose. According to DOD regulations,
    these unliquidated funds should have been deobligated once services had
    been performed, final payment issued, and the funds made available for
    other purposes consistent with the appropriation. In many of our sample
    cases, the entire amount of an obligation was not required to meet billing
    needs and resulted in funds remaining over. For example, in one of the
    cases we reviewed, $4.7 million had been disbursed from a 1997 obligation,
    valued at $6 million, to support the San Diego Harbor Tug Charter;
    however, the last disbursement was made in October 1999. We discovered
    that the remaining unliquidated funds were no longer needed and the Navy
    subsequently deobligated the unliquidated $1.3 million. Similarly, we
    reviewed a 1996 (fiscal year 1997) obligation to fund systems development
    at the Bureau of Naval Personnel. When the responsible Navy fund manager
    reviewed the unliquidated obligation at our request, he determined that
    the outstanding balance of $1.4 million attached to this obligation was no
    longer required and deobligated it. In both of these cases, if Navy
    personnel had reviewed these obligations in accordance with DOD
    regulations, they would have detected the error and deobligated the funds
    years ago, thereby possibly allowing Navy to use the funds for other
    permissible purposes, including contract modifications, or other
    obligation needs of the same appropriation and fiscal year.

    The Navy had also not properly accounted for an estimated $147 million in
    unliquidated operating obligations due to expenditures that were not
    properly matched to a specific obligation recorded in the Navy*s records*
    problem disbursements. We previously reported that the Navy*s financial

    Page 8 GAO- 03- 275 Defense Budget

    control policy and procedures do not ensure that the Navy can match
    payments to corresponding obligations before or at the time a payment is
    made. 19 Consequently, if the Navy cannot resolve these problem
    disbursements by matching the disbursement to the original obligation, it

    must record a new obligation to cover the disbursement after a payment is
    made. For example, one of our sample items had an unliquidated obligation
    balance of $1,362,790 on September 30, 2001. The fund manager of this 1998
    obligation stated that all of the funds had been disbursed; however, the
    Navy*s Standard Accounting and Reporting System indicated that no
    disbursements had been made. We discovered that in fact all of the

    funds had been disbursed for this obligation, but the disbursements had
    been posted to the wrong obligation in the accounting system. Funds that
    remain unliquidated due to a problem disbursement may not be deobligated
    and used for other purposes because the funds are still needed

    to reimburse the obligation that was erroneously charged for the
    disbursement.

    The Navy had not properly accounted for an estimated $330 million due to
    unresolved accounting and recording errors. These obligations remained
    unliquidated for several reasons. Most unresolved errors in our sample
    occurred because fund managers were unable to identify whether the
    providers of goods or services had been paid in full for services
    rendered. The fund managers claimed that providers were often slow to bill
    or had not sent a final bill. For example, we reviewed a 1997 obligation
    for aircraft maintenance that had an unliquidated balance of $14.4
    million. The fund managers said that they had not received a bill from the
    Air Force, which provided the maintenance service. In this case, the $14.4
    million remained on the books as unresolved, because the fund managers
    still expected to receive a bill for the services. An example of a
    recording error is illustrated in a $12 million obligation to support
    alterations on the USS LaSalle. A disbursement was input twice and then
    reversed twice instead of once. The second reversal of the disbursement
    left an unliquidated

    balance on the obligation that should have been disbursed. Funds that
    remain unliquidated due to unresolved accounting and recording errors
    cannot be deobligated and used for other purposes, because the Navy needs
    to have funds available to pay providers after the errors have been
    resolved.

    19 U. S. General Accounting Office, Financial Management: Problems in
    Accounting for Navy Transactions Impair Funds Control and Financial
    Reporting, GAO/ AIMD- 99- 19 (Washington, D. C.: Jan. 19, 1999).

    Page 9 GAO- 03- 275 Defense Budget

    The Navy did not fully adhere to DOD regulations to review all
    unliquidated operating obligations, including those obligations valued at
    $50,000 or more three times per year and those obligations valued at less
    than $50,000 once every year. Furthermore, the Navy did not utilize

    internal controls to determine the accuracy of the review process or the
    outcomes of the reviews. As a result, the Navy did not know how much money
    was tied up in unliquidated operating obligations that could potentially
    be used for other permissible needs.

    According to DOD regulations, obligation reviews are to be conducted by
    fund managers within 14 days following the end of January, May, and
    September. DOD regulations also require the services to implement
    effective internal controls to ensure that the reviews are completed and
    corrective actions are implemented in a timely manner. The purpose of

    these reviews is to ensure that the unliquidated balances are accurate and
    still needed. The Navy issued implementing guidance that (1) restates the
    three deadlines provided in the DOD regulations, (2) requires that
    internal controls be implemented by each entity as described in DOD
    regulations, and (3) requires each fund manager to complete a checklist of
    the review steps performed. For example, one required step is to follow up
    and ensure the obligation is still needed. The guidance also requires the
    comptroller of each major command to consolidate the review results from
    the fund managers and include a list of all fund managers who did not
    fully adhere to DOD regulations and the reason why. The major command
    confirmation statement is to be forwarded to the Assistant Secretary of
    the Navy (Financial Management and Comptroller), Office of Budget.

    Although DOD regulations require Navy fund managers to review all
    operating obligations once annually and those $50,000 and above three
    times each year, fund managers have not fully adhered. Fund managers
    stated that they selectively reviewed some unliquidated operating
    obligations, but were unable to make all the required reviews or complete
    all the steps on some of the cases they reviewed. For example, fund
    managers first prioritize for review the high- value unliquidated
    operating obligations in the current fiscal year to accommodate immediate
    funding

    requirements. That frees the funds for reobligation during the same fiscal
    year. Unliquidated operating obligations that are approximately 5 years
    old and, based on appropriations that will cancel at the end of the fiscal
    year, are also a high priority for review in order to pay outstanding
    bills while

    funds are available. As a result of prioritized and selective obligations
    review, some operating obligations are not reviewed three times a year as
    required by DOD regulations and some are not reviewed at all. Navy Did Not
    Fully

    Adhere to DOD Review Regulations

    Page 10 GAO- 03- 275 Defense Budget

    Navy fund managers provided several reasons why they selectively reviewed
    obligations and did not review all of them. They stated that the process
    of reviewing an obligation can be time- consuming due to a lack of
    automated tools and, often, a lack of accurate billing information needed
    to assess the validity of an obligation, especially for older obligations.
    Officials acknowledged that the Navy*s Standard Accounting and Reporting
    System provides users with the capability to conduct ad hoc queries of the
    obligation database, but they claim these tools are not userfriendly
    because users must be familiar with the system*s databaseprogramming code
    to take full advantage of its capabilities. Few of the staff assigned to
    perform obligation reviews had the required computer training or knowledge
    to write queries. Some of the fund managers also told us that they were
    reluctant to review the large volume of low dollar unliquidated operating
    obligations because they felt the expected rate of return was not cost
    beneficial given the magnitude of resources required

    to conduct the review. To illustrate the large volume, Atlantic Fleet
    officials reported that they had 579,904 unliquidated operating
    obligations valued $50, 000 or less, 20 and officials at the Pacific Fleet
    reported 724,266 such unliquidated operating obligations. 21 Further, some
    fund managers

    stated that it was impossible for them to comply with the requirement to
    review all such unliquidated operating obligations even once a year,
    because they did not have enough staff to review the large number of such
    obligations. Officials in the Navy Comptroller Office acknowledged that
    fund managers

    have reported difficulties performing obligation reviews. Navy officials
    also acknowledged that inaccurate obligation data compromises the
    reliability of their financial statements, and therefore it is reasonable
    that they review their obligations according to the regulations.
    Consequently,

    the Navy has not sought relief from DOD obligation review regulations. The
    Navy did not utilize internal control activities necessary to ensure that
    fund managers performed thorough obligation reviews in accordance with DOD
    regulations. Although some major commands had developed written standard
    operating procedures or checklists to track whether fund managers had
    reviewed their unliquidated operating obligations, they did not hold
    managers accountable for the accuracy and completeness of the reviews.
    Fund managers submitted obligation- review confirmation

    20 As of Mar. 10, 2002. 21 As of June 14, 2002.

    Page 11 GAO- 03- 275 Defense Budget

    statements to their major commands, but often the commands could not
    determine specific details about the obligations, including the number of
    unliquidated operating obligations reviewed, the amount of the obligations
    reviewed, and the resolution of any problems identified during the review.
    For example, one major command has a process to review whether fund
    managers submit the required obligation review paperwork. However, the
    command does not spot- check obligations to determine if they are valid as
    claimed by the fund managers and accepts the fund managers obligations
    review paperwork as is. Officials in the Navy Comptroller Office stated
    that fund managers should

    place more emphasis on reviewing obligations in accordance with DOD
    regulations. However, they did not think it would be productive to
    discipline fund managers for failure to adhere to the regulations. Rather,
    they believe that the Navy should rely on financial system upgrades to
    improve the accuracy of obligation data.

    As highlighted in our 2001 Performance and Accountability Series reports,
    financial management is one of the major management challenges facing DOD.
    22 The large dollar value of unliquidated Navy obligations that were

    not properly accounted for contributes to inaccuracies in the Navy*s
    budget and financial reports, and subsequently leads to inaccuracies in
    federal financial statements and the President*s budget. Moreover, the
    Navy will not be able to pass the test of an independent financial audit
    until it corrects inaccurate obligation data.

    DOD regulations and Navy guidance provide for unliquidated obligations to
    be reviewed by fund managers on a regular basis. The fund managers*
    ability to deobligate or resolve the errors on many of our sample items
    demonstrates that the review process could be effective. But the fund
    managers have chosen to only selectively follow the requirements for
    review because they said they were constrained by too little time to
    review the large number of transactions, inaccurate billing information,
    and the lack of automated tools. Although the Navy recognized the
    potential benefits of timely identification of funds that are no longer
    needed or in error, its internal controls have not ensured that required
    reviews were made and corrective action taken. We note that fund managers
    were able

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

    Page 12 GAO- 03- 275 Defense Budget

    to successfully resolve nearly all of the unliquidated operating
    obligations in our sample even though the resolution of some of the
    obligations required an extensive amount of time and effort. Therefore, it
    is likely that many of the unliquidated obligations in our sample that
    were not properly accounted for could have been identified and accounting
    errors could have been corrected prior to our review had fund managers
    performed obligation reviews in accordance with the DOD regulations.

    We recommend that the Secretary of Defense direct the Secretary of Navy
    to:  adhere to DOD unliquidated operating obligation review regulations;
    and  better apply existing internal control activities to ensure
    adherence to

    these regulations, and to hold fund managers accountable for the accuracy
    and completeness of their reviews.

    As you know, 31 U. S. C. requires the head of a federal agency to submit a
    written statement of the actions taken on our recommendations to the
    Senate Committee on Government Affairs and the House Committee on
    Government Reform not later than 60 days after the dare of this report. A
    written statement must also be sent to the House and Senate Committees on
    Appropriations with the agency*s first request for appropriations made
    more than 60 days after the date of this report.

    The Director, Office of the Budget, Department of the Navy provided DOD*s
    written comments on a draft of this report, which are provided in their
    entirety in appendix II. The Navy partially concurred with our
    recommendations and noted that more thorough efforts dedicated to the
    review of obligations would increase the accuracy and reliability of
    financial reports. It also plans to make the review process a part of its
    management structure and stress the importance of accurate financial
    statements. The Navy, however, commented that because numerous factors
    contribute to problems in financial reports, it has to prioritize its
    remedial efforts. Specifically, the Navy places a premium on reviewing
    unliquidated obligations in available appropriations, correcting systemic
    problems, and pursuing broad improvements in financial management. For
    example, the Navy stated it made significant improvements in correcting
    systemic issues* such as problem disbursements* and is working to provide
    automated tools and correct systemic issues that would positively impact
    the fund managers* ability to conduct obligation reviews. While it noted
    validating unliquidated obligations is desirable and important, the
    Recommendations for

    Executive Action Agency Comments and Our Evaluation

    Page 13 GAO- 03- 275 Defense Budget

    Navy emphasized that systemic improvement of its financial information
    offers the better opportunity for success.

    The Navy did not agree that the difficulty the fund managers have had in
    reviewing unliquidated obligations precluded the use of funds for other
    appropriate needs. It noted that Congress has intentionally and
    progressively limited the availability of funds from prior year
    appropriations, clearly establishing that the appropriateness of use
    outweighs the efficiency of use. When appropriate requirements for the
    application of available funds from prior year appropriations have arisen,
    the Navy commented that encumbrances for unliquidated obligations have not
    been an impediment to obtaining necessary funds.

    While we understand numerous factors, including systemic issues, affect
    the accuracy of Navy financial reports, DOD regulations require that fund
    managers annually review all unliquidated obligations and, as currently
    written, do not provide for prioritization of such reviews. We recognize
    the Navy has taken steps to significantly reduce the amount of outstanding
    problem disbursements; however, as our report points out, problem
    disbursements are only part of the reason for the significant amount of

    unliquidated obligations. For example, about $782 million of the $929
    million in unliquidated obligations in our sample were improperly
    accounted for due to reasons unrelated to problem disbursements.
    Specifically, the aggregate of these transactions involved funds that were
    no longer needed for their original purpose or involved unresolved
    accounting and recording errors. While we agree that focusing on systemic
    issues offers opportunities to improve the Navy*s financial information,
    we also note that the internal control procedures reflected in DOD*s
    obligation review regulations are in fact designed to minimize systemic
    problems such as problem disbursements. To the extent that the Navy*s
    efforts to make systemic improvements include automated tools designed to
    assist the fund managers in complying with obligation review requirements,
    we believe these efforts represent a positive step.

    We disagree with the Navy*s views regarding the impact of failing to
    review all unliquidated obligations as required under current DOD
    regulations. Regardless of whether the Navy is able to gain the funds
    necessary from unliquidated obligations to satisfy appropriate
    requirements as they arise, inaccurate obligation data in the Navy*s

    financial system has broader implications, such as inaccurate financial
    reports and misstatements of budgetary information on federal financial
    statements and in the President*s budget. While we agree Congress has
    placed statutory limitations on the availability of appropriated funds,
    DOD,

    Page 14 GAO- 03- 275 Defense Budget

    like all agencies, is responsible for effectively and efficiently
    implementing its activities within the limitations applicable to the
    appropriations it receives. Indeed, Congress specifically established in
    chapter 15 of title 31, United States Code, a framework for reviewing,
    adjusting, certifying to, and reporting on, among other items, the status
    and amounts of unliquidated obligations. 23 In addition, the Federal
    Managers* Financial Integrity Act of 1982 24 requires that agencies have
    controls to reasonably ensure that revenues and expenditures applicable to
    agency operations are recorded and accounted for properly so that accounts
    and reliable financial and statistical reports may be prepared and
    accountability of assets may be maintained. 25 Finally, for many
    interagency obligations entered under a specific statutory authority* such
    as the Economy Act 26 * the authorizing statute may mandate the
    deobligation of appropriations at specific times or when certain
    conditions arise. 27 In this context, the ability of the Navy to access
    funds encumbered by unliquidated obligations does not relieve it of the
    responsibility to adhere to existing laws and

    regulations governing sound financial management. We therefore are making
    no changes to the recommendations in our report.

    We are sending copies of this report to congressional committees with
    jurisdiction over DOD*s budget and the Secretary of the Navy. We will also
    make copies available to others upon request. In addition, the report will
    be available at no charge on the GAO Web site at http:// www. gao. gov.

    23 31 U. S. C., chapter 15, subchapter IV. 31 U. S. C. S: 1554( b)
    specifically directs heads of agencies to report to the President and the
    Secretary of the Treasury, and to certify to those reports regarding
    unliquidated obligations and other balances and adjustments. Section 1554(
    c) directs agencies to establish controls to assure that an adequate
    review of obligated balances is performed.

    24 P. L. 97- 255, S: 2, 96 Stat. 814, September 8, 1982 (codified at 31 U.
    S. C. S: 3512( b) and (c)), and is commonly called the Federal Managers*
    Financial Integrity Act of 1982. 25 31 U. S. C. S: 3512( c)( 1).

    26 31 U. S. C. S: 1535. 27 Section 1535( d) of the Economy Act, for
    example, requires deobligation of funds at the end of their period of
    availability if the performing agency has not performed or otherwise made
    authorized contracts.

    Page 15 GAO- 03- 275 Defense Budget

    If you or your staff have any questions about this report, please call me
    at (202) 512- 9619. Key contributors to this report are listed in appendix
    III.

    Sharon Pickup Director, Defense Capabilities and Management

    Appendix I: Scope and Methodology Page 16 GAO- 03- 275 Defense Budget

    Our objective was to determine whether the Navy*s unliquidated operating
    obligations were (1) properly accounted for and (2) periodically reviewed
    in accordance with DOD regulations.

    To determine whether Navy*s unliquidated operating obligations were
    properly accounted for, we requested that the Defense Finance Accounting
    Office provide us with a database that identified all unliquidated
    operating obligations outstanding on September 30, 2001. We relied on the
    completeness and accuracy of that database based on the

    office*s representations and did not independently test or reconcile the
    validity of their database. For our review, we selected unliquidated
    operating obligations for fiscal years 1997- 99. Older obligations are
    more likely to be in error and thus provided a better test of the Navy*s
    obligation management practices. We then divided the individual
    unliquidated operating obligations into two groups* those valued at less
    than $50,000 and those valued at $50,000 or more. Those valued at $50,000
    or more represented $1.4 billion, or 67 percent of the value of all
    outstanding operating obligations for fiscal years 1997- 99.

    From the population of obligations valued at $50,000 or more, we drew a
    stratified random sample of 205 unliquidated operating obligations to
    review. For each transaction, we obtained the following documentation: (1)
    documentary support describing each obligation, including amendments and
    modifications for each sample transaction; (2) responses

    from Navy officials regarding whether each unliquidated operating
    obligation in our sample was still needed for its original purpose
    according to the criteria in the DOD Financial Management Regulation 1
    (FMR); and (3) support for how to classify each unliquidated operating
    obligation in our sample as still needed, no- longer- needed, problem
    disbursement, or an unresolved accounting and recording error.

    The sample was selected from three strata defined by the dollar value of
    the obligations, as shown in table 3. 1 DOD FMR volume 3, chapter 8,
    section 080303 A. Appendix I: Scope and Methodology

    Appendix I: Scope and Methodology Page 17 GAO- 03- 275 Defense Budget

    Table 2: Dollar Value Distribution of Fiscal Year 1997- 99 Obligations
    Reviewed in the GAO Sample, as of September 30, 2001

    Strata Number of items Total value

    Over $10,000,000 5 $240,382,914.38 $500,000 to $10, 000,000 100
    113,190,918.46 $50,000 to $499, 999 100 14,571,125.75

    Total 205 $368,144,958.59

    Source: DOD. Note: GAO analysis of DOD data. To determine whether the
    amount of each unliquidated operating

    obligation was properly accounted for, we reviewed support provided by the
    Navy, discussed the status of the unliquidated obligation with the primary
    Navy official responsible for the individual transaction, and used the
    criteria set forth in DOD*s regulations. We classified unliquidated
    operating obligation transactions as *still needed* and properly accounted
    for when the Navy provided documentation to support that the contracted
    goods or services were still needed; thus, the transaction passed a bona
    fide needs test. Items not properly accounted for fell into three
    categories. We classified the transaction *no longer needed for original
    purposes*

    when the Navy could not provide support that a bona fide need existed. We
    classified transactions as *problem disbursements* when specific
    disbursements were not properly matched to corresponding obligations
    recorded in the department*s records. We classified the remaining
    unliquidated operating obligation transactions as *unresolved accounting
    and recording errors* when they did not clearly meet the criteria for
    needed, no- longer- needed, or problem disbursements.

    To determine if the Navy*s unliquidated operating obligations were
    periodically reviewed in accordance with DOD regulations, we requested
    that the Navy provide documentation and guidance on the Navy*s
    implementation of the regulations. We also interviewed officials at 12
    locations to discuss (1) their procedures for performing obligation
    reviews, (2) the magnitude of transactions involved to perform the review
    as set forth in the DOD obligation review regulations, and (3) whether the
    officials had difficulty meeting the obligation review requirements,
    including the reasons why. We visited the Commander in Chief of the
    Atlantic Fleet in Norfolk, Va.; the Commander, Navy Mid- Atlantic Region
    in Norfolk, Va.; the Commander, Naval Sea Systems Command in Washington,
    D. C.; the Naval Facilities Engineering Command in Washington, D. C.; the
    Director of Strategic Systems Programs in

    Washington, D. C.; the Commander in Chief of the Pacific Fleet in Pearl

    Appendix I: Scope and Methodology Page 18 GAO- 03- 275 Defense Budget

    Harbor, Hawaii; the Commander, Naval Region in Pearl Harbor, Hawaii; the
    Commander, Naval Air Force Command of the Pacific Fleet in San Diego,
    Calif.; the Commander, Naval Surface Force Command of the Pacific Fleet in
    San Diego, Calif.; the Space and Naval Warfare Systems Command in San
    Diego, Calif.; the Commander, Naval Air Systems Command in Patuxent River,
    Md.; and the Bureau of Medicine and Surgery in Washington, D. C.

    We conducted our review from October 2001 through October 2002 in
    accordance with generally accepted government auditing standards.

    Appendix II: Agency Comments Page 19 GAO- 03- 275 Defense Budget

    Appendix II: Agency Comments

    Appendix II: Agency Comments Page 20 GAO- 03- 275 Defense Budget

    Appendix III: GAO Contacts and Staff Acknowledgments

    Page 21 GAO- 03- 275 Defense Bud

    Sharon Pickup (202) 512- 9619 Gary L. Billen (214) 777- 5703

    In addition to the individuals named above, Lori Adams, Linda Garrison,
    Gregory Kutz, Steve L. Pruitt, Rhonda P. Rose, and R. K. Wild made key
    contributions to this report. Appendix III: GAO Contacts and Staff

    Acknowledgments GAO Contacts Staff Acknowledgments

    (350126)

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