DOD Contract Payments: Management Action Needed to Reduce	 
Billions in Adjustments to Contract Payment Records (08-AUG-03,  
GAO-03-727).							 
                                                                 
GAO has reported that the Department of Defense's (DOD) inability
to accurately account for and report on disbursements is a	 
long-term, major problem. GAO was requested to determine (1) the 
magnitude of the adjustments and related costs in fiscal year	 
2002, (2) why contracts, including payment terms, are so complex,
(3) the key factors that caused Defense Finance and Accounting	 
Service (DFAS) Columbus to make payment adjustments, and (4) what
steps DOD is taking to address the payment allocation problems.  
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-727 					        
    ACCNO:   A07762						        
  TITLE:     DOD Contract Payments: Management Action Needed to Reduce
Billions in Adjustments to Contract Payment Records		 
     DATE:   08/08/2003 
  SUBJECT:   Contract modifications				 
	     Price adjustments					 
	     Accountability					 
	     Strategic planning 				 
	     Contract costs					 
	     DFAS Mechanization of Contract			 
	     Administration Services System			 
                                                                 

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GAO-03-727

                                       A

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Letter

August 8, 2003 The Honorable Jim Nussle Chairman Committee on the Budget
House of Representatives Dear Mr. Chairman: The reliability of contract
disbursing data is critical to the Department of Defense (DOD) for (1)
properly accounting for and accurately making contract payments, (2)
effectively accounting for and controlling billions of dollars in budget
authority, and (3) preparing reliable financial information on the results
of operations to support management and congressional decision making on
programs, operations, and budget requests. We have previously reported 1
on DOD*s inability to accurately account for and report on disbursements,
which is a long- term problem that is pervasive and complex in nature. For
example, Defense Finance and Accounting Service (DFAS) Columbus fiscal
year 1999 data showed that almost $1 of every $3 in contract payment
transactions in the Mechanization of Contract Administration Services
(MOCAS) system was for adjustments to

previously recorded payments*$ 51 billion of adjustments out of $157
billion in transactions. You asked that we determine (1) the magnitude of
adjustments that affected previously recorded payments and DFAS Columbus*s
reported cost to make these adjustments during fiscal year 2002, (2) why
contracts, including payment instructions, were so complex, (3) the key
factors that caused DFAS Columbus to make payment adjustments for the two
contracts that we reviewed in detail, and (4) what steps DOD has taken or
planned to address the adjustment problem. As agreed with your office, we
analyzed two contracts to determine how complex contracts and related
payment instructions contributed to DOD*s payments not being properly

allocated to the correct obligations. In selecting these two contracts, we
worked with DFAS Columbus to identify complex contracts for which they had
encountered problems with correctly allocating payments to obligations.
Thus, the two contracts* a $565 million Army missile contract and a $49
million Air Force communications contract* are not

1 See Related GAO Products at the end of this report.

representative of all DOD contracts but, based on our experience, have
characteristics similar to other complex contracts.

Our review was performed from August 2002 through July 2003 in accordance
with U. S. generally accepted government auditing standards. We did not
audit the DFAS Columbus data on disbursements, collections, and
adjustments or the costs incurred by DFAS Columbus to reconcile contracts.
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 Director,
Defense Procurement and Acquisition Policy, Under Secretary of Defense
(Acquisition, Technology, and Logistics), are reprinted in appendix II.

Results in Brief For fiscal year 2002, DFAS Columbus data showed that
about $1 of every $4 in contract payment transactions in MOCAS was for
adjustments to

previously recorded payments*$ 49 billion of adjustments out of $198
billion in disbursement, collection, and adjustment transactions. This is
an improvement over fiscal year 1999 when reported adjustments represented

$1 of every $3 in contract payment transactions. To research the payment
allocation problems and make adjustments to correct the disbursing and
accounting records, DFAS Columbus reported that it incurred costs of about
$34 million in fiscal year 2002 primarily for hundreds of DOD and

contractor staff. This represents about 35 percent of the total $97
million in reported costs related to the DFAS Columbus contract pay
service operations. DFAS Columbus currently bills DOD activities (for
example, the Army) for contract pay services based solely on the number of
lines of accounting on an invoice. Consequently, all DOD activities pay
the same line rate, regardless of whether substantial work is needed to
reconcile

problem contracts and adjust the payment records. As a result, the
contracting offices that contributed to payment allocation problems had
insufficient incentives to reduce payment errors and associated costs.

Our analysis of the two contracts we reviewed in detail showed that the
contracts and payment instructions were complex because of a combination
of factors including the following:

 Legal and DOD requirements to track and report on the funds used to
finance the contract. For example, on the $565 million Army missile
contract, (1) 74 different accounting classification reference numbers
(ACRN) 2 were funded by eight different appropriation accounts and sales
to three foreign countries, (2) 24 of the 74 ACRNs were created to

comply with legal requirements to report on the appropriations used to
finance the contract as well as the types of obligations, such as
personnel, supplies, and acquisition of assets, and (3) the remaining 50
ACRNs were created to comply with DOD requirements.

 Substantial number of contract modifications over the years that added
goods and/ or services, or added or changed payment instructions. For
example, the $49 million Air Force communications contract was modified 82
times over a 3- year period, including 73 modifications that changed the
payment instructions.

 Different pricing provisions for goods and services on the contract. For
example, the Army contract contained 25 separate contract line items 3 *15
were to be paid for under fixed price provisions and 10 were to be paid
for under cost reimbursable provisions. Our analysis of $160 million of
adjustments for the two contracts we

reviewed showed that 1,458 adjustment transactions were made to reallocate
payments to the correct ACRNs for four reasons: (1) the Army made an error
in accounting for obligations, resulting in about $127 million in payment
allocation adjustments, (2) DFAS Columbus did not follow its internal
procedures for allocating payments to ACRNs on an Army contract containing
multiple pricing provisions when the Army failed to provide payment
instructions, resulting in about $5 million in adjustments, (3) DFAS
Columbus made over $2 million in adjustments to correct

recording errors on the Army contract due to complex and changing payment
instructions, and (4) the Air Force frequently changed payment

2 For all contracts, the contracting office assigns a two- digit ACRN to
each line of accounting containing unique accounting information in
accordance with the requirements contained in the Defense Federal
Acquisition Regulation Supplement (DFARS). Obligations are established at
the ACRN level to ensure that funds are available to cover disbursements.
DFAS Columbus allocates the payments to the ACRNs in an attempt to match
contractor payments to the corresponding obligations.

3 According to DFARS 204.7103- 1, contracts shall identify the items or
services to be acquired as separate contract line items.

instructions after payments were made on the Air Force contract, resulting
in about $26 million in adjustments. Since 1995, DOD had been attempting
to develop a new system* called the Defense Procurement Payment System
(DPPS)* to resolve DOD*s longstanding disbursement problems. However, DOD
terminated DPPS in December 2002, after 7 years in development at a
reported cost of over $126 million, because of poor program performance
and increasing life cycle costs. DOD has now initiated a major long- term
effort* referred to as an enterprise architecture* to improve its business
operations, including its acquisition and disbursement activities. If
implemented successfully, this initiative may help correct many of the
contract payment allocation problems. In the interim, DOD officials
informed us they have several efforts under

way to address these types of payment allocation problems that would help
reduce adjustments made to previously recorded payments. First, beginning
in fiscal year 2004, DFAS Columbus plans to realign its billing

structure and bill contracting offices for reconciliation services to
provide them with an incentive to reduce payment errors and related
reconciliation costs. Second, DFAS Columbus, in partnership with the
Defense Contract Management Agency, visited major procuring activities
throughout DOD and provided information on the correct methods for
presenting payment instructions on contracts. Finally, in September 2002,
DOD established a working group 4 to develop payment allocation options
for presenting standard payment instructions on complex contracts that, if
implemented, would be used throughout the DOD contracting community. Our
analysis

showed that this initiative should help reduce some of the payment
allocation errors that are the result of misinterpreted payment
instructions but would not completely eliminate payment allocation errors
made by

DFAS Columbus when it manually allocates payments to contract ACRNs. In
order to eliminate payment allocation errors, DOD would need to take the
next step in the process and automate the standard payment instructions so
that DFAS Columbus can electronically process the payments with minimal
manual intervention. The working group has not completed its work and has
not yet established a completion date. Further, DOD has not yet made a
final decision to implement the payment allocation 4 The working group
consists of representatives from the Offices of the Under Secretary of

Defense (Comptroller) and the Under Secretary of Defense (Acquisition,
Technology, and Logistics), DFAS Columbus, and the Defense Contract
Management Agency.

options for presenting standard payment instructions throughout the DOD
contracting community.

We are making recommendations to the Secretary of Defense to improve the
process of properly allocating payments to correct ACRNs, including (1)
developing payment allocation options for presenting standard payment
instructions contained in contracts and (2) automating the standardized
payment instructions. We are also making recommendations to the Under

Secretaries of Defense (Acquisition, Technology, and Logistics) and
(Comptroller) to follow existing regulations and procedures concerning
contract payment instructions. In its comments on a draft of this report,
DOD concurred with two of the four recommendations and partially concurred
with the two recommendations related to developing and automating the
standard payment instructions. DOD stated that although the working group
would analyze their feasibility, until the coordination and review process
was completed, it could not commit to these actions. DOD did not indicate
any time frame for completing the coordination and

review process referred to in its response. We continue to believe that
decisive steps towards a lasting solution in these two areas are essential
to address DOD*s long- standing contract payment problems.

Background DFAS Columbus uses MOCAS to make contract payments for the
Army, Navy, Air Force, and other DOD organizations. In fiscal year 2002,
DFAS Columbus reported that it made about $87 billion of contract
payments. DOD, including DFAS Columbus, uses a line of accounting to
accumulate appropriation, budget, and management information for contract
payments. Figure 1 shows a line of accounting on the Air Force contract
that we reviewed.

Figure 1: Sample Line of Accounting on the Air Force Contract

Fiscal year Commitment

Commitment issuing document number

Appropriation limit office code

Appropriation Element of resource

account code (object class)

BK 97 0 0400 4500 0 5D 5D07 71001000000 255Y 9HZZZZ MIPROLRAB9H756 09H690
S28043 ACRN Operating

Job order number agency Fiscal accounting Department

Allotment station number code serial number

Fiscal Army management

year structure code Source: DOD.

A line of accounting provides various information, such as (1) department
code (for example, those for the military services) and (2) fiscal year
and appropriation account financing the contract. For all contracts, the
contracting office assigns an ACRN to each line containing unique
accounting information in accordance with the requirements contained in
the Defense Federal Acquisition Regulation Supplement (DFARS). Obligations
5 are established at the ACRN level to ensure that funds are available to
cover disbursements. DFAS Columbus allocates payment

amounts to ACRNs to match contractor payments to the corresponding
obligations.

Organizations Involved in DOD payment and accounting processes are
complex, generally involving

the Contract Payment separate functions carried out by separate offices in
different locations

Process using different procurement, accounting, and payment systems. The

processes are not always integrated and require data to be entered and 5
Obligations are the amounts of orders placed, contracts awarded, services
received, and similar transactions during an accounting period that will
require payment during the same, or a future, period.

sometimes reentered manually. Figure 2 shows the payment process
information flow for the Air Force contract that we reviewed. Figure 2:
Payment Process Information Flow for the Air Force Contract

Contract and Goods and

modifications services

Communications DOD

contractor activities

Purchase requests

DOD funding Air Force

Invoices/ Payments

contracting office

vouchers activities

Contract and modifications

Receiving reports

Defense Contract

Voucher approval

Management Agency DFAS Columbus

(paying office)

Disbursement Adjustments data Defense Contract

Audit Agency DFAS accounting

stations

Source: GAO and Art Explosion.

As illustrated above, the payment process information flow for the Air
Force contract began when DOD funding activities requested that the Air
Force contracting office procure engineering and technical services as
well as spare parts. The Air Force contracting office awarded the contract
and modified it to procure additional items. The Air Force contracting
office forwarded the contract and modifications to several organizations,
such as the communications contractor and DFAS Columbus paying office.
Upon receipt of the contract and modifications, the communications
contractor

performed work for the DOD activities and submitted invoices to DFAS
Columbus for payment. For goods procured under the contract, the Defense
Contract Management Agency, which is located at the contractor*s site,
accepted the goods on behalf of the DOD activities and provided

receiving report information to DFAS Columbus. The communications
contractor then forwarded the goods to the DOD activities. For services
provided by the contractor, the contractor submitted vouchers for services

directly to DFAS Columbus for payment. The vouchers were subject to later
audit by the Defense Contract Audit Agency.

Before making payments to the contractor, DFAS Columbus matched the
documents* through automated and manual processes* provided by the Air
Force contracting office, the communications contractor, and Defense
Contract Management Agency to ensure that (1) items ordered were received
and (2) funds were obligated and available to make the payments.

Finally, DFAS Columbus paid the contractor, recorded the payment data in
DFAS Columbus records, and forwarded these data to the DFAS accounting
stations responsible for recording the data in the various DOD
organizations* accounting systems. When errors occurred in allocating
payments to the correct ACRNs, the DFAS Columbus contract reconciliation
branch made adjustments to correct the payment allocations in DFAS
Columbus and the applicable DFAS accounting station records.

Description of the Army and In order to identify some of the problems DFAS
Columbus has experienced

Air Force Contracts in properly allocating payments to the ACRNs on
contracts, we selected an

Reviewed Army and an Air Force contract for a detailed review. These
contracts

support two programs* the Army Tactical Missile System and the Army Data
Link System. A description of each of these programs is presented below.

 We reviewed an Army contract (contract number DAAH01- 98- C- 0093) with
Lockheed Martin Vought Systems Corporation concerning the Army Tactical
Missile System. This missile system is one of a family of

complementary weapons initially developed by the Army and Air Force for
engaging enemy forces deep behind the front battle lines. The missile
system was designed to attack those forces that are in a position to have
an immediate or directly supporting impact on the close- in battle, but
are beyond the range of cannon and rocket artillery systems.

It is intended to delay, disrupt, neutralize, or destroy targets, such as
second echelon maneuver units, missile sites, and forward command posts.
The Army Tactical Missile System consists of a surface- to- surface

ballistic missile that can be launched from and controlled by the Army*s
Multiple Launch Rocket System. The missile system was initially fielded
with an *antipersonnel/ antimaterial warhead* for attacking stationary
targets. Since the weapon system was first fielded, the missile system has
been modified to increase its range, improve its guidance systems, and
reduce collateral damage. This missile system was used in the recent war
in Iraq. Figure 3 is a photograph of the missile system.

Figure 3: Army Tactical Missile Launched from Multiple Launch Rocket
System

Source: U. S. Army Aviation and Missile Command, Public Affairs Office.

 We reviewed an Air Force contract (contract number F09604- 00- C- 0090)
with L- 3 Communications to maintain the Army portion of the Army Data
Link System. 6 The Army and Air Force developed the Army Data Link System
to transfer near- real- time targeting information collected by aircraft,
satellites, and ground stations and provides this information to aircraft
and tactical commanders on the ground in- theater. The system consists of
three major components* the Army Interoperable Data Link, the Direct Air
to Satellite Relay, and the Reach Back Relay. The Army

6 In prior years, the Army portion of the Army Data Link System was part
of another contract that supported both the Army and Air Force. According
to Air Force contracting officials, the Air Force separated its portion
from the Army portion of the contract because the contract became
difficult to administer due to its size. The Air Force contracting office
retained responsibility for administering both the Army and Air Force
portions of the data link systems.

Interoperable Data Link provides two- way secure direct communications
between aircraft and aircraft- to- ground stations. The Direct Air to
Satellite Relay communicates data gathered by aircraft through a secure
satellite link to an in- theater ground processing facility. The Reach
Back Relay communicates data gathered through a secure satellite link to
ground processing facilities in the continental United

States. The Data Link System was also used in the recent war in Iraq.
Figure 4 shows how the communications system transfers data.

Figure 4: Army Data Link System Transferring Information Collected by
Aircraft, Satellites, and Ground Stations ARL DASR

ETRAC TMET Remote Repeater Guardrail

Source: Air Force contractor L- 3 Communications.

DFAS Columbus Made For fiscal year 2002, our analysis of DFAS Columbus
data showed that

$49 Billion of about $1 of every $4 in contract payment transactions in
MOCAS was for

adjustments to previously recorded payments*$ 49 billion of adjustments
Adjustments at a Cost

out of $198 billion in disbursement, collection, and adjustment of about
$34 Million in

transactions. This is an improvement over fiscal year 1999 when DFAS
Fiscal Year 2002

Columbus data showed that about $1 of every $3 in contract payment
transactions (transactions for disbursements, collections, and
adjustments) in MOCAS was for adjustments to previously recorded
payments*$ 51 billion of adjustments out of $157 billion in transactions.
While DOD has been working on resolving these problems for years, it has
yet to correct them. To research the payment allocation problems and make
adjustments to

correct the disbursing and accounting records, DFAS Columbus reported that
it incurred costs of about $34 million in fiscal year 2002, primarily for
hundreds of DOD and contractor staff. This represented about 35 percent of
the $97.4 million that DFAS Columbus spent on contract pay service
operations. Our review showed that the specific contracting offices that
contributed to payment allocation problems resulting in adjustments did
not pay for all of the work DFAS Columbus performed to make the
adjustments. This occurred because DFAS Columbus currently bills DOD
activities (for example, the Army) for contract pay services based solely
on the number of lines of accounting on an invoice. Consequently, all DOD

activities pay the same line rate, regardless of whether substantial work
is needed to reconcile problem contracts and adjust the payment records.
As a result, the contracting offices that contributed to payment
allocation problems had insufficient incentives to reduce payment errors
and associated costs. As discussed later in this report, DOD is taking
action to

change its billing structure for DOD activities. Contracts Were

Our analysis of an Army and an Air Force contract showed that the Complex
Due to Legal

contracts and related payment instructions were complex because of a
combination of factors, including the (1) legal and DOD requirements to
and DOD

track and report on the funds used to finance the contract, (2) number of
Requirements,

modifications made to the contract over the years that added goods and/ or
Contract

services, or added or changed payment instructions for these goods and/ or
services, and (3) different pricing provisions to pay for goods and
services Modifications, and

on the contract. While we identified these three factors as unique areas,
Pricing Provisions

the factors are interrelated and contributed to the contracts containing
complex payment instructions and the difficulty DFAS Columbus had in

properly allocating payment amounts to the correct ACRNs, ultimately
contributing to a high rate of adjustments.

Legal and DOD In order to maintain administrative control over
appropriated funds, DOD

Requirements Contribute to has established a system of controls to help
ensure that funds obligated and

Complex Contracts then expended for the procurement of goods and services
were used as

intended and in accordance with applicable laws and regulations. A system
of controls should be designed to help ensure that agencies do not
obligate or expend more funds than available. However, DOD*s system
contributes to the complexity of the contracts. To report on the status of
its appropriated funds* including amounts

obligated and expended* DOD uses a line of accounting to accumulate
appropriation, budget, and management information. For all contracts, the
contracting office assigns a two- digit ACRN to each line containing
unique accounting information in accordance with the requirements
contained in DFARS 204.7107 (c). DFAS Columbus allocates payments to the
ACRNs to match contract payments to the corresponding obligations.

For the two contracts that we reviewed, the Army contract that was valued
at $565 million contained 74 separate ACRNs funded by 8 different
appropriation accounts and sales to three foreign countries, and the Air
Force contract that was valued at $49 million contained 89 ACRNs funded by
23 different appropriation accounts. Each ACRN was established to comply
with the DFARS requirement for a separate ACRN for each unique line of
accounting. The information on the line of accounting (1) is needed to
track the obligations and disbursements back to the DOD activity

authorizing the work and (2) provides information on the obligations and
disbursement data, such as the organizations providing the funding. While
DOD created all of these ACRNs to comply with its requirements, our
analysis of the lines of accounting showed that DOD used ACRNs to provide
the information needed to comply with legal requirements to

account for obligations by appropriation account 7 and by object class. 8
On the Army contract that contained 74 ACRNs, 24 of these ACRNs* about
one- third* were used by DOD to provide the information needed to satisfy
the legal requirements. Likewise, on the Air Force contract that contained
89 ACRNs, 48 of these ACRNs* or more than half* were used by DOD to
provide the information needed to satisfy the legal requirements. DOD
accounts for each of these ACRNs separately* in effect treating them as
separate bank accounts* even though they all fund the same contract. Each
additional ACRN increases the risk of incorrectly allocating payments

to the wrong ACRN. Frequent Contract

While accounting requirements and related ACRNs contributed to complex
Modifications Contribute to

contracts, frequent contract modifications to procure additional goods and
Complex Contracts

services are another factor that contributed to complex contracts. When
DOD orders more goods and/ or services than provided on the original
contract, DOD modifies the contract and pays the contractor for the
additional goods and/ or services. Many times different appropriation
accounts are used to pay for these additional goods and/ or services
resulting in DOD creating more ACRNs to account for the funds. Our
analysis of two DOD contracts showed that they were modified many times
over the years to procure additional goods and/ or services, as well as to
add or change payment instructions. Our review found that modifications
that changed payment instructions resulted in DFAS Columbus making
adjustments to correct prior payment allocations to ACRNs.

 In 1997, the Army contracted with Lockheed Martin Vought Systems
Corporation to produce an updated version of the Army Tactical Missile
System. The basic contract was for the procurement of 100 guided 7 Several
statutes and implementing regulatory requirements established by the
Secretary of

the Treasury (Treasury) and the Office of Management and Budget (OMB)
require the reporting of contractual obligations, properly recorded as
prescribed by 31 U. S. C. Section 1501, and related disbursements.
Principal among these are the content requirements for agencies* annual
budget submission and budget execution reports, 31 U. S. C. Sections 1108c
and 1554, respectively, and the Treasury and OMB accounting system and
financial reporting requirements that implement 31 U. S. C. Sections 1511
to 1514.

8 Object classes present information on obligations by the items or
services purchased by the federal government. Object classes include
personnel compensation and benefits, contractual services and supplies,
and acquisition of assets. The President*s budget is

required by 31 U. S. C. Section 1104( b) to present obligations by object
class for each account, and OMB requires agencies to report on these
object classes.

missiles and launching assemblies for the Army missile program. The Army
program office initially obligated $14.2 million in 1997 for this effort.
As of September 30, 2002, the estimated contract value increased

to almost $565 million. Our analysis of this contract showed that it was
modified 122 times over a 5- year period to (1) increase the number and
type of missile systems ordered for the Army and three foreign countries
from 100 to 833, (2) procure over 270,000 engineering service hours to
support the production of the missile systems, and (3) make other changes
necessary to administer the contract. The Army contracting office also
issued six modifications to provide detailed payment instructions to DFAS
Columbus. According to the Administrative Contracting Officer, the payment
instructions were issued to resolve payment allocation errors made by DFAS
Columbus and to ensure that the payments were applied to the correct ACRNs
on the contract.

 Like the Army contract, the Air Force contract was also modified a
number of times to procure additional goods and services and to administer
the contract. In October 1999, the Air Force contracted with L- 3
Communications to maintain the Army portion of the Army Data Link System.
The basic contract contained a description of the engineering and
technical services and spare parts necessary to maintain the
communications system worldwide. The contract also stated that funding for
the engineering and technical services as well as miscellaneous spare
parts would be included on individual funding

modifications on this contract. As of September 30, 2002, the estimated
contract value was about $49 million. Our analysis of this contract showed
that it was modified 82 times over a 3- year period by five different
procurement contracting officers to (1) provide funding for and/ or
increase/ decrease the requirements for engineering and technical services
and miscellaneous spare parts to maintain the Army assets for the Army
Data Link System and (2) make other changes necessary to administer the
contract. Furthermore, 73 of the 82 modifications revised the payment
instructions.

Contract Pricing Provisions Our analysis of two DOD contracts showed that
contract- pricing provisions

Contribute to Complex were a third factor that contributed to the
complexity of these contracts. Contracts

As stated previously, the Army and Air Force contracting offices issued
many contract modifications to procure goods and services on behalf of the
military services. These modifications included several contract line
items that contained numerous goods or services with different pricing
provisions. Contract pricing provisions can be placed into two broad
categories* fixed price or cost reimbursable. For example, the Army
contract contained firm- fixed- price provisions 9 for procuring 833
missiles, and cost- plus- fixed- fee 10 and cost- plus- award- fee 11
provisions for procuring

270,000 engineering service hours to support the missile production. Our
review found that contracts containing different pricing provisions are
more complex, and thus it is more difficult to properly allocate payments
to the correct ACRNs because DFAS Columbus voucher examiners must allocate
payment amounts manually, resulting in a greater opportunity for error.
When DFAS Columbus voucher examiners manually allocate payment amounts to
contract ACRNs, the voucher examiners must ensure that the payment amounts
associated with fixed price and cost reimbursable provisions are allocated
to those ACRNs funding those payment provisions only. However, in some
cases it is difficult for the voucher examiner to readily identify these
ACRNs without performing a labor- intensive review of the contract. As a
result, sometimes the voucher examiner incorrectly applies the payment
amounts to ACRNs funding fixed price provisions instead of ACRNs funding
cost reimbursable provisions. Our review of the Army contract found that
it contained 25 separate contract line items* 15 were to be paid for under
fixed price provisions

9 A firm- fixed- price contract provides for a price that is not subject
to any adjustment on the basis of the contractor*s cost experience in
performing the contract. This contract type places the maximum risk and
full responsibility for all costs and resulting profit or loss on the
contractor.

10 A cost- plus- fixed- fee contract is a cost reimbursement contract that
provides for payment to the contractor of (1) allowable incurred cost, to
the extent prescribed in the contract, and (2) a negotiated fee that is
fixed at the inception of the contract. The fee does not vary with actual
cost, but may be adjusted as a result of changes in the work to be
performed under the contract.

11 A cost- plus- award- fee contract is a cost reimbursement contract that
provides for a fee consisting of (1) allowable incurred cost, to the
extent prescribed in the contract, (2) a base amount fixed at inception of
the contract, and (3) an award amount, based on the judgmental evaluation
by the government, sufficient to provide motivation for excellence in
contract performance.

and 10 were to be paid for under cost reimbursable provisions. Similarly,
the Air Force contract contained 66 separate contract line items* 16 were
to be paid for under fixed price provisions and 50 were to be paid for
under cost reimbursable provisions.

Reasons for DFAS As stated previously, the Army and Air Force contracts
that we reviewed

Columbus Making were complex due to a number of factors, including legal
and DOD requirements, contract modifications, and pricing provisions.
These

$160 Million of factors contributed to the difficulty DFAS Columbus had in
properly

Adjustments to Correct allocating payment amounts to the correct ACRNs. As
a result, payment

Prior Payment amounts on these contracts were not allocated to the correct
ACRNs, and

DFAS Columbus made substantial adjustments to correct the payment
Allocations

allocations. Our evaluation of $160 million of adjustments showed that
DFAS Columbus made these adjustments to reallocate payments to the correct
ACRNs. Table 1 summarizes the reasons for the adjustments and provides the
number and dollar amount of adjustment transactions made to reallocate
payments to the correct ACRNs.

Tabl e 1: Reasons for $160 Million in Contract Payment Adjustments for Two
Contracts

Dollar value of Number of

adjustments adjustment (dollars in Reasons for the adjustments
transactions

millions)

Army contract writing system error in accounting for contract obligations.
92 $127.2

Procedures and regulations for an Army contract containing multiple
pricing provisions were not followed. 88 4.7

Complex and changing payment instructions for the Army contract. 16 2.4

Frequent contract modifications to change payment instructions for the Air
Force contract. 1,262 26.1

Tot al 1,458 $160.4

Source: GAO.

An Army Contract Writing From 1998 through 2001, DFAS Columbus paid 43
invoices totaling System Error in Accounting

$63.5 million for the procurement of several missile systems. DFAS for
Contract Obligations

allocated these payment amounts to two ACRNs according to the payment
instructions in effect at the time of the payment. Subsequently, the
contractor submitted price reductions to the Army for certain contract
items that DFAS Columbus had previously paid. In response to the price
reductions, the Army issued a contract modification to account for the
reductions. When the Army processed this modification, the Army contract
writing system incorrectly deobligated the amount for the missiles on the
two ACRNs in error and established two new ACRNs on the contract
containing the reduced amount. As a result, in January 2002, DFAS Columbus
processed 92 adjustment transactions totaling about $127.2 million to move
payment amounts to the new ACRNs. In discussing

this problem with Army officials, they informed us that they did not know
that the system error resulted in DFAS Columbus having to do additional
work to make these adjustments. According to these officials, the system
problem that resulted in the creation of the new ACRNs was corrected in

2001. Procedures and Regulations

From June 1999 through April 2001, DFAS Columbus paid 38 invoices for an
Army Contract

totaling about $16 million for engineering services on the Army contract.
Containing Multiple Pricing When DFAS Columbus paid the contractor, the
contract did not contain

Provisions Were Not specific payment instructions on how to allocate
payment amounts to ACRNs as required by DFARS 204.7107 (e)( 3)( i).
According to this

Followed regulation, when a contract line item is funded by multiple
ACRNs, the

contracting officer shall provide adequate instructions in the contract to
permit the paying office (DFAS Columbus in this case) to accurately charge
the ACRNs assigned to that contract line item. Without these payment
instructions, DFAS Columbus voucher examiners should follow DFAS Columbus
internal procedures. 12 These procedures require voucher

examiners to prorate payment amounts across all available ACRNs under cost
reimbursable provisions when the contract or contractor*s invoice does not
provide specific payment instructions on which ACRNs should be charged.
However, instead of charging ACRNs funding cost reimbursable provisions
only (engineering services), DFAS Columbus voucher examiners manually
allocated the payment amounts to ACRNs that funded both engineering
services (cost reimbursable provisions) and missiles

12 DFAS Columbus Contract Entitlement, Desk Procedure 401, June 1996.

(fixed price provisions). As a result, some payment amounts for
engineering services were incorrectly allocated to ACRNs funding the
procurement of missiles.

According to Army contracting officials, in April 2001* almost 2 years
after DFAS Columbus paid the first invoice* the Army issued a modification
containing detailed payment instructions once it became aware that DFAS
was having difficulty in allocating payment amounts to the correct ACRNs.
These instructions were different from the payment allocation procedures
followed by DFAS Columbus. However, by that time, DFAS Columbus had made
38 payments to the contractor for engineering services and allocated these
payments to several ACRNs. To correct payment allocation problems
associated with 7 of the previous 38 payments, DFAS Columbus processed 88
adjustment transactions totaling about $4.7 million to reallocate
previously recorded payments according to the new instructions.

Complex and Changing DFAS Columbus also processed 16 transactions totaling
about $2.4 million

Payment Instructions for in adjustments to correct payment errors made by
DFAS Columbus

the Army Contract voucher examiners when they manually applied payment
amounts to

ACRNs on the Army contract. In April 2001, the Army issued a contract
modification that provided specific payment instructions to ensure that
funds were used prior to cancellation. DFAS Columbus officials told us
that these payment instructions were complex and changed several times
after the modification was first issued. For example, the following
instructions were included in contract modifications to provide payment
instructions for contract line item number (CLIN) 13 0030.

 Contract modification 74 dated April 2001 stated that, *Subclins under
CLIN 0030 * prorate across ACRNs BR, BS, and BT.*

 Seven months later, in November 2001, contract modification 89 added
additional payment terms for CLIN 0030 by incorporating instructions for
CLIN 0031 and instructions for contract award fees under these two

CLINs. The modification stated, *Subclins under CLIN 0030/ 0031 * prorate
across ACRNs BR, BS, BT, BX, BY, and CD, unless voucher identifies award
fee then prorate across ACRNs CE, CF, CG, and CH.*

13 According to DFARS 204.7103- 1, contracts shall identify the items or
services to be acquired as separate contract line items.

 Seven months later, in June 2002, contract modification 109 provided
more payment instructions for CLIN 0030/ 0031. The modification noted
that, *Subclins under CLIN 0030/ 0031 * prorate across ACRNs BR, BS, BT,
BX, CD, CN, CT, CU, CW and DA, unless voucher identifies award fee then
prorate across ACRNs CE, CF, CG, CH and CV, or if voucher identifies
technical publications then prorate across ACRNs BY, CR, and DA.*

Our analysis of the payment instructions showed that the instructions were
complex, changed several times, and were difficult to administer properly.
We found that $2.4 million of adjustment transactions were the result of

errors made by voucher examiners. These errors occurred because the
examiners did not follow the complex, frequently changed, and nonstandard
payment instructions correctly. In order for DFAS Columbus to properly
allocate payments on CLIN 0030, our work showed that the

voucher examiner must (1) identify the current modification in effect at
the time of payment to ensure payments are allocated in accordance with
the payment instructions, (2) determine the type of invoice to ensure the

allocations are made against the correct ACRNs, for example, technical
publications or award fee, (3) identify the current available balance
associated with ACRNs funding the services, and (4) calculate a prorated

balance to be distributed to each ACRN funding the services. For example,
for one invoice totaling $350, 635 on the Army contract, DFAS Columbus
paid two contract line items and allocated the payment amounts to 23 ACRNs
in an attempt to comply with the payment instructions on the contract that
were in effect on the payment date. This condition resulted in errors in
the contract records when voucher examiners incorrectly allocated payment
amounts to the wrong ACRNs.

In discussing this problem with DFAS Columbus officials, they confirmed
our analysis that the payment instructions were complex and difficult to
administer properly. The officials stated that when a contract contains
payment instructions similar to the instructions presented above, DFAS
Columbus voucher examiners must manually allocate the payment amounts to
contract ACRNs. The officials also stated that the instructions on this
contract were very complicated and could easily be misinterpreted if
voucher examiners do not carefully review the payment instructions prior
to allocating the payment amount to ACRNs on the contract.

Frequent Contract In March 2001, DFAS Columbus processed 1,262
transactions totaling over

Modifications to Change $26 million to adjust previously recorded payment
allocations on the Air

Payment Instructions for Air Force contract. At the time these adjustments
were made, the Air Force

Force Contract had already issued 42 modifications, which changed the
payment

percentages that DFAS Columbus was required to follow to make correct
payment allocations. Because the number and frequency of the payment
percentages changed, DFAS Columbus did not allocate payment amounts to the
correct ACRNs in many cases.

The Air Force awarded a contract in October 1999 to procure engineering
and technical services and spare parts to maintain the Army Data Link
System. Over the next 3 years, the contract was modified numerous times to
increase the requirements for engineering and technical services and spare
parts, along with the necessary incremental funding amounts to support
these requirements. As additional funds were added to the contract, (1)
new ACRNs were added or obligation balances for existing ACRNs increased
and (2) the payment percentages were modified to reflect

the new obligation balances of the affected ACRNs. For example, the Air
Force modified contract line item number 0006 for engineering services
three times over a 2- month period to incrementally fund these services.
Each time, the Air Force changed the ACRN payment percentages funding

the contract line item. Our analysis of the contract showed that
allocating payments on this contract has been very difficult, and voucher
examiners could easily misinterpret the payment instructions because of
the numerous contract modifications that changed ACRN payment percentages.
These instructions were complex and difficult to administer because (1)
modifications frequently changed the payment instructions and (2) many
ACRNs were financing numerous contract line items. The

percentages changed so frequently that DFAS Columbus voucher examiners
could not keep track of ACRN balances in order to allocate payment
percentages properly. Also, when many ACRNs financed numerous contract
line items, DFAS Columbus had difficulty identifying how much of an ACRN*s
obligation amount related to each line item. Therefore, many payments were
not allocated in accordance with the current modification, and adjustments
were needed to correct these

allocations. Figure 5 illustrates the current funding structure for 3 of
the 66 contract line items on the Air Force contract.

Figure 5: Contract Funding Structure for Three Contract Line Items on the
Air Force Contract

Air Force contract CLIN

CLIN CLIN

1016 1st Military Intelligence 1018 15th Military Intelligence

1019 224th Military Intelligence Specialized Repair Activity

Specialized Repair Activity Specialized Repair Activity

$55,000 (41%) into BV

$44,996 (16%) into AJ

$152,764 (55%) into BV

$77,580 (59%) into BZ $100,000 (35%) into BV

$124,977 (45%) into BZ

$100,000 (35%) into CD

$38,212 (14%) into DK S

S S

S S AJ

BV BZ

CD DK 5 ACRN "Accounts"

Source: GAO illustration of contract funding structure contained in Air
Force contract modification P00073.

As shown above, the relationship of CLINs to ACRNs is complex because
there is not a one- to- one relationship. This makes it difficult for DFAS
Columbus to accurately allocate payments to ACRNs. Because the contract
funding structure was complex, DFAS Columbus voucher

examiners did not properly allocate payments to the correct ACRNs. Thus,
DFAS Columbus sent the contractor*s invoices to its contract
reconciliation branch for payment. In addition, beginning in the fall of
2001, the contractor began providing a detailed payment distribution
schedule with each invoice submitted to DFAS Columbus to assist it in
properly allocating

payments to the correct ACRNs. We found that an invoice totaling
$94,237.18 contained 31 pages of contractor costs and billing charges for
45 contract line items charging 56 different ACRNs. The amounts charged to
the ACRNs by the contractor were as little as $. 59 to as much as $88,107.
03.

DOD Initiatives to DOD officials acknowledged that there have been long-
standing contract

Address Payment payment allocation problems that have required DFAS
Columbus to

undertake time- consuming and costly reconciliations to correct allocation
Allocation Problems

errors. DOD has initiated a major long- term effort to develop and
implement an enterprise architecture, which is intended to improve its
business operations, including its acquisition and disbursement
activities. If implemented successfully, this initiative may help correct
many of the contract payment allocation problems. In the interim, DOD has
several

initiatives under way to address the payment allocation problems caused by
complex contracts with confusing payment instructions. First, DFAS plans
to bill reconciliation costs to contracting offices that contribute to
payment allocation problems. Second, DFAS Columbus is briefing the DOD
acquisition community on methods for presenting payment instructions in
contracts. Finally, a DOD working group is examining payment allocation
problems and plans to develop and implement payment allocation options for
presenting standard payment instructions on contracts DOD- wide to address
these problems. System Improvement

Since 1995, DOD had been attempting to develop a new system* DPPS* to
Initiatives

replace MOCAS, which was developed in the 1960s. DPPS was being designed
to resolve DOD*s long- standing disbursement problems, streamline contract
and vendor payment processes, and reduce manual interventions. However as
we previously reported, 14 DOD terminated DPPS in December 2002, after 7
years in development at a cost of over $126 million, because of poor
program performance and increasing life

cycle costs. DOD officials informed us that enhancements to MOCAS are now
being considered to provide some of the automated capabilities that DPPS
had been attempting to achieve.

14 U. S. General Accounting Office, DOD Business Systems Modernization:
Continued Investment in Key Accounting Systems Needs to be Justified, GAO-
03- 465 (Washington, D. C.: Mar. 28, 2003).

The failure of DPPS to become DOD*s standard procurement payment system is
indicative of DOD*s long- standing inability to efficiently and
effectively modernize its financial management and business systems. For
example, we recently reported 15 that over $300 million has been invested
to develop several DFAS financial management systems and that DOD has not
demonstrated that this investment will substantially improve the financial
management information needed for decision- making and financial reporting
purposes. To help avoid this type of result, we recommended in 2001 that
DOD develop and implement an enterprise architecture, an essential
modernization management tool. 16 As part of its current effort to
transform its business operations, DOD is

developing a business enterprise architecture. A key area of focus is
DOD*s acquisition and disbursement activities. As we have previously
reported, DOD contract management has been a high- risk area within the
department since 1992. 17 To address these problems, DOD*s business
enterprise

architecture development effort is intended to (1) incorporate federal
accounting and financial management requirements, (2) consider leading
practices in procurement and contract payments, and (3) reengineer its
business processes. If implemented as planned, this initiative has the
potential to address many of the contract payment allocation problems
discussed in this report. However, this is a long- term effort that will
take many years to implement.

DFAS Plans to Bill As pointed out earlier, the contracting offices that
contributed to payment

Contracting Offices That allocation problems have insufficient incentives
to structure their

Contribute to Payment contracts, including payment instructions, in a
manner that would reduce

Allocation Problems payment errors and related reconciliation costs. This
condition exists

because DFAS Columbus currently bills DOD activities (for example, the
Army) for contract pay services based solely on the number of lines of
accounting on an invoice. DFAS Columbus officials recognized this
shortcoming in establishing their billing rates and have informed us that

15 GAO- 03- 465. 16 U. S. General Accounting Office, Information
Technology: Architecture Needed to Guide Modernization of DOD*s Financial
Operations, GAO- 01- 525 (Washington, D. C.: May 17, 2001). 17 U. S.
General Accounting Office, High- Risk Series: An Update, GAO- 03- 119
(Washington, D. C.: January 2003).

they plan to use a separate billing rate, based on DFAS contract
reconciliation costs, to bill customers for reconciling, adjusting, and
correcting contract payments beginning in fiscal year 2004. According to
the officials, the direct billing hour rate for reconciliation services
will be $74.55 in fiscal year 2004 and will be billed to the contracting
offices responsible for writing the contracts that require reconciliation.
According to the Deputy Director of DFAS Columbus*s Commercial Pay
Services, separately billing contracting offices for the reconciliation
work should provide an incentive to those offices to reduce the number of
payment allocation problems that result in adjustments. In our view, this
billing initiative should encourage contracting offices to structure
contracts, including payment instructions, in a manner that should help
reduce payment errors and reconciliation costs.

DFAS Columbus Briefs DOD DFAS Columbus, in partnership with the Defense
Contract Management

Acquisition Community on Agency, is providing formal briefings to the DOD
acquisition community on

Contract Administration, various issues related to contract
administration, payment, and closeout. Payment, and Closeout

These briefings are designed to give contracting, procurement, and budget
Issues

personnel throughout DOD better insight into the contract entitlement,
payment, and accounting processes provided by DFAS Columbus. They also
help to promote teamwork between DFAS Columbus and the acquisition
community and provide an opportunity to enhance the communications link
that is necessary for these organizations to interoperate efficiently and
effectively. These briefings began in November 2001 and have been provided
to numerous activities across the military services. As of March 2003,
presentations had been provided to 18 major acquisition organizations,
such as the Army Aviation and Missile Command, the Navy Space and Naval
Warfare Systems Command, and the Air Force Space and Missile Systems
Center.

Among the topics included in these briefings are methods for correctly
presenting payment instructions in contracts. The briefing materials
emphasize that payment instructions provide a method for assigning
payments to the appropriate ACRNs, based on anticipated work performance.
Specifically, the materials discuss payment instruction requirements for
fixed price and cost reimbursement contracts and provide recommendations
for contracting officers to consider when they develop payment
instructions. Reference materials that provide additional payment
instruction information, available on the Internet, are also cited in
these briefings.

DOD Working Group In September 2002, DOD formed a working group 18 to
review contract

Examines Payment payment instructions. The working group*s results were
incorporated into

Instruction Problems a broader DOD initiative to identify needed
improvements and reductions

to procurement policies, procedures, and processes in DFARS. The working
group completed the first phase of its work by researching the types of
payment instructions that have caused payment allocation problems and
developing proposed changes to DFARS. The working group concluded that
payment allocation errors at DFAS Columbus (1) were often the result of
problems experienced with confusing payment

instructions and (2) were further compounded because DOD did not have
payment allocation options for including standard contract payment
instructions for use on DOD contracts. As illustrated earlier in this
report, payment instructions can be unique to each contract. For example,
DFAS Columbus made $2.4 million in payment allocation errors on the Army

contract because the voucher examiners made errors when they manually
applied payment amounts to ACRNs following complex, nonstandard payment
instructions that changed several times. This makes it difficult for DFAS
Columbus personnel* who must process the payments and make the adjustments
manually* to properly allocate the payments to the correct ACRNs.

In the second phase of this effort, the working group developed proposals
for regulatory changes to address the types of standard payment
instructions applicable to specific contracting situations. Depending on
their specific requirements, contracting officers would be able to choose
a contracting option that would include the standard payment instructions
applicable to that particular situation. For example, the working group is
evaluating several different standard payment instructions that DOD
contracting offices may use on contracts, including standard payment
instructions (1) for ensuring that funds are used before they are no
longer available for expenditure and (2) for ensuring that funds can be
allocated to the various contract ACRNs based on the balance available on
each contract ACRN. The group*s consensus was that such standardization
should enable DFAS Columbus to substantially increase its level of
automated payments.

18 The working group consists of representatives from the Offices of the
Under Secretary of Defense (Comptroller) and the Under Secretary of
Defense (Acquisition, Technology, and Logistics), DFAS Columbus, and the
Defense Contract Management Agency.

During phase three, the final phase that began in May 2003, the working
group*s proposals will be presented to the Defense Acquisition Regulations
Council 19 and other experts for review. The results from this review
process will eventually determine whether the working group*s proposals
will be accepted. DOD has not yet established a milestone date for
completing the third phase of this effort and has not yet made the final
decision to implement the options for presenting standard payment
instructions. While the working group did not study the possibility of
automating the standard payment instructions, it informed us that
automating them would be the next logical step if they were implemented.
Our analysis of the working group initiative to develop standard payment

instructions showed that it is a good first step because it should reduce
some of the payment allocation errors that were the result of DFAS
Columbus voucher examiners misinterpreting contract payment instructions.
However, even with the standard payment instructions, DFAS Columbus will
still manually allocate payments to contract ACRNs on complex contracts
such as the two mentioned in this report. As we previously stated, manual
payment allocations increase the opportunity for errors. In order to
eliminate payment allocation errors, DFAS should take the next step and
automate the standard payment instructions so that DFAS Columbus can
electronically process the payments with minimal manual intervention.

Conclusions Resolving DOD*s long- standing contract payment problems will
require major improvements to its processes and systems. One key element
of

DOD*s efforts to improve its business operations is its effort to develop
an enterprise architecture to guide and constrain its ongoing and planned
investments in business systems. Another key element to resolving contract
payment problems would be to determine whether DOD can reengineer the way
its contracts are written, including the length of time covered by a
contract as well as the number of modifications made to the contract. If
successful, these efforts could result in reengineered business processes
and financial management systems that could address many of DOD*s long-
standing contract payment allocation problems that have

required DFAS Columbus to undertake time- consuming and costly 19 Pursuant
to DOD Instruction 5000.63, subject: Defense Acquisition Regulations
System, July 31, 2002, the Defense Acquisition Regulations Council is
responsible for developing fully coordinated recommendations for revisions
to the FAR and the DFARS.

reconciliations to correct allocation errors. However, these reengineered
processes and systems are years from becoming reality.

In the interim, DOD is addressing some of the fundamental weaknesses that
have resulted in billions of dollars of adjustments to correct contract
payment allocations annually. However, DOD has not yet completed its work
to (1) provide information to the procuring activities on the correct
methods for presenting payment instructions on contracts, (2) develop and
implement standardized payment instructions to be used DOD- wide, and (3)
fully automate the payment process using these instructions. Without

standardized and automated payment instructions, DOD will continue to
spend millions of dollars each year to process payments manually and then
adjust those payments. Further, DOD activities must follow existing
regulations and procedures covering payment instructions to help ensure
that payment data are accurately recorded against the correct obligations.
Until DOD successfully modernizes its business operations, these interim

steps will help avoid the inaccurate contract payment data that have
hindered DOD*s ability to accurately account for and report on contract
disbursements. Recommendations for

We recommend that the Secretary of Defense direct the Under Secretary of
Executive Action

Defense (Acquisition, Technology, and Logistics) to  develop payment
allocation options for presenting standard payment

instructions in contracts containing multifunded contract line items and 
issue guidance to the contracting community reiterating the

requirement in DFARS that all contracts containing multifunded contract
line items contain payment instructions and that these instructions be
revised when additional ACRNs are added.

We also recommend that the Secretary of Defense direct the Under Secretary
of Defense (Comptroller) to direct the Director of the Defense Finance and
Accounting Service to

 automate the standardized payment instructions in MOCAS once the
standard payment instructions are adopted and

 issue guidance reiterating DFAS*s internal requirement that when a
contract does not contain payment instructions and the contractor invoice
does not contain payment instructions, the payments for costs

and services must be allocated to ACRNs financed on a cost reimbursable
basis in accordance with DFAS*s desk procedures.

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

Our Evaluation DOD concurred with two of the four recommendations and
partially

concurred with the remaining two recommendations. DOD*s comments are
reprinted in appendix II.

For the two recommendations with which it concurred, DOD stated that the
department will issue memorandums to (1) contracting personnel reiterating
the requirements contained in DFARS and (2) DFAS personnel to adhere to
DFAS policies and procedures, especially as they relate to the lack of
definitive payment instructions in the contractual documents.

Regarding the two partial concurrences, DOD stated that it would establish
a standard section of the contract for placement of payment provisions,
which would include any payment allocation provisions. In addition, DOD
agreed that it would, as part of the working group effort referred to in
this report, evaluate the feasibility of developing and automating payment
allocation options to include in standard payment instructions. However,
until the coordination and review process within DOD is complete, DOD

stated that it could not commit to the development and automation of
standard payment instructions. We understand that actions to develop and
automate standard payment instructions must be coordinated with interested
parties throughout DOD. At the same time, a clear commitment to completing
this effort in a timely manner is critical if DOD is to resolve its long-
standing problem of spending tens of millions of dollars each year to make
tens of billions of dollars in adjustments to correct the payment
allocation problems. When $1 out of every $4 in contract payment
transactions continues to be for adjustments to previously recorded
payments, decisive steps towards a lasting solution are essential. One
concern that we have is that DOD has not indicated any time frame for
completing the coordination and review process referred to in its
response. As we recently testified, 20 cultural resistance to change,
military service parochialism, and stovepiped

20 U. S. General Accounting Office, Department of Defense: Status of
Financial Management Weaknesses and Progress Toward Reform, GAO- 03- 931T
(Washington, D. C.: June 25, 2003).

operations have played a significant role in previous failed attempts to
implement management reforms at DOD. Breaking down these barriers will be
critical to successfully reforming DOD*s contract payment processes and
saving the millions of dollars currently spent annually on inefficient and
inaccurate manual processes.

In addition, DOD stated that our findings were based on a review of only
two contracts that had known problems. DOD recommended that the report
specifically state that, due to the nature of this review, the results
cannot be extrapolated to other DOD contracts. The draft report already
included such a statement. The report states that the two contracts we
reviewed are not representative of all DOD contracts but, based on our
experience, have characteristics similar to other complex contracts. DFAS
Columbus provided these contracts as examples of complex contracts with
which they had encountered problems in correctly allocating payments to
ACRNs. We selected these two contracts so we could identify the root cause
of payments not being properly allocated to ACRNs and to determine what
actions DOD is taking to address the problem. We believe that the two
contracts provide a good perspective regarding the types of serious
problems that have long plagued DOD*s contract payment process.

As agreed with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days from
its date. At that time, we will send copies of the report to interested
congressional committees. We will also send copies of this report to the
Secretary of Defense; the Under Secretary of Defense (Comptroller); the
Under Secretary of Defense (Acquisition, Technology, and Logistics); the
Secretaries of the Army, Navy, and Air Force; and the Director of the
Defense Finance and Accounting Service. We will make copies available to
others upon request. In addition, the report will be available at no
charge on the GAO Web site at http:// www. gao. gov. If you or your staff
have any questions regarding this report, please contact me at (202) 512-
9505 or kutzg@ gao. gov or Greg E. Pugnetti, Assistant Director, at (703)
695- 6922 or

pugnettig@ gao. gov. Major contributors to this report are acknowledged in
appendix III.

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

Appendi Appendi xes x I

Scope and Methodology To determine the magnitude of adjustments that
affected previously recorded payments and Defense Finance and Accounting
Service (DFAS) Columbus*s reported cost to make these adjustments in
fiscal year 2002, we obtained and analyzed a Mechanization of Contract
Administration Services (MOCAS) database of contract payment transactions,
including disbursements, collections, and adjustments, made for fiscal
year 2002. We then determined the dollar amount and percentage of those
adjustments that were made to previously recorded payments. We also
interviewed and obtained cost information from DFAS officials to determine
the costs for the DFAS Columbus commercial pay services, including the
cost incurred by DFAS Columbus to make adjustments to previously recorded
payments.

To determine why contracts, including payment instructions, were complex,
we reviewed applicable laws, Department of Defense (DOD) memorandums,
regulations, administrative guidelines, policies, and procedures governing
contract payments. These included a review of the

key contract payment provisions provided in the Defense Federal
Acquisition Regulation, DOD acquisition guidance, and DFAS policies. We
also requested that DFAS Columbus provide us with several contracts that

created problems for DFAS Columbus technicians when recording payments.
DFAS Columbus officials provided us with 10 contracts that contained
problems that DFAS Columbus was having with properly allocating payments
to accounting classification reference numbers (ACRN), such as (1) missing
payment instructions, (2) complex payment instructions, or (3) the
contracting office changing payment instructions. Based on our review of
contract documentation and interviews with DFAS Columbus officials, we
selected two contracts for a detailed review to determine why the
contracts, including payment instructions, were

complex and caused payment allocation problems. The two contracts selected
were an Army missile contract (contract number DAAH01- 98- C- 0093) and an
Air Force communications contract (contract number F09604- 00- C- 0090).
In selecting these two contracts, we considered several factors, including
(1) goods and/ or services purchased,

(2) the dollar amount of obligations and disbursements made on the
contract, (3) the number of modifications made to the contract, (4) the
number of ACRNs financing the contract, (5) payment provisions on the
contract, and (6) the number of contract reconciliations performed by DFAS
Columbus. Because contract data were constantly changing, we used a cutoff
point of September 30, 2002, to gather, review, and analyze data on the
two contracts.

To determine the key factors that caused DFAS Columbus to make payment
adjustments for the two contracts reviewed, we obtained the contracts,
purchase requests, contract modifications, vouchers, invoices, and other
contract documentation. We reviewed this information and analyzed in
detail (1) the payment instructions contained in the contract and contract
modifications, (2) the purpose for and the number of ACRNs funding the
contract, and (3) the number, dollar amount, and reasons for adjustments
on the contracts. To determine why these adjustments were necessary, we
analyzed 2 of the 67 reconciliations performed by DFAS

Columbus (1 review for each contract), which resulted in $160 million of
the $264 million in adjustments. Finally, to determine what steps DOD has
taken or planned to address the

adjustment problem, we (1) reviewed applicable DOD policies to identify
changes in payment instruction guidance, (2) interviewed DFAS officials
responsible for system development projects that affected MOCAS payments,
and (3) interviewed DFAS officials on a working group formed to improve
payment instructions. In addition, we discussed with officials from DFAS
and the Office of the Under Secretary of Defense (Acquisition, Technology,
and Logistics) why the contract payment instructions were so complex,
whether they needed to be so complex, and what the officials were doing to
address this problem.

We performed our review at the headquarters Offices of the Under Secretary
of Defense (Comptroller) and the Under Secretary of Defense (Acquisition,
Technology, and Logistics), Washington D. C., and DFAS, Arlington,
Virginia; DFAS, Columbus, Ohio; Army Aviation and Missile Command,
Redstone Arsenal, Alabama; and Air Force Materiel Command, Robins Air
Force Base, Georgia. Our review was performed from August 2002 through
July 2003 in accordance with U. S. generally accepted government auditing
standards, except that we did not validate the

accuracy of (1) DFAS Columbus disbursement data pertaining to the dollar
amount and percentage of those adjustments that were made to previously
recorded payments and (2) the cost incurred to reconcile DFAS Columbus

contracts. We also did not review the DOD acquisition process, including
how contracts are written. We did analyze the payment instructions in the
two contracts that we reviewed. We requested comments on a draft of this
report from the Secretary of Defense or his designee. DOD provided written
comments on July 3, 2003, which are discussed in the *Agency Comments and
Our Evaluation* section of this report and are reprinted in appendix II.

Appendi x II Comments from the Department of Defense

Appendi x III

GAO Contact and Staff Acknowledgments GAO Contact Greg E. Pugnetti, (703)
695- 6922 Acknowledgments Staff members who made key contributions to this
report were Francine M.

DelVecchio, Francis L. Dymond, Dennis B. Fauber, Keith E. McDaniel, and
Harold P. Santarelli.

Related GAO Products

Canceled DOD Appropriations: Improvements Made but More Corrective Actions
Are Needed. GAO- 02- 747. Washington, D. C.: July 31, 2002.

DOD Contract Management: Overpayments Continue and Management and
Accounting Issues Remain. GAO- 02- 635. Washington, D. C.: May 30, 2002.

Canceled DOD Appropriations: $615 Million of Illegal or Otherwise Improper
Adjustments. GAO- 01- 697. Washington, D. C.: July 26, 2001.

Financial Management: Differences in Army and Air Force Disbursing and
Accounting Records. GAO/ AIMD- 00- 20. Washington, D. C.: March 7, 2000.

Financial Management: Seven DOD Initiatives That Affect the Contract
Payment Process. GAO/ AIMD- 98- 40. Washington, D. C.: January 30, 1998.

Financial Management: Improved Reporting Needed for DOD Problem
Disbursements. GAO/ AIMD- 97- 59. Washington, D. C.: May 1, 1997.

Contract Management: Fixing DOD*s Payment Problems Is Imperative. GAO/
NSIAD- 97- 37. Washington, D. C.: April 10, 1997.

Financial Management: Status of Defense Efforts to Correct Disbursement
Problems. GAO/ AIMD- 95- 7. Washington, D. C.: October 5, 1994.

(192069)

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Report to the Chairman, Committee on the Budget, House of Representatives

August 2003 DOD CONTRACT PAYMENTS Management Action Needed to Reduce
Billions in Adjustments to Contract Payment Records

GAO- 03- 727

                                       A

Contents Letter 1

Results in Brief 2 Background 5 DFAS Columbus Made $49 Billion of
Adjustments at a Cost of about

$34 Million in Fiscal Year 2002 12 Contracts Were Complex Due to Legal and
DOD Requirements, Contract Modifications, and Pricing Provisions 12

Reasons for DFAS Columbus Making $160 Million of Adjustments to Correct
Prior Payment Allocations 17 DOD Initiatives to Address Payment Allocation
Problems 23 Conclusions 27 Recommendations for Executive Action 28 Agency
Comments and Our Evaluation 29

Appendixes

Appendix I: Scope and Methodology 32

Appendix II: Comments from the Department of Defense 34

Appendix III: GAO Contact and Staff Acknowledgments 37 GAO Contact 37
Acknowledgments 37

Related GAO Products 38 Table Table 1: Reasons for $160 Million in
Contract Payment Adjustments

for Two Contracts 17 Figures Figure 1: Sample Line of Accounting on the
Air Force Contract 6

Figure 2: Payment Process Information Flow for the Air Force Contract 7
Figure 3: Army Tactical Missile Launched from Multiple Launch Rocket
System 10

Figure 4: Army Data Link System Transferring Information Collected by
Aircraft, Satellites, and Ground Stations 11 Figure 5: Contract Funding
Structure for Three Contract Line

Items on the Air Force Contract 22

a

GAO United States General Accounting Office

For fiscal year 2002, DFAS Columbus data showed that about $1 of every $4
in contract payment transactions in the MOCAS system was for adjustments
to previously recorded payments*$ 49 billion of adjustments out of

$198 billion in transactions. To research payment allocation problems,
DFAS Columbus reported that it incurred costs of about $34 million in
fiscal year 2002. This represents about 35 percent of the total $97
million that DFAS Columbus spent on contract pay services. DFAS Columbus
bills DOD activities for contract pay services based on the number of
accounting lines on an invoice. Consequently, all DOD activities pay the
same line rate, regardless of whether substantial work is needed to
reconcile problem contracts and adjust payment records. GAO*s analysis of
two contracts showed that the contracts were complex

because of the (1) legal and DOD requirements to track and report on the
funds used to finance the contracts, (2) substantial number of
modifications made on the contracts to procure goods and/ or services, and
(3) different pricing provisions on the contracts. GAO*s review of $160
million of adjustments showed that the adjustments were made for four
reasons:

 The Army made an error in accounting for obligations, resulting in about
$127 million in payment allocation adjustments.

 DFAS Columbus did not follow its internal procedures for allocating
payments to accounts on an Army contract containing multiple pricing
provisions, resulting in about $5 million in adjustments.

 DFAS made over $2 million in adjustments to correct recording errors on
an Army contract due to complex and changing payment instructions.

 The Air Force frequently changed payment instructions after payments
were made on an Air Force contract, resulting in about $26 million in
adjustments. DOD has initiated a major long- term effort to improve its
business

operations, including its acquisition and disbursement activities. If
implemented successfully, this initiative may help correct many of the
contract payment allocation problems. In the interim, DOD has initiatives
under way to address payment allocation problems, including (1) billing
DOD contracting offices for contract reconciliation services, (2)
providing DOD activities information on the correct method for presenting
payment instructions, and (3) establishing a working group to develop
options for presenting standard contract payment instructions. While the
DOD working group initiative may reduce payment allocation errors
associated with misinterpreting contract payment instructions, DOD needs
to automate the standard payment instructions to eliminate payment
allocation errors associated with manually allocated payments. GAO has
reported that the

Department of Defense*s (DOD) inability to accurately account for and
report on disbursements is a long- term, major problem. GAO was requested
to determine (1) the magnitude of the adjustments and related costs in
fiscal year 2002, (2) why contracts, including

payment terms, are so complex, (3) the key factors that caused Defense
Finance and Accounting Service (DFAS) Columbus to make payment
adjustments, and (4) what steps DOD is taking to address the

payment allocation problems. GAO recommends that DOD (1) develop options
for presenting standard payment instructions in contracts and (2) automate
those instructions in the Mechanization of Contract Administration
Services (MOCAS) system. GAO also recommends that DOD*s

contracting community and DFAS follow existing regulations and procedures
concerning contract

payment instructions. In its comments, DOD concurred with two
recommendations and partially

concurred with two others related to developing and automating the
standard payment instructions. DOD stated that although the working group
would analyze their feasibility, until the coordination and review process
was completed, it could not commit to these

actions. We continue to believe that decisive steps towards a lasting
solution are needed to address DOD*s long- standing contract payment
problems.

www. gao. gov/ cgi- bin/ getrpt? GAO- 03- 727. 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- 727, a report to the

Chairman, Committee on the Budget, House of Representatives August 2003

DOD CONTRACT PAYMENTS

Management Action Needed to Reduce Billions in Adjustments to Contract
Payment Records

Page i GAO- 03- 727 DOD Contract Payments

Contents

Page ii GAO- 03- 727 DOD Contract Payments

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Appendix I Scope and Methodology

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Appendix II

Appendix II Comments from the Department of Defense Page 35 GAO- 03- 727
DOD Contract Payments

Appendix II Comments from the Department of Defense Page 36 GAO- 03- 727
DOD Contract Payments

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Appendix III

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