Navy Working Capital Fund: Backlog of Funded Work at the Space	 
and Naval Warfare Systems Command Was Consistently Understated	 
(01-JUL-03, GAO-03-668).					 
                                                                 
The Space and Naval Warfare Systems Command (SPAWAR) has hundreds
of millions of dollars of funded work that its working capital	 
fund activities did not complete before the end of the fiscal	 
year. Reducing the amount of workload carryover at fiscal	 
year-end is a key factor in the effective management of 	 
Department of Defense (DOD) resources and in minimizing the	 
"banking" of funds for work to be performed in subsequent years. 
GAO was asked to analyze SPAWAR's carryover balances. GAO	 
assessed the accuracy of the budgeted amounts, the accuracy of	 
the reported actual carryover balance, and the reliability of	 
underlying financial data on which reported actual carryover is  
based.								 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-668 					        
    ACCNO:   A07403						        
  TITLE:     Navy Working Capital Fund: Backlog of Funded Work at the 
Space and Naval Warfare Systems Command Was Consistently	 
Understated							 
     DATE:   07/01/2003 
  SUBJECT:   Financial analysis 				 
	     Funds management					 
	     Budget surplus					 
	     Financial records					 

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GAO-03-668

                                       A

July 1, 2003 Let er t The Honorable Jerry Lewis Chairman, Subcommittee on
Defense Committee on Appropriations House of Representatives

Dear Mr. Chairman: This is the third in a planned series of reports that
discusses the Defense Working Capital Fund fiscal year- end workload
funding issue, generally referred to as *carryover.* Section 1051 of the
Floyd D. Spence National Defense Authorization Act For Fiscal Year 2001 1
required that we review various aspects of the Department of Defense (DOD)
policy that allowed Defense Working Capital Fund activities to carry over
a 3- month level of work 2 to ensure continuity of operations from one
fiscal year to the next. Excessive amounts of carryover 3 financed with
customer appropriations may indicate excessive or unneeded funds and are
subject to reductions by DOD and the congressional defense committees
during the budget review process. To the extent that carryover is high,
the Congress may redirect the funds gained from such reductions to other
priority initiatives. In May 2001, we reported 4 that (1) DOD did not have
a sound analytical

basis for its 3- month carryover standard, (2) military services used
different methods to calculate the number of months of carryover, and (3)
some activity groups underestimated their budgeted carryover year

after year, thereby providing decision makers with misleading year- end
carryover information resulting in more funding being provided than was 1
Floyd D. Spence National Defense Authorization Act For Fiscal Year 2001,
Pub. L. No. 106- 398, Section 1051, 114 Stat. 1654, 1654A- 264 (2000). 2
DOD changed this policy in December 2002 by revising its methodology for
calculating the allowable amount of carryover. Under the revised method,
DOD eliminated the 3- month standard, and the allowable amount of
carryover is to be based on the overall disbursement rate of the
customers* appropriations financing the work.

3 The carryover amount includes work for which customers have recorded
obligations but the work has not yet started and the cost to complete work
that has been started. 4 U. S. General Accounting Office, Defense Working
Capital Fund: Improvements Needed for Managing the Backlog of Funded Work,
GAO- 01- 559 (Washington, D. C.: May 30, 2001).

intended. In June 2002, we reported 5 on our review of the contract
portion of the Air Force depot maintenance activity group. We found that
the Air Force reported carryover balances were not reliable due to (1)
faulty assumptions used in calculating work- in- process and (2) records
not accurately reflecting work that was actually completed by fiscal year-
end.

As requested and agreed to with your office, this report assesses
carryover related to the Navy*s Space and Naval Warfare Systems Command
(SPAWAR) systems centers located at Charleston, South Carolina and San
Diego, California. The SPAWAR systems centers have hundreds of millions of
dollars of carryover and the carryover balance has been steadily
increasing over the last 5 years. Our objectives were to determine if (1)
differences existed between the budgeted and reported actual gross 6
carryover and, if so, the reasons for the variances, (2) the reported
actual

carryover balances accurately reflected the amount of work that remained
to be accomplished, and (3) the SPAWAR systems centers had reliable
underlying financial information to serve as the basis for reported actual
carryover. Our review was performed from July 2002 through June 2003 in
accordance with U. S. generally accepted government auditing standards.

However, we did not fully validate the accuracy of the accounting and
budgeting data referred to in this report, all of which were provided by
the Navy. Further details on our scope and methodology can be found in
appendix I. We requested comments on a draft of this report from the
Secretary of Defense or his designee. Written comments from the Under
Secretary of Defense (Comptroller) are reprinted in appendix II.

Results in Brief We found that the budgeted and reported actual amounts of
gross carryover were consistently understated, resulting in the Congress
and

DOD decision makers not having carryover information they need to make
decisions regarding the level of funding to be provided to working capital
fund customers. For fiscal years 1998 through 2002, SPAWAR systems centers
reported that actual gross year- end carryover was substantially greater
than their budgeted gross carryover. For example, for fiscal year

5 U. S. General Accounting Office, Air Force Depot Maintenance: Management
Improvements Needed for Backlog of Funded Contract Maintenance Work, GAO-
02- 623 (Washington, D. C.: June 20, 2002).

6 Gross carryover is the dollar value of work that has been ordered and
funded (obligated) by customers but not completed by working capital fund
activities at the end of the fiscal year.

2002, the Navy budget request estimated that the SPAWAR systems centers
would have about $610 million in gross carryover, but the Navy
subsequently reported that the centers actually had about $896 million* a
difference of $286 million, or 47 percent.

The budget requests substantially underestimated gross carryover because
the Navy also underestimated the dollar value of orders that the SPAWAR
systems centers would receive from customers by hundreds of millions of
dollars from fiscal years 1998 through 2002. For example, for fiscal year
2002, in formulating its budget request the Navy expected the SPAWAR

systems centers to receive about $1.3 billion in customer orders, but the
Navy reported that the centers actually received about $2.4 billion in
customer orders* a difference of $1.1 billion, or 88 percent. The Navy
underestimated customer orders from fiscal years 1998 through 2002 for the
following reasons.

 The customers had consistently underestimated the amount of orders being
placed with the SPAWAR systems centers.

 Orders received from certain Navy customers, called third- party
customers, were not included in SPAWAR*s budget.

 The Naval Computers and Telecommunications Command merged with SPAWAR
systems centers, resulting in about $125 million of additional orders
being received in fiscal year 2001 than were reflected in the systems
centers* fiscal year 2001 budget request.

 The Navy changed its policy on performing work on certain types of
orders placed with the San Diego Systems Center, resulting in more work
being performed in the working capital fund than envisioned in the
original budget estimates for fiscal years 2001 and 2002.

 The SPAWAR systems centers received about $167 million in orders
financed with a supplemental appropriation in fiscal year 2002 that was
not reflected in the budget.

In addition, we found that the systems centers* reported actual carryover
balances were unreliable and adjusted downward by hundreds of millions of
dollars because (1) DOD*s guidance for calculating the number of months of
carryover allowed these adjustments and (2) the systems centers
manipulated customer work orders at year- end to reduce reported
carryover.

 In May 2001, we reported 7 that DOD*s guidance was not clear regarding
the treatment of contractual obligations in calculating carryover. The
number of months of carryover is a ratio of the dollar value of unfinished
orders (numerator) at year- end to revenue earned for that fiscal year
(denominator). Since DOD*s guidance was unclear, the Navy reduced the
dollar value of unfinished orders in the numerator related to

contractual obligations but did not reduce revenue in the denominator by
the amount of revenue earned from customers for contractual services. As a
result of this practice and another discussed below, from fiscal years
1998 through 2002, the Navy was able to reduce SPAWAR*s carryover balances
below the 3- month standard. In May 2001, we also reported that the months
of carryover reported by Navy activity groups, which include the SPAWAR
systems centers, would more accurately reflect the actual backlog of in-
house work if adjustments for contract obligations affected both contract
carryover and contract revenue. The Office of the Under Secretary of
Defense (Comptroller) agreed with our May 2001 report. DOD revised its
carryover policy in December 2002, and the policy became effective with
the fiscal year 2004 budget submission. Under the revised method, DOD
eliminated the 3- month standard, and the allowable amount of carryover is
to be based on the overall disbursement rate of the customers*
appropriations financing the work. This policy, if implemented as
designed, would eliminate the contractual obligation and related revenue
problem discussed above. DOD is in the process of developing written
procedures for implementing the new policy.

 We found that the two systems centers manipulated their reported
carryover by making accounting entries at fiscal year- end that shifted
reimbursable work (working capital fund) to direct cite work (direct
appropriation) for the sole purpose of reducing reported carryover below
the 3- month standard. 8 This practice resulted in the Navy providing
misleading carryover information to the Congress and DOD. For example, the
systems centers made these accounting entries at fiscal year- end 2000 for
at least $38 million and at fiscal year- end 2001 for at least $50
million. SPAWAR officials told us that this has been a

long- standing practice to reduce reported carryover below the 3- month 7
GAO- 01- 559. 8 Reimbursable work is work performed for the customer by
the systems centers for which the customer pays the systems centers
directly. Direct cite work is work performed for the customer by a private
sector contractor, which bills the customer directly.

standard. After we discussed this with SPAWAR officials, guidance was
issued discontinuing this practice beginning in fiscal year 2002.

Furthermore, the actual carryover data that the two SPAWAR systems centers
reported were based on unreliable underlying financial data, in part,
because the two centers had not fully complied with DOD*s May 1996
guidance that requires them, and all other DOD fund holders, to conduct
tri- annual reviews of commitments, obligations, and accrued expenditures
to ensure the accuracy and timeliness of financial transactions.
Specifically, our work showed that the two systems centers (1) did not
begin conducting their reviews until September 2001 and September 2002* at
least 5 years after the establishment of the DOD requirement, (2) excluded
about 46 percent of their September 2002 reported actual

carryover from their tri- annual reviews, (3) did not effectively review
dormant obligations (obligations with balances that have not changed for
more than 120 days) and, therefore, returned unneeded funds to customers
after the funds had expired, and (4) were not effectively reviewing
accrued expenditure data (accrued expenditures reduce carryover). We also
found that neither SPAWAR headquarters nor the two systems centers*
commanders had developed effective policies and procedures for ensuring
that tri- annual reviews are conducted in accordance with DOD guidance and
that timely and appropriate corrective action is taken on problems that
are identified during the reviews.

We are making recommendations to the Secretary of Defense to (1) improve
the reliability of reported carryover amounts to decision makers and (2)
issue procedures for DOD*s new carryover policy. We are also making a
recommendation to the Secretary of the Navy to improve the management and
reporting of budgeted and actual carryover by comparing budgeted orders to
actual orders received from customers, and to consider these trends in
developing the budget estimates on orders to be received from customers.
We are also making recommendations to the

Commanders of SPAWAR and one of the systems centers that are aimed at
improving the effectiveness of their tri- annual reviews. In its comments
on a draft of this report, DOD concurred with 12 of our 14 recommendations
and partially concurred with the remaining 2 recommendations. For these 2
recommendations, DOD agreed with our intent to ensure that obligations,
unobligated balances, and commitments are reviewed regularly to ensure
effective use of funds. To that end, DOD said it would review its guidance

to ensure clarity of intent.

Background According to the Navy*s fiscal year 2003 budget, the Navy
Working Capital Fund will earn about $20.8 billion in revenue during
fiscal year 2003. The

Navy Working Capital Fund consists of the following six major activity
groups: depot maintenance, transportation, base support, information
services, supply management, and research and development. The Navy
estimates that the research and development activity group will earn about
$7.7 billion during fiscal year 2003, the largest activity group in terms
of the dollar amount of revenue earned. This activity group includes the
following subactivity groups: (1) the Naval Surface Warfare Center, (2)
the Naval Air Warfare Center, (3) the Naval Undersea Warfare Center, (4)
the Naval Research Laboratory, and (5) the Space and Naval Warfare Systems
Centers.

The SPAWAR systems centers are the Navy*s full- spectrum research,
development, test and evaluation, engineering, and fleet support centers
for command, control, and communication systems and ocean surveillance and
the integration of those systems. The systems centers (1) support the
fleet in mission and capability by providing capable and ready command and
control systems for the Navy and (2) provide the innovative scientific and
technical expertise and facilities necessary to ensure that the Navy can
develop, acquire, and maintain the warfare systems needed to meet
requirements. The SPAWAR systems centers* primary locations are in San
Diego, California and Charleston, South Carolina. Description of the
Working

As part of the Navy Working Capital Fund, the SPAWAR systems centers
Capital Fund Process of

rely on sales revenue rather than direct congressional appropriations to
Setting Prices and finance their operations. DOD policy requires working
capital fund activity Obligating Customer Funds groups to (1) establish
prices that allow them to recover their expected costs from their
customers and (2) operate on a break- even basis over time* that is, not
make a profit nor incur a loss. DOD policy also requires the activity
groups to establish their sales prices prior to the start of each fiscal
year and to apply these predetermined or *stabilized* prices to most
orders received from customers during the year* regardless of when the
work is actually accomplished or what costs are actually incurred.
Customers use appropriated funds to finance the orders placed with the

SPAWAR systems centers. When a systems center accepts the customer order,
its own obligational authority is increased and the customer*s
appropriation is obligated by the amount of the order. The working capital

fund activity incurs obligations for costs, such as material and labor, to
perform the work.

In addition to receiving orders from customers to do work as part of the
working capital fund, SPAWAR systems centers also award hundreds of
millions of dollars in contracts with the private sector for work to be
performed for the centers* customers. These contracts and related work are
not included in the working capital fund from a financial standpoint
because the contractors directly bill the customers for work performed and
the customers directly pay the contractors. DOD and the Navy refer to this
process of awarding contracts for customers as direct cite orders, since
the

SPAWAR systems centers cite the customers* appropriation( s) on the
contracts. The customers* funds are obligated when the systems centers
award the contracts with contractors. 9 What Is Carryover and Why

Carryover is the dollar value of work that has been ordered and funded Is
It Important?

(obligated) by customers but not yet completed by working capital fund
activities at the end of the fiscal year. 10 Carryover consists of both
the unfinished portion of work started but not yet completed, as well as
requested work that has not yet commenced. To manage carryover, DOD
converted the dollar amount of carryover to equivalent months of work.
This was done to put the magnitude of the carryover in proper perspective.
For example, if an activity group performs $100 million of work in a year
and had $100 million in carryover at year- end, it would have 12 months of
carryover. However, if another activity group performs $400 million of
work in a year and had $100 million in carryover at year- end, this group
would have 3 months of carryover. 9 The systems centers charge customers a
fee for awarding and administering these

contracts. 10 The two basic types of orders customers can place with a
working capital fund activity are Project Orders and Economy Act orders,
which are issued under the authority of Section 23 of Title 41, United
States Code, and Section 1535 of Title 31, United States Code,
respectively. These two types of orders are distinguished for accounting
purposes by the period of time that the related funding is available for
use by a working capital fund. For example, an Economy Act order funded by
the Navy Operation and Maintenance appropriation that is not used
(obligated) by the working capital fund activity by the end of the fiscal
year is no longer available for new obligations and must be returned to
the customer, absent some specific statutory authorization. However, the
same appropriated funds used to finance a Project Order may be used (or
*carried over*) by the working capital fund activity to enter into new
obligations in the next fiscal year.

The congressional defense committees and DOD have acknowledged that some
carryover is necessary at fiscal year- end if working capital funds are to
operate efficiently and effectively. In 1996, DOD established a 3- month
carryover standard for all the working capital fund activities except for
the contract portion of the Air Force depot maintenance activity group. 11
In

May 2001, we reported 12 that DOD did not have a basis for its carryover
standard and recommended that DOD determine the appropriate carryover
standard for the depot maintenance, ordnance, and research and development
activity groups. Based on our recommendation, in December 2002, DOD
revised its carryover policy for working capital fund activities. Under
the revised method, DOD eliminated the 3- month standard, and the
allowable amount of carryover is to be based on the overall disbursement
rate of the customers* appropriations financing the work. Too little
carryover could result in some activity groups not having work to perform
at the beginning of the fiscal year, resulting in the inefficient use of
personnel. On the other hand, too much carryover could result in an
activity group receiving funds from customers in one fiscal year but not
performing the work until well into the next fiscal year or subsequent
years. By minimizing the amount of the carryover, DOD can use its

resources most effectively and minimize the *banking* of funds for work
and programs to be performed in subsequent years. Gross Carryover

For fiscal years 1998 through 2002, SPAWAR systems centers* budgeted
Budget Estimates Were

gross carryover was significantly less than reported actual gross
carryover, thereby providing decision makers, including the Office of the
Under Consistently and

Secretary of Defense (Comptroller) and congressional defense committees,
Substantially

misleading carryover information. 13 These decision makers use carryover
Understated

information to determine whether the SPAWAR systems centers have too much
carryover. If the systems centers have too much carryover, the decision
makers may reduce the customers* budgets and use these

resources for other purposes. For example, during its review of the fiscal
11 The Air Force is the only military service that includes its contract
depot maintenance operation in its working capital fund. To reflect this
difference, DOD established a 4.5- month carryover standard to account for
the additional administrative functions associated with awarding
contracts. The Air Force is currently in the process of taking its
contract depot maintenance operation out of the working capital fund.

12 GAO- 01- 559. 13 We previously reported on this issue in May 2001 in
our report GAO- 01- 559.

year 2003 budget, the Office of the Under Secretary of Defense
(Comptroller) noted that the Navy research and development activities
carryover had been steadily increasing from about $2.2 billion in fiscal
year

1997 to about $3.4 billion in fiscal year 2003. Since a significant
portion of the carryover was related to work that was to be contracted
out, the Office of the Under Secretary of Defense (Comptroller) reduced
the customer funding by $161.1 million because these efforts could be
funded in fiscal year 2004 with no impact on performance.

Customers* Underestimated SPAWAR systems centers* reported actual year-
end gross carryover was

Budgeted Orders Caused substantially greater than their budgeted gross
carryover. Table 1 shows

Understated Budgeted that from fiscal year 1998 through fiscal year 2002
reported actual gross

Gross Carryover carryover exceeded budgeted gross carryover, and the
difference has

increased from about $153 million to about $286 million.

Tabl e 1: SPAWAR Systems Centers* Budgeted and Reported Actual Gross
Carryover from Fiscal Year 1998 through Fiscal Year 2002

Dollars in millions

Budgeted gross Actual gross Actual exceeds Fiscal year carryover a
carryover a budgeted carryover

1998 $377 $530 $153 1999 332 563 231 2000 358 613 255 2001 567 875 308
2002 610 896 286 Sources: Navy budget and accounting reports. a Gross
carryover is the dollar value of work that has been ordered and funded
(obligated) by customers but not completed by working capital fund
activities at the end of the fiscal year.

The Navy*s budget requests consistently underestimated SPAWAR systems
centers* gross carryover, in part, because the Navy consistently
underestimated the amount of orders to be received from customers by
hundreds of millions of dollars. Table 2 shows that the amount of
difference between budgeted and reported actual orders increased from
about $352 million (39 percent) in fiscal year 1998 to about $1.1 billion
(88

percent) in fiscal year 2002. Since orders received from customers are the
major source of funds for SPAWAR and one of the key factors in determining
the amount of carryover at fiscal year- end, it is critical that the

Navy has accurate budget estimates on the amount of orders to be received
from customers. However, for fiscal years 2000, 2001, and 2002 actual
orders exceeded budgeted orders by at least 68 percent each year. Tabl e
2: SPAWAR Systems Centers* Budgeted and Reported Actual Orders Received

from Customers for Fiscal Year 1998 through Fiscal Year 2002

Dollars in millions

Fiscal year Fiscal year

Fiscal year Fiscal year

Fiscal year 1998 a 1999 a 2000 a 2001 2002

Budgeted $ 912 $ 913 $ 890 $1, 226 $1, 259 Actual 1,263 1,243 1,533 2,055
2,363 Difference 352 329 644 829 1,104

Percentage difference 39 36 72 68 88

Sources: Navy budget and accounting reports. a Figures do not add due to
rounding.

The data in table 2 indicate that the SPAWAR systems centers* customers
have not accurately estimated the amount of orders they will place with
the systems centers. Customers determine and justify their anticipated
requirements for goods and services and the levels of performance they
require from the systems centers to fulfill mission objectives. Our
analysis of budget and accounting reports that provide information on
customer orders shows that orders financed with three appropriations made
up a large part of the differences in fiscal years 2000, 2001, and 2002.
The appropriations used by customers to finance 49 percent to 67 percent
of the differences for these 3 fiscal years were the

 Other Procurement, Navy appropriation;  Research, Development, Test,
and Evaluation, Defense appropriation;

and  Research, Development, Test, and Evaluation, Navy appropriation.

Reasons for Variances Officials from the Charleston and San Diego Systems
Centers and SPAWAR

between Budgeted and headquarters stated, and our work found, that
customers have historically

Reported Actual Gross understated their budget estimates on customer
orders that are received by

Carryover and Orders the SPAWAR working capital fund. They stated that the
systems centers*

budgets for orders are based on what the customers tell them their
Received from Customers

requirements would be for a particular fiscal year. However, they also
told us that customers are hesitant to make a full commitment to the
estimated amount of work that will need to be performed.

SPAWAR and Navy headquarters budget officials acknowledged that the SPAWAR
systems centers* budgets have consistently understated gross carryover and
orders received from customers (claimants). They also stated that the
dollar amount of orders that the systems centers receive

from customers must match the dollar amount of orders that customers
submit in their appropriated fund budgets. Customers only record in their
budgets those orders that they will be sending directly to the systems
centers. If a customer initially allocates budgeted funds to an activity
not related to the working capital fund* which is a third party* and the
third party places the order with a SPAWAR systems center, the customer*s
budget reflects that these funds went to a third party. This results in
the

amount of budgeted orders that the systems centers receive from customers
being understated. Navy headquarters officials stated that this is not an
easy problem to resolve because there are many customers and no

one person or office is responsible for fixing the problem and it is hard
to pinpoint which customers are not budgeting correctly.

Navy headquarters budgeting officials also stated that the fiscal year
2001 and 2002 budgets further understated gross carryover and orders for
the following three reasons. First, the Naval Computers and
Telecommunications Command merged with SPAWAR, which resulted in about
$125 million of additional orders being received in fiscal year 2001 than
was reflected in SPAWAR systems centers* budget. Second, the Navy changed
its policy on work performed on certain types of work orders placed with
the San Diego Systems Center. As a result, customers placed more orders
for work that was contracted out by the working capital fund than was
originally budgeted for in fiscal years 2001 and 2002. Third, the SPAWAR
systems centers received $166.7 million in orders financed by the

Defense Emergency Response Fund in fiscal year 2002 that was not reflected
in the SPAWAR systems centers* budget. These funds were provided via a
supplemental appropriation.

Navy headquarters officials were aware of this budgeting problem and
issued guidance in March 2002 on preparing the fiscal 2004/ 2005 budget
estimates that stressed the importance of customers accurately preparing

budget estimates for orders placed with the Navy Working Capital Fund,
including the SPAWAR systems centers. The guidance also stated that (1) it
was imperative that all funds to be sent to the Navy Working Capital Fund
be accurately reflected in the budget and (2) customers have historically
underreported the funds to be placed with the Navy Working Capital Fund
(particularly with the research and development business area that
includes the SPAWAR systems centers) and overreported the use of these

funds in other areas. Reported Actual In addition to understating budgeted
gross carryover, SPAWAR systems Carryover Balances

centers also consistently understated their reported actual carryover.
Inaccurate carryover information results in the Congress and DOD officials
Were Consistently

not having the information they need to perform their oversight
Understated

responsibilities, including reviewing DOD*s budget. Navy reports show that
the systems centers* fiscal year- end carryover balances for fiscal years
1998 through 2002 did not exceed DOD*s 3- month carryover standard.
However, we found that the systems centers* reported carryover balances
were

understated because (1) DOD*s guidance for calculating the number of
months of carryover allowed this to happen and (2) the systems centers
used accounting entries to manipulate customer work orders at year- end to
help reduce reported carryover below the 3- month standard.

Defense Carryover Policy Prior to 1996, if working capital fund activity
groups* budgets projected more than a 3- month level of carryover, their
customers* budgets could be,

and sometimes were, reduced by the Office of the Under Secretary of
Defense (Comptroller) and/ or congressional committees. Because of the
military services* concerns about (1) the methodology used to compute the
months of carryover and (2) the reductions that were being made to
customer budgets because of excess carryover, Defense performed a joint
review 14 of carryover in 1996 to determine if the 3- month standard
should be revised. Based on the joint review, DOD decided to retain the 3-
month

carryover standard for all working capital fund activity groups except Air
Force contract depot maintenance. 15 Furthermore, as a result of the
review and concerns expressed by the Navy, DOD also approved several
policy changes that had the effect of increasing the carryover standard
for all working capital fund activities. Specifically, under the policy
implemented after the 1996 review, certain categories of orders, such as
those from nonDOD

customers, and contractual obligations, such as SPAWAR system centers*
contracts with private sector firms for research and development work, can
be excluded from the carryover balance 16 that is used to determine
whether the carryover standard has been exceeded.

These policy changes were documented in an August 2, 1996, DOD decision
paper that provided the following formula for calculating the number of
months of carryover. (See fig. 1.)

14 This joint study group included representatives from the Office of the
Secretary of Defense, the Office of the Joint Chiefs of Staff, and each of
the military services. 15 The Air Force is the only service that contracts
out significant amounts of depot maintenance work through the working
capital fund. Because of the additional administrative functions
associated with awarding contracts, DOD set a 4.5- month carryover
standard for Air Force contract depot maintenance. The Air Force is
currently in the process of removing the contract portion of its depot
maintenance operation from the working capital fund.

16 Adjusted carryover is the obligated balance of budget authority carried
over from one fiscal year to the next and adjusted for contractual
obligations and certain categories of orders, such as those from non- DOD
customers.

Figure 1: DOD Carryover Computation Based on the Fiscal Year 2002 Budget

Carryover Calculation DOD*s 1996 decision to allow certain categories of
orders to be excluded

Understated Reported (adjustments) from reported gross carryover has had a
significant impact

Carryover on SPAWAR systems centers* reported carryover, particularly the

adjustment for contractual obligations. As table 3 shows, these
adjustments have allowed the systems centers to significantly reduce
actual reported gross carryover by hundreds of millions of dollars,

resulting in reported carryover below the 3- month standard. As discussed
below, we do not agree with how the Navy interpreted DOD*s guidance for
using contractual obligations and related revenue in calculating
carryover. Our analysis of the systems centers* adjustments to their
carryover

amounts shown in table 3 found that contractual obligations accounted for
75 percent to 89 percent of the dollar adjustments made.

Tabl e 3: SPAWAR Systems Centers* Reported Actual Gross Carryover before
and after Adjustments for Fiscal Years 1998 through 2002

Dollars in millions

Before adjustments After adjustments Fiscal year Dollars Months Dollars
Months

1998 $530 5.8 $196 2.1 1999 563 5.4 212 2.0 2000 613 4.8 243 1.9 2001 875
6.0 368 2.5 2002 896 4.5 421 2.1 Sources: Navy budget and accounting
reports.

In May 2001, we reported 17 that the months of carryover reported by Navy
activity groups, which include the SPAWAR systems centers, would more
accurately reflect the actual backlog of in- house work if adjustments for
contract obligations affected both contract carryover and contract
revenue. As shown in figure 1, DOD*s formula for calculating months of
carryover is based on the ratio of adjusted orders carried over to
revenue. The formula specifies that gross carryover should be reduced by
the

amount of contract obligations. However, DOD did not provide clear
guidance on whether downward adjustments for the revenue associated with
contract services should also be made. Unless this is done, the number of
months of reported carryover will be understated.

In our May 2001 report we recommended, among other things, that the
revenue used in calculating months of carryover be adjusted (reduced) for
revenue earned for work performed by contractors. However, as discussed
below, until recently DOD had not changed its policy for calculating
carryover. As a result, the Navy did not adjust the revenue amount used in
the denominator of the calculation and, therefore, continued to understate
its reported carryover in its budget submissions to the Congress through
fiscal year 2003. Navy officials informed us that they used total revenue
in their calculation because total revenue represents the full operating

17 GAO- 01- 559.

capability of a given activity group to accomplish a full year*s level of
workload. Further, even though Navy officials acknowledged that the
revenue amount used in the calculation includes revenue earned from
contracts, they stated the reason for not removing contract- related
revenue from the denominator of the calculation was that the numerator of
the

calculation includes carryover (funds) related to work for which contracts
would eventually be awarded but which had not yet been awarded at fiscal
year- end. In addition, Navy officials told us that the accounting systems
cannot readily break out what portion of the total revenue amount is
contract- related. They further told us that the revenue information can
be extracted from the system, but doing so involves a lot of work to
develop the program( s) necessary to obtain the information.

When the Navy reduces the dollar amount of carryover (numerator) by the
amount of contractual obligations and does not reduce the revenue amount
(denominator) for revenue associated with contracts, it is not being
consistent with the use of adjustments in the formula to calculate
carryover. Because the Navy cannot readily determine the amount of
contract- related revenue, we asked SPAWAR headquarters to estimate what
the amount would be for the systems centers based on the same criteria
they use to determine the dollar amount of contractual obligations to be

deducted in the carryover calculation. SPAWAR*s estimate shows that 63
percent of the total revenue amount used in calculating the SPAWAR systems
centers* number of months of actual carryover reported for fiscal year
2002 is related to revenue associated with contractual services. By not

reducing total revenue used in the calculation for revenue related to work
performed by contractors, the systems centers* reported months of
carryover for that fiscal year were understated. In response to our May
2001 report, the Under Secretary of Defense (Comptroller) agreed that the
methodology for calculating carryover

needed to be revised. In December 2002, the Under Secretary of Defense
(Comptroller) issued new guidance on carryover for working capital fund
activities. Under the revised methodology, the formula shown in figure 1
has been eliminated and, therefore, working capital fund activities can no
longer reduce reported carryover by the amount of their contractual
obligations. DOD adopted the revised methodology for the Defense Working
Capital Fund fiscal year 2004 budget estimates, but DOD has not yet issued
written procedures to ensure that the services consistently implement the
new policy. DOD officials informed us that they are developing the
procedures and will update the appropriate regulations in 2004. We did not
evaluate DOD*s revised carryover policy.

Customer Orders Were We also found that the systems centers reduced
reported carryover by Manipulated at Year- end to

simply making accounting entries that took work to be performed by the
Reduce Reported Carryover

working capital fund and turned it into work to be performed outside the
working capital fund. Customer work that is performed by the working
capital fund is referred to as reimbursable work. Customer work that is
not performed by the working capital fund is referred to as direct cite
work. Under the direct cite method of performing work, the working capital
fund acts as an agent to get the work done through a private sector
contractor. Customer funds that finance work done on a direct cite basis
are not

included in the working capital fund. Instead, the customer uses the
direct cite funds to directly pay private sector contractors for the work
performed rather than reimbursing or paying the working capital fund.
Because the funds for direct cite work are not part of the working capital
fund, there is

no carryover associated with this work. Therefore, the work is not subject
to DOD*s 3- month carryover standard.

The two SPAWAR systems centers made some accounting entries at fiscal
year- end that moved customer orders out of the working capital fund for
the sole purpose of reducing reported carryover below the 3- month
standard, which understated the amount of carryover that SPAWAR reported
to the Navy and DOD. They then reversed these accounting entries in the
beginning of the next fiscal year. Specifically, the systems

centers did this at fiscal year- end 2000 for customer orders totaling at
least $38 million and at fiscal year- end 2001 for orders totaling at
least $50 million. SPAWAR systems centers* officials acknowledged that
these

accounting adjustments were made at fiscal year- end to reduce reported
carryover. The officials told us that this has been a long- standing
practice and was used as a *tool* to manage reported carryover. For
example, comptroller officials at one systems center told us that as the
fiscal yearend grew near, they had a good idea of how much they needed to
move from reimbursable to direct cite in order to get down below the 3-
month carryover standard. At year- end, if it was determined that they
moved more funds than needed to get below the standard, they would move
the excess back to reimbursable before the accounting period was
officially closed.

We do not view these actions as a tool for managing workload as reflected
by the reported carryover but as a misrepresentation of actual carryover
balances in order to mislead decision makers, including DOD budget
officials and the Congress. After discussing this practice with SPAWAR
headquarters officials, they issued guidance in September 2002,
prohibiting the use of reimbursable/ direct cite accounting adjustments to
mask yearend carryover balances. In discussing this with Navy headquarters
and

DOD officials, they told us that they were not aware that the systems
centers were doing this and that they did not agree with this practice.

Reported Actual In addition to understating budgeted and reported actual
carryover

Carryover Is Based on information, the two SPAWAR systems centers* actual
carryover data that

were reported to the Congress as part of the President*s budget were based
Unreliable Underlying

on some unreliable underlying financial data. Although many factors could
Financial Data

have contributed to this data problem, a primary cause was that the two
centers had not fully complied with DOD guidance that required them and
all other DOD fund holders 18 to conduct tri- annual reviews of their
financial data (outstanding commitments, obligations, and accrued
expenditures). In fact, although DOD established its tri- annual review
requirement in 1996 in order to improve the timeliness and accuracy of its
financial data, the Charleston and San Diego Systems Centers did not
conduct their first

reviews until September 2001 and September 2002, respectively. Further, as
of September 2002, the systems centers were fully complying with only a
few of the 16 specific tasks that they were required to accomplish during
their reviews.

As discussed below, three carryover- related problems with the two systems
centers* tri- annual reviews are that the centers (1) excluded about 46
percent of their reported actual carryover from their September 2002
triannual

reviews, (2) were not effectively reviewing dormant obligations 19 and,
therefore, were sometimes returning unneeded funds to customers after the
funds had expired, and (3) were not effectively reviewing accrued
expenditure data (accrued expenditures reduce carryover). A fourth problem
was that neither SPAWAR headquarters nor the systems centers* commanders
had developed effective policies and procedures for ensuring that (1) tri-
annual reviews are conducted in accordance with DOD guidance and (2)
timely and appropriate corrective action is taken on problems that are
identified during the reviews.

18 The fund holder is the organization on whose accounting records a
commitment, obligation, and/ or accrued expenditure is recorded. 19
Obligations are considered dormant if their unliquidated balances have not
changed for more than 120 days.

Effective Tri- Annual The May 1996 memorandum from the Under Secretary of
Defense

Reviews Can Result in More (Comptroller) that established DOD*s tri-
annual review requirement noted Informed Carryover- Related

that the timely review of commitments and obligations to ensure the Budget
Decisions and Other

accuracy and timeliness of financial transactions is a vital phase of
financial management. To illustrate this point, the Under Secretary stated
Benefits

that the accurate recording of commitments and obligations (1) forms the
basis for formal financial reports issued by the department and (2)
provides information for management to make informed decisions regarding
resource allocation.

Carryover- related budget decisions are examples of resource allocation
decisions that require reliable obligation data. This is because there is
a direct link between the (1) carryover data that working capital fund
activities report to the Congress and DOD decision makers and (2)
obligation data contained in the accounting records of working capital

fund activities and their customers. Specifically,  when working capital
fund activities, such as the SPAWAR systems

centers, accept customer orders, obligations are created in the customers*
accounting records, and the systems centers become the *fund holders* and
 as work is performed and customers are billed, both the unliquidated

obligation balances in the customers* accounting records and the working
capital fund activities* reported carryover balances are reduced.

DOD*s implementing guidance for the tri- annual reviews requires fund
holders, such as the two SPAWAR systems centers, to certify that they
completed 16 specific tasks during their reviews. For example, the
guidance requires fund holders to confirm, among other things, that they
have (1) traced the obligations and commitments that are recorded in their
accounting systems back to source documents and (2) conducted adequate
follow- up on all dormant obligations and commitments to determine if they
are still valid. 20 Additionally, the guidance requires fund holders to 20
All obligation and commitment balances that have not changed for more than
120 days are

required to be reviewed during the 4- month period ending September 30
each fiscal year* but only those balances greater than a certain amount
are required to be reviewed during each of the 4- month periods ending
January 31 and May 31 of each fiscal year (e. g., for customer order-
related obligations and commitments, the amount is $50,000).

(1) identify the problems that were noted during their reviews, (2) advise
their higher headquarters* SPAWAR headquarters for the two systems
centers* whether, and to what extent, adjustments or corrections to remedy
noted problems have been taken, (3) summarize, by type, the actions or
corrections remaining to be taken, (4) indicate when such actions/
corrections are expected to be completed, and (5) identify the actions
that have been taken to preclude identified problems from recurring in the
future. Thus, if properly implemented, tri- annual reviews can provide a
systematic process that helps fund holders not only improve the
reliability of their financial data but also identify and correct the
underlying causes of their data problems.

Tri- Annual Reviews Have As noted previously, DOD established the tri-
annual review requirement in

Received Very Little May 1996, but the Charleston and San Diego Systems
Centers did not

Management Emphasis conduct their first reviews until September 2001 and
September 2002,

respectively. Discussions with SPAWAR officials and the centers* financial
managers indicated that a lack of management emphasis is the primary
reason for this delayed implementation.

For example, SPAWAR headquarters officials pointed out that the Navy*s
implementing guidance was not issued until July 2001* more than 5 years
after DOD established the requirement, and San Diego Systems Center
financial managers stated that they were not aware of the tri- annual
review requirement until fiscal year 2001. Further, when Charleston and
San Diego

financial managers were asked why their centers did not conduct their
first tri- annual reviews until the end of fiscal year 2001 and 2002,
respectively, they stated that their personnel were busy reconciling data
problems that

were caused by multiple organizational consolidations and accounting
system conversions, and indicated that their personnel did not have time
to conduct tri- annual reviews.

DOD Guidance Allows a The SPAWAR systems centers* reported actual
carryover falls into two

Substantial Amount of major categories* obligated carryover and
unobligated carryover.

Carryover to Be Excluded Obligated carryover refers to the portion of
customer orders for which the

from Tri- Annual Reviews systems centers have obligated their own funds.
For example, if a

customer submits a $1,000 order for engineering services, and a contractor
will accomplish 10 percent of the work, then the systems center will award
a contract for $100* which will obligate the center*s funds* and the $100
will, therefore, be referred to as obligated carryover. A customer order*s
unobligated carryover balance is calculated by subtracting obligated
carryover from the total amount remaining on the order* or $900 for this

example. As of September 30, 2002, the two SPAWAR systems centers had
about $896.1 million of reported actual carryover*$ 379.5 million of
obligated carryover and $516.6 million of unobligated carryover.

The distinction between obligated carryover and unobligated carryover is
important because (1) neither DOD nor Navy guidance explicitly requires
the systems centers to review unobligated carryover during their tri-
annual reviews (unless the work is recorded as a commitment in their
accounting records) and (2) about $414 million of the systems centers*
September 30, 2002, unobligated carryover was not recorded as a commitment
in the centers* accounting records. In other words, even if the tri-
annual reviews

were performed effectively and in a timely manner, they would not cover
about 46 percent of the systems centers* reported actual carryover.

DOD guidance does require customers, as part of their tri- annual reviews,
to validate the orders they have placed with working capital fund
activities because these orders are recorded as obligations in their
accounting records, regardless of whether they are obligated or
unobligated carryover in the working capital fund activities* records.
However, customers have limited visibility over whether the unobligated
portion of their funded

orders are needed to finance future work, and, therefore, the working
capital fund activities are in a better position than the customers to
make this determination.

If the systems centers were required to review unobligated carryover
balances when performing their tri- annual reviews, they could (1) reduce
the amount of carryover on their records and (2) better identify unneeded
funds and be in a better position to return them to customers before the
funds expired 21 so the customers could use them for new obligations. For
example, our review of 34 customer orders that (1) had $7 million of
unobligated carryover balances as of September 30, 2001, and (2) were
financed with funds that had already expired as of that date showed that
most of the orders contained unneeded funds that were eventually returned
to customers. Our analysis showed that (1) 27 of the orders (about 79
percent) had unneeded funds and (2) $2. 9 million, or about 41 percent, of
the orders we reviewed represented unneeded funds.

21 The Congress generally provides budget authority to an agency for use
during a specific period, referred to as the period of availability.
During this period of availability, the agency may incur new obligations,
for example, those for goods and services, and charge them against the
appropriation. At the end of the period of availability, the appropriation
expires,

meaning that it may not be used to incur new obligations.

Although most of the unneeded funds we identified were eventually returned
to customers, in some instances the funds were not returned until long
after the funds expired. For example, $469,916 of unneeded funds on two
Charleston Systems Center orders expired in September 2001, but was not
returned to the customer until September 2002* almost 1 year after the
funds had expired. Similarly, $71,718 of unneeded funds on a San Diego
order expired in September 1998, but was not returned to the customer
until December 2002* more than 4 years after the funds had expired.

We believe, and a senior DOD accounting official agreed, that the systems
centers and other working capital fund activities should be required to
validate their unobligated carryover during tri- annual reviews because,
as noted previously, they have better visibility over whether unobligated
funds will be needed in the future. However, neither center requires its
managers to review unobligated carryover during the tri- annual reviews
because, as financial managers at one center pointed out, they are
concentrating on the requirements explicitly identified in the DOD
guidance, and they will add

other tasks, such as reviews of unobligated carryover, if and when (1) the
guidance is changed or (2) they have the time and resources to do so.

More Effective Reviews of A key element of the tri- annual reviews is the
requirement to follow up on Dormant Obligations Could

all obligations that have been dormant for more than 120 days to determine
Result in More Effective Use

if unused funds are still needed. This task is one of the 16 tri- annual
review of Customer Funds

requirements and is important from the systems centers* perspective
because the identification and return of unneeded funds to the customer
will reduce the centers* reported carryover* thereby reducing the
likelihood of customers* budget cuts. Additionally, the task is important
from the customers* perspective because the funds can be reused for other
purposes if they are returned before they expire.

However, our analysis of the two centers* financial data and review of
individual customer orders showed that neither center was effectively
identifying unneeded funds and returning them to customers in a timely
manner. For example, our analysis of the two systems centers* financial
data showed that, as of September 30, 2002, the two centers had thousands
of obligated carryover balances, valued at more than $7 million, that had
not changed for more than a year. Further, some of these dormant balances
were financed with customer funds that had long since expired. For
example, 165 of the dormant carryover balances were financed with fiscal
year 1996 or earlier appropriations. According to a systems center
official, the monumental financial workload involved with the acquisition
of

additional activities and the transition to a consolidated financial
accounting system occurring over the past several years greatly hindered
their efforts to close all expired funding documents and return the unused
funds to customers in a timely manner. For example, the official pointed
out that the center had almost 13,000 old funding documents needing to be
reconciled and closed at the start of fiscal year 2000 because of these
problems and that the center was still working on them.

Large Accrued Expenditure At the conclusion of their tri- annual reviews,
fund holders are required to

Balances Warrant Increased certify that they have conducted adequate
research on all accrued

expenditures 22 that are more than 120 days old to determine if they are
Management Emphasis

valid. This task is important because  large accrued expenditure
balances, in general, and large dormant

accrued expenditure balances, in particular, can indicate either serious
accounting problems or ineffective procedures for developing accrued
expenditure schedules and

 accrued expenditures reduce reported carryover balances, and overly
optimistic accrued expenditure schedules can, therefore, cause reported
carryover to understate actual carryover. The task of validating accrued
expenditures is especially important for the two SPAWAR systems centers
because they had about $673 million of accrued expenditures as of
September 30, 2002.

However, the San Diego Systems Center, which had the larger accrued
expenditure balance* about $423 million as of September 2002* is currently
developing a methodology for validating its accrued expenditures. Further,
although the Charleston Systems Center had developed a methodology to
review its accrued expenditures, the

Charleston Comptroller was concerned about the timeliness and adequacy of
these reviews and, therefore, was unwilling to certify that the center
adequately reviewed its dormant accrued expenditures.

22 According to DOD*s Financial Management Regulation 7000.14- R, Volume
1, accrued expenditures represent the amount of paid and unpaid
expenditures for (1) services performed by employees, contractors, etc.,
(2) goods and tangible property received, and (3) amounts owed under
programs for which no current service or performance is required.

Although the tri- annual review*s tasks related to accrued expenditures
focus primarily on accounting problems, reviews of dormant accrued
expenditures are also important from a carryover perspective. Overly
optimistic accrued expenditure schedules* which are the basis for
determining when accrued expenditures will be recorded in the accounting
system* can cause reported carryover to understate actual carryover. For
example, if a contractor is to perform $600 of work, and an accrued
expenditure schedule is based on the assumptions that the work will begin
immediately and will be performed at a uniform rate over a 6- month
period, then (1) $100 of expenditures will be accrued each month and (2)
each accrued expenditure will trigger a $100 customer payment and, in
turn, a $100 reduction in the reported carryover. Thus, after 4 months,
the reported carryover will be $200, regardless of how much work has
actually been accomplished. If the work begins later than expected or if
it takes longer than expected to complete, and accrued expenditures are
not adjusted accordingly, reported carryover would be understated.

Two ways to put the magnitude of the systems centers* accrued expenditure
balances in perspective are to (1) compare the balances with other
financial indicators and (2) show their impact on reported carryover. For
example, the San Diego Systems Center*s September 2002 accrued expenditure
balance of $423 million is the equivalent of about 32 percent of the
orders the center received during fiscal year 2002 ($ 1.315 billion) and
about 31 percent of the revenue it received during the year ($ 1.372
billion). The accrued expenditures allowed the center to reduce its
reported carryover at the end of fiscal year 2002 by about 3.7 months.

A San Diego Systems Center accounting official acknowledged that the
center*s large accrued expenditure balance is a major area of concern.
Specifically, this official indicated that the center*s large accrued

expenditure balance is caused partly by delays in contractor and interfund
billings, but acknowledged that there are other apparent problems that
warrant attention. For example, the official said that the $405 million
variance between the center*s September 30, 2002, accrued expenditure and
accounts payable balances is an apparent problem that should be

reviewed. However, the accounting official also pointed out that currently
the center cannot analyze its accrued expenditures because its new
accounting system, which has been tailored to meet its specific needs and
is unique within DOD, cannot provide the data in a format that will allow
it to do so.

When asked what the San Diego Systems Center is doing to develop the

data needed to effectively analyze its accrued expenditure data, the
accounting official indicated that the center is developing a *data
warehouse.* However, the official acknowledged that (1) they have just
begun identifying the specific requirements for the data warehouse, (2)
there will be many competing requirements, (3) due to resource

constraints, the data warehouse will not be able to satisfy all of the
center*s data analysis needs, and (4) they, therefore, do not know when
or, for that matter, if they will ever have the data they need to
effectively analyze their accrued expenditures.

Improvements Are Needed In addition to the major problems identified
above, our review of the

in SPAWAR*s Tri- Annual procedures that SPAWAR headquarters and its two
systems centers use to Review Procedures

conduct their tri- annual reviews identified several areas that need
improvements. For example, SPAWAR headquarters has not evaluated the
systems centers* reviews and, as a result, the command (1) does not have a
sound basis for assessing the adequacy of the reviews that the centers
have conducted on individual obligation, commitment, and accrued
expenditure balances and (2) was not aware of the process- related
problems discussed below.

San Diego*s Decentralized The San Diego Systems Center accomplishes its
tri- annual reviews on a

Review Process Needs to Be decentralized basis. During the first step of
the process, the Office of the

Refined Comptroller, which has overall responsibility for the reviews,
develops

computer lists that contain information on all of the center*s outstanding
obligations and commitments. The Comptroller*s Office then provides these
lists to the center*s technical departments, which are then required to
conduct the actual reviews. When the technical departments finish their
reviews, their department heads certify that the reviews have been
completed and then forward this certification to the San Diego Systems
Center*s Comptroller. On the basis of the technical departments*
certifications, the Comptroller then certifies that the center has
completed its review.

Although this approach seems reasonable on the surface, we found numerous
problems with the process. For example, because the systems center*s draft
tri- annual review guidance does not specifically require the technical
departments to accomplish many important tasks, the effectiveness and
usefulness of the reviews varied significantly from one department to
another. For example, two of the center*s technical departments did not
(1) summarize or analyze the results of their reviews, (2) establish
internal controls to ensure that timely and appropriate

corrective action was taken on problems that were identified during the
reviews, or (3) maintain adequate documentation to show who conducted the
reviews, what problems were identified, and/ or what additional actions
were required.

Conversely, although it was not required to do so, another department (1)
summarized the results of its reviews in a single Excel spreadsheet to
facilitate analysis of the review results, (2) analyzed the data to
determine if there were any indications of systemic or compliance problems
(e. g., inadequate reviews by one or more of the department*s divisions or
problems with accrual schedules), and (3) developed internal control
procedures to ensure that timely and appropriate action was taken on

identified problems and/ or unresolved research requirements.
Additionally, this department requires its managers to maintain
documentation that (1) shows who conducted the actual reviews (so these
individuals can be held accountable for the adequacy of the reviews), (2)
identifies the additional research or corrective action that is required
as a result of the reviews, and (3) indicates who is responsible for
taking the

action. Managers from this department said that they were initially
skeptical about the benefits of the tri- annual reviews, but indicated
that they are now strong supporters because the reviews have provided a
structured way to address their data problems and have already resulted in
significant

improvements in the quality of their data. Additionally, they acknowledged
that documenting what corrective action is required and who is responsible
for taking it requires additional time, at least in the short term.
However, they believe this documentation is essential for (1) holding
people

accountable and (2) having effective internal controls to ensure that
timely and appropriate corrective action is taken on the problems that are
identified. Further, they believe that the documentation may save time in
the long term because it will serve as a *memory jogger* for subsequent

reviews. Additional process- related problems we identified during our
assessment of the San Diego Systems Center*s tri- annual review process
include the following.

 As noted previously, although the center had about $423 million of
accrued expenditures as of September 2002, it had not yet developed a
methodology for identifying and reviewing its accrued expenditures.

 Fund holders are required to conduct sufficient follow- up on dormant
obligations and commitments to determine if they are still valid. However,
the computer lists that the San Diego Comptroller provides to the center*s
technical departments do not distinguish between the obligations and
commitments that have been dormant and those that have not. As a result,
the technical departments have no way to focus their attention on the
obligations and commitments that require followup action.

 The certifications that the department heads sign are much more general
than the one that the Comptroller must sign on behalf of the system center
and they, therefore, do not provide an adequate basis for the
Comptroller*s certification. For example, the Comptroller is required,
among other things, to (1) advise SPAWAR headquarters whether, and to what
extent, adjustments or corrections to remedy noted problems have been
taken, (2) summarize, by type, the actions or corrections remaining to be
taken, (3) indicate when such

actions/ corrections are expected to be completed, and (4) identify the
actions that have been taken to preclude identified problems from
recurring in the future. However, the Comptroller does not require the
departments to report this information to him and, therefore, cannot
report this information to SPAWAR headquarters.

 Although, as noted previously, the Comptroller has overall
responsibility for the center*s tri- annual reviews, his office has not
assessed the adequacy of the reviews that are being conducted by the
technical departments. As a result, the Comptroller does not have a sound
basis for his certification.

Charleston*s Basic Approach Is The Charleston Systems Center has developed
a basic approach for its triannual

Sound, but Some Improvements reviews that appears sound. Charleston*s
approach addressed

Are Needed several of the concerns we noted with the San Diego Systems
Center*s approach. First, rather than assigning all review requirements to
the

technical departments, Charleston divides the responsibilities between the
Comptroller*s Office and the technical departments. This approach allows
the Comptroller*s Office to concentrate on the tasks it is best qualified
to perform, such as tracing obligations back to source documents, and lets
the technical departments concentrate on those tasks that they are best
qualified to perform, such as verifying that dormant obligations are still
valid. Second, the Charleston Comptroller provides the technical
departments with a list of all dormant commitments, obligations, and
accrued expenditures so they can easily focus on those that they must

follow up on. Finally, Charleston*s tri- annual review guidance requires
those who conduct the reviews to document actions taken during the reviews
and is to (1) include corrective actions remaining to be taken and when
such actions will be completed and (2) identify actions that have been
taken to preclude identified problems from recurring in the future.

However, we did identify several problems with Charleston*s overall
approach. More specifically, we found the following:

 Although the Comptroller must sign a certification statement attesting
to the results of the center*s tri- annual review, the systems center has
not conducted all of the required reviews, and the Comptroller has not
developed internal control procedures to ensure that the reviews that were
conducted were performed properly and completely.

 Charleston*s technical department heads are responsible for ensuring
that reviews are properly conducted and documented, but they are not
required to certify that this has been done. Consequently, the Comptroller
does not have a sound basis for certifying that the triannual review tasks
the center is required to accomplish have been completed. In fact,
Charleston*s Comptroller acknowledged that our work shows that the
technical departments* reviews are not adequate, and he indicated that his
concern about the timeliness and adequacy of the technical departments*
reviews is the reason why he has limited his tri- annual review
certification to the 4 tasks that are under his control and why he has
been unwilling to certify the remaining 12 tasks. The Comptroller stated,
and we agree, that department heads should be held accountable for their
respective departments* portion of the tri- annual

review process. Specifically, he believes they should be required to
complete and sign certification statements similar to the one that he must
complete and sign on behalf of the systems center, and accordingly, has
developed a proposed certification statement for the department heads to
sign.

We also found that DOD*s tri- annual review guidance regarding the dollar
thresholds for reviewing outstanding commitments and obligations was
unclear. The guidance states that during the January and May reviews,
commitments and obligations of (1) $200,000 or more for investment
appropriations (e. g., procurement funds and the capital budget of the
working capital funds) should be reviewed and (2) $50,000 or more for
operating appropriations (e. g., operation and maintenance funds and the
operating portion of the working capital funds) should be reviewed.

Charleston interpreted the guidance to mean that customer orders* which
are the operating portion of the working capital fund* financed with
investment funds fell into the $200, 000 threshold category for review
purposes, rather than the $50,000 category, and conducted its tri- annual
reviews accordingly. In discussing this issue with the Office of the Under
Secretary of Defense (Comptroller) and Navy headquarters officials, the
officials acknowledged that the guidance was unclear and, thus, open to
interpretation. They stated that the guidance needed to be examined and
clarified.

Conclusions SPAWAR has consistently understated and provided misleading
carryover information to the Congress. Reliable carryover information is
essential

for the Congress and DOD to perform their oversight responsibilities,
including reviewing DOD*s budget. To provide assurance that SPAWAR systems
centers report reliable carryover information, managers at SPAWAR
headquarters and the systems centers must be held accountable for the
accuracy of reported carryover and ensure the timely identification of
unneeded customer funds. This includes increased management

attention that would provide more assurance that the systems centers are
effectively reviewing funded orders as part of their tri- annual review
process. Until these problems are resolved, the Congress and DOD

decision makers will be forced to make key budget decisions, such as
whether or not to enhance or reduce customer budgets, based on unreliable
information.

Recommendations for We recommend that the Secretary of Defense

Executive Action  direct the Secretary of the Navy to issue guidance to
all Navy working

capital fund activities, including SPAWAR, that prohibits them from
deobligating reimbursable customer orders at fiscal year- end and
reobligating them in the next fiscal year for the sole purpose of reducing
carryover balances that are ultimately reported to the Congress;

 direct the Under Secretary of Defense (Comptroller) to determine the
extent to which working capital fund activities throughout DOD may be
similarly manipulating customer order data at fiscal year- end to reduce
reported carryover and, if necessary, issue DOD- wide guidance

prohibiting this practice as needed; and

 direct the Under Secretary of Defense (Comptroller) to develop and issue
written procedures to implement the December 2002 carryover policy.

To provide reasonable assurance that the dollar amount of orders to be
received from customers in developing annual budgets are based on more
realistic estimates, we recommend that the Secretary of the Navy direct
the Commander of the Space and Naval Warfare Systems Command to compare
budgeted to actual orders received from customers and consider these
trends in developing the following year*s budget estimates on orders to be
received from customers. We recommend that the Under Secretary of Defense
(Comptroller)

 revise the tri- annual review guidance in the DOD Financial Management
Regulation so that working capital fund activities are required to expand
the scope of their tri- annual reviews to include unobligated balances on

customer orders and  review and clarify the tri- annual review guidance
for the January and

May reviews in the DOD Financial Management Regulation as it pertains to
the dollar threshold for reviewing outstanding commitments and obligations
for the capital budget and operating portion of the working capital fund.

We recommend that the Commander of the Space and Naval Warfare Systems
Command establish internal control procedures and accountability
mechanisms that provide assurance that the systems centers are complying
with DOD*s tri- annual review guidance.

We also recommend that the Commander of the Space and Naval Warfare
Systems Command direct the Commanders of the Charleston and San Diego
SPAWAR Systems Centers to

 maintain documentation that shows who conducted the tri- annual reviews
so that these individuals can be held accountable for the reviews;

 maintain documentation that identifies (1) any additional research or
corrective action that is required as a result of the tri- annual reviews
and (2) who is responsible for taking the action;

 require cognizant managers, such as department heads, to confirm in
writing that they have (1) performed the required tri- annual reviews and
(2) completed the related follow- up actions by signing a statement, such
as the draft certification statement developed by the Charleston Systems
Center Comptroller, that describes the specific tasks that were
accomplished and provide this statement to the systems centers*

comptrollers;  develop and implement internal control procedures to
provide

assurance that tri- annual reviews of individual commitment, obligation,
and accrued expenditure balances are adequate; and  develop policies and
procedures to capture the information on triannual

review results, such as the amount of obligations reviewed, confirmed, and
revised, that they are required to report to SPAWAR headquarters and that
SPAWAR headquarters, in turn, is required to report to Navy headquarters.

We recommend that the Commander, San Diego SPAWAR Systems Center direct
the Center Comptroller to

 develop and implement a methodology for identifying and analyzing
accrued expenditure balances and

 identify dormant commitments, obligations, and accrued expenditures in
the tri- annual review computer lists that are provided to the technical
departments.

Agency Comments and DOD provided written comments on a draft of this
report. In its comments,

Our Evaluation DOD concurred with 12 of our 14 recommendations and
partially

concurred with the remaining 2 recommendations. For these 2
recommendations, DOD agreed with our intent to ensure that obligations,
unobligated balances, and commitments are reviewed regularly to ensure
effective use of funds. Our evaluation of DOD*s comments is presented

below. DOD*s comments are reprinted in appendix II. For the 12
recommendations with which DOD concurred, it stated that 7 of them were
completed based on the issuance of SPAWAR Instruction 7301.1A on Tri-
Annual Reviews of Commitments and Obligations, dated October 9, 2002. We
believe that the guidance provided in the instruction is an important
step. SPAWAR and the systems centers now need to develop

and issue implementing procedures because, in most cases, the guidance
provided in the instruction that is related to these 7 recommendations is
too general to fully address our recommendations. For example, although
the instruction requires those responsible for conducting the review to
report the results to the systems center*s comptroller, the instruction
does not require, as we recommended, that cognizant managers, such as
department heads, sign a written statement to be provided to the

comptroller to confirm that they have performed the required reviews and
certify the results of those reviews.

Further, in concurring with our recommendation that SPAWAR compare
budgeted to actual orders received from customers and consider these
trends in developing budget estimates on orders to be received from
customers, DOD did not state how the Navy would ensure that SPAWAR*s
budget estimates would accurately reflect orders to be received from
customers. In its comments, DOD stated that the Navy will continue to
refine its budget estimates for customer orders. We believe that the Navy
must take additional actions to develop more reliable budget estimates. As
noted in our report, reported actual customer orders received exceeded
budget estimates from 36 percent to 88 percent during fiscal years 1998
through 2002. For example, for fiscal year 2002, in formulating its budget

request, the Navy expected the SPAWAR systems centers to receive about
$1.3 billion in customer orders, but the Navy reported that the centers
actually received about $2.4 billion in customer orders* a difference of
$1.1 billion, or about 88 percent. Having reliable budget estimates on
customer orders to be received is critical since this information is used
in calculating carryover using DOD*s new carryover policy.

DOD partially concurred with our recommendation that it revise its
triannual review guidance in the DOD Financial Management Regulation to
require working capital fund activities to expand their tri- annual
reviews to include unobligated balances on customer orders. In its
comments, DOD stated that reviewing such balances during the tri- annual
reviews was the responsibility of the customer who placed the order with
the working capital fund and that the working capital fund activity should
work in cooperation with the customer to ensure that unobligated balances
are reviewed. We agree that the working capital fund activity should work
in conjunction with customers to review unobligated balances. However, as
stated in our report, working capital fund activities are in the best
position to determine whether unobligated balances are still needed to
finance future work. To ensure that unobligated balances are properly
reviewed during the tri- annual review process, we continue to recommend
that the

DOD Financial Management Regulation be revised to specify the working
capital fund activities* role in reviewing unobligated balances on
customer orders. DOD also partially concurred with our recommendation for
the SPAWAR systems centers to review all balances related to dormant
customer orders in excess of $50,000 during the January and May tri-
annual reviews. In its comments, DOD indicated that the current guidance
is not clear with regard to whether all such dormant balances over $50,000
are to be reviewed during the specified months. DOD stated that it will
review the

guidance, as it pertains to working capital fund activities, and make
adjustments if appropriate. We agree that DOD*s tri- annual review
guidance regarding the dollar thresholds for reviewing outstanding
commitments and obligations was unclear. We have revised our report
accordingly, including the related recommendation, to reflect that DOD*s
tri- annual review guidance was unclear.

In addition, in the cover letter transmitting its comments on our draft
report, DOD took exception to our discussion in the draft report regarding
the methodology used by Navy to determine the levels of carryover*
reducing the numerator in the carryover formula by the amount of
contractual obligations, but not reducing the formula*s denominator by the
amount of revenue earned from contractual services. Because DOD revised
its methodology for calculating carryover in December 2002, DOD commented
that such a discussion in the report was irrelevant and confusing to the
reader and recommended that it be deleted. We disagree with DOD*s comment.
Although DOD revised its methodology for calculating carryover, it was not
incorporated into Navy*s budget submissions until fiscal year 2004. When
we undertook this review in July 2002, one of our objectives was to
determine if reported carryover accurately reflected the amount of work
remaining to be accomplished. As such, this issue was and still is
relevant. As stated in this report, our May 2001 report recommended that
the revenue used in calculating carryover be adjusted (reduced) for
revenue earned for work performed by contractors. Unless this is done,
reported carryover will be understated. The Navy did not adjust the
revenue amount and, therefore, continued to

understate its reported carryover in its budget submissions to the
Congress. We continue to believe that this is a reportable issue and have
made a related recommendation for DOD to develop and issue written
procedures to implement the December 2002 carryover policy. Further, we
believe this issue remains of interest to the Congress since the Navy has

understated SPAWAR*s reported carryover from fiscal year 1998 through
fiscal year 2002.

We are sending copies of this report to the Chairmen and Ranking Minority
Members of the Senate Committee on Armed Services; the Subcommittee on
Readiness and Management Support, Senate Committee on Armed Services; the
Subcommittee on Defense, Senate Committee on

Appropriations; the House Committee on Armed Services; the Subcommittee on
Readiness, House Committee on Armed Services; and the Ranking Minority
Member, Subcommittee on Defense, House Committee on Appropriations. We are
also sending copies to the Secretary of Defense, the Secretary of the
Navy, and other interested parties. Copies will be

made available to others upon request. Should you or your staff have any
questions concerning this report, please contact Gregory D. Kutz,
Director, at (202) 512- 9505. He can also be reached by E- mail at kutzg@
gao. gov.

An additional contact and key contributors to this report are listed in
appendix III.

Sincerely yours, Gregory D. Kutz Director, Financial Management and
Assurance

William M. Solis Director, Defense Capabilities and Management

Appendi Appendi xes I x Scope and Methodology To determine if differences
existed between the budgeted and reported actual gross carryover and, if
so, the reasons for the variances, we obtained and analyzed budget and
accounting documents that provided information on budgeted and reported
actual gross carryover and orders received from customers from fiscal year
1998 through fiscal year 2002. When variances occurred between the
budgeted and reported actual information, we met

with accounting and budgeting SPAWAR and Navy headquarters officials to
ascertain why there were differences. We also discussed with officials
what actions they were taking to develop more reliable budget information
on carryover and orders received from customers.

To determine if the reported actual carryover balances reflected the
amount of work that remained to be accomplished, we obtained and analyzed
the Department of Defense*s (DOD) regulations and guidance on carryover.
We also obtained and analyzed the SPAWAR systems centers* calculations for
the fiscal year 1998 through fiscal year 2002 actual reported year- end
carryover balances. We met with officials from SPAWAR and Navy
headquarters to discuss the methodology they used to calculate carryover.
We (1) obtained explanations about why the Navy made adjustments in
calculating the dollar amount of carryover balances as well as the number
on months of carryover and (2) determined the impact of those adjustments
on the carryover figure. We also reviewed year- end transactions that
affected the dollar amount and number of months of

carryover. For these year- end transactions, we met with officials from
SPAWAR and the two systems centers to determine why these transactions
occurred at year- end.

To determine if the Charleston and San Diego SPAWAR Systems Centers have
the financial data they need in order to provide reliable data on actual
carryover levels to DOD and congressional decision makers, we reviewed the
policies and procedures SPAWAR headquarters and the two systems centers
have used to implement DOD*s tri- annual review guidance. Specifically, we
(1) reviewed the DOD, Navy, SPAWAR headquarters, and the two SPAWAR
systems centers* tri- annual review guidance and discussed it with
cognizant individuals, (2) reviewed the tri- annual review certifications
that the two systems centers have submitted since DOD issued its tri-
annual review guidance in 1996, and discussed these certifications with
cognizant individuals, (3) discussed the systems centers* tri- annual
review procedures with cognizant individuals, including those

who actually accomplished the reviews, and (4) reviewed documentation on
the results of the reviews. We also obtained data on the status of
unfilled orders and carryover at the end of fiscal year 2001.
Additionally,

from these data, we selected and analyzed 34 orders that had outstanding
carryover balances at the end of fiscal year 2001 to determine if the
carryover balances accurately reflected the amount of work that remained
to be performed. We selected orders that (1) were financed with expired
appropriations and (2) were unobligated carryover at year- end since these
orders were more likely to have unneeded funds and because a review of
these orders was, therefore, more likely to identify problems with the

systems centers* review procedures. We performed our work at the
headquarters offices of the Under Secretary of Defense (Comptroller) and
the Assistant Secretary of the Navy (Financial Management and
Comptroller), Washington, D. C.; Space and

Naval Warfare Systems Command, San Diego, California; the Charleston Space
and Naval Warfare Systems Center, Charleston, South Carolina; and the San
Diego Space and Naval Warfare Systems Center, San Diego, California. The
reported actual year- end carryover information used in this

report was produced from DOD*s systems, which have long been reported to
generate unreliable data. We did not independently verify this
information. The DOD Inspector General has cited deficiencies and internal
control weaknesses as major obstacles to the presentation of financial
statements that would fairly present the Defense Working Capital Fund*s
financial position for fiscal years 1993 through 2002.

Our review was performed from July 2002 through June 2003 in accordance
with U. S. generally accepted government auditing standards. The Navy
provided the budgeting and accounting information referred to in this
report. We requested comments on a draft of this report from the Secretary
of Defense or his designee. DOD provided written comments, and these
comments are presented in the Agency Comments and Our Evaluation section
of this report and are reprinted in appendix II.

Appendi I I x Comments from the Department of Defense Note: GAO comments
supplementing those in the report text appear at the end of this appendix.
See comment 1.

Now on p. 30. Now on p. 30.

Now on p. 30.

Now on p. 30. Now on p. 30. See comment 1.

Now on p. 31. See comment 1.

Now on p. 31.

Now on p. 31. Now on p. 31. Now on p. 31. Now on p. 31.

See comment 2. Now on p. 30. See comment 2.

Now on p. 32. Now on p. 32.

The following are GAO*s comments on the Department of Defense*s (DOD)
letter dated June 10, 2003.

GAO Comments 1. See the Agency Comments and Our Evaluation section of this
report. 2. As discussed in the Agency Comments and Our Evaluation section
of

this report, we have modified this recommendation and the related section
of the report in response to DOD*s comment.

Appendi I I I x GAO Contact and Staff Acknowledgments GAO Contact Greg
Pugnetti, (703) 695- 6922 Acknowledgments Staff who made key contributions
to this report were Francine DelVecchio,

Karl Gustafson, William Hill, Christopher Rice, Ron Tobias, and Eddie
Uyekawa.

(192067)

Report to the Chairman, Subcommittee on Defense, Committee on
Appropriations, House of Representatives

July 2003 NAVY WORKING CAPITAL FUND Backlog of Funded Work at the Space
and Naval Warfare Systems Command Was Consistently Understated

GAO- 03- 668

Letter 1 Results in Brief 2 Background 6 Gross Carryover Budget Estimates
Were Consistently and

Substantially Understated 8 Reported Actual Carryover Balances Were
Consistently Understated 12

Reported Actual Carryover Is Based on Unreliable Underlying Financial Data
18 Conclusions 29 Recommendations for Executive Action 29 Agency Comments
and Our Evaluation 31

Appendixes

Appendix I: Scope and Methodology 35

Appendix II: Comments from the Department of Defense 37 GAO Comments 42

Appendix III: GAO Contact and Staff Acknowledgments 43 Tables Table 1:
SPAWAR Systems Centers* Budgeted and Reported Actual Gross Carryover from
Fiscal Year 1998 through Fiscal Year

2002 9 Table 2: SPAWAR Systems Centers* Budgeted and Reported Actual
Orders Received from Customers for Fiscal Year 1998

through Fiscal Year 2002 10 Table 3: SPAWAR Systems Centers* Reported
Actual Gross

Carryover before and after Adjustments for Fiscal Years 1998 through 2002
15

Figure Figure 1: DOD Carryover Computation Based on the Fiscal Year 2002
Budget 14

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a

GAO United States General Accounting Office

The budgeted and reported actual amounts of SPAWAR gross carryover were
consistently understated, resulting in the Congress and DOD decision
makers not having reliable information to decide on funding levels for
working capital fund customers. First, GAO found that SPAWAR centers*
budgeted gross carryover for fiscal years 1998 through 2002 was
significantly less than the reported actual year- end gross carryover.

SPAWAR Systems Centers* Budgeted and Reported Actual Gross Workload
Carryover Dollars in millions Fiscal year Budgeted carryover Actual

carryover Actual exceeds budgeted carryover

1998 $377 $530 $153 1999 332 563 231 2000 358 613 255 2001 567 875 308
2002 610 896 286 Sources: Navy budget and accounting reports.

Note: Gross carryover is the dollar value of work that has been ordered
and funded (obligated) by customers but not completed by working capital
fund activities at the end of the fiscal year.

Budgeted gross carryover was understated primarily due to problems with
estimating the underlying customer order data. For example, for fiscal
year 2002, SPAWAR*s budgeted amount for customer orders was 88 percent
less than the reported actual orders received.

Second, SPAWAR*s reported actual carryover balances were also unreliable
and adjusted downward by hundreds of millions of dollars. These
adjustments understated carryover and resulted in Navy reports to the
Congress showing that SPAWAR carryover balances for fiscal years 1998
through 2002 did not exceed DOD*s 3- month carryover standard. SPAWAR

was able to report reduced carryover balances for the following reasons. 
As GAO previously reported, the DOD guidance for calculating the

number of months of carryover allowed carryover to be adjusted and
understated. DOD agreed with GAO*s previous recommendation and in December
2002 changed its carryover guidance.  SPAWAR centers used accounting
entries to manipulate the amount of

customer orders for the sole purpose of reducing reported carryover below
the 3- month standard. For example, the centers did this for at least $50
million at the end of fiscal year 2001. SPAWAR officials issued guidance
in September 2002 discontinuing this practice.

Finally, SPAWAR had not taken key steps to verify the underlying financial
data on which reported actual carryover is based. The SPAWAR centers had
only recently begun conducting the required tri- annual reviews of such
data, which DOD has required since 1996. However, the reviews were
ineffective, including the exclusion of slightly less than half of their
reported actual carryover from the review process. The Space and Naval
Warfare Systems Command (SPAWAR) has hundreds of millions of dollars of

funded work that its working capital fund activities did not complete
before the end of the fiscal year. Reducing the amount of workload
carryover at fiscal year- end is a key factor in the

effective management of Department of Defense (DOD) resources and in
minimizing the *banking* of funds for work to be performed in subsequent
years. GAO was asked to analyze SPAWAR*s carryover balances. GAO assessed
the accuracy of the budgeted amounts, the accuracy of the reported actual
carryover balance, and the reliability of

underlying financial data on which reported actual carryover is based. GAO
is making several recommendations aimed at improving the accuracy and

reliability of SPAWAR*s and other working capital fund activities*
budgeted and reported actual yearend carryover amounts. GAO is also making
recommendations to

improve SPAWAR*s tri- annual review process so that these reviews can
serve to verify the reliability of underlying financial

data. DOD concurred with 12 of the 14 recommendations and partially
concurred with 2. For these 2 recommendations, DOD agreed with GAO*s
intent to ensure that obligated and unobligated balances are reviewed
regularly to ensure effective use of funds.

www. gao. gov/ cgi- bin/ getrpt? GAO- 03- 668. To view the full report,
including the scope and methodology, click on the link above. For more
information, contact Gregory D. Kutz at (202) 512- 9505 or kutzg@ gao.
gov.

Highlights of GAO- 03- 668, a report to the Chairman, Subcommittee on
Defense, Committee on Appropriations, House of Representatives

July 2003

NAVY WORKING CAPITAL FUND

Backlog of Funded Work at the Space and Naval Warfare Systems Command Was
Consistently Understated

Page i GAO- 03- 668 Navy Working Capital Fund

Contents

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Appendix I Scope and Methodology

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Appendix II

Appendix II Comments from the Department of Defense

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Appendix II Comments from the Department of Defense

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Appendix II Comments from the Department of Defense

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Appendix II Comments from the Department of Defense

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Appendix II Comments from the Department of Defense

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Appendix III

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