Army Depot Maintenance: Ineffective Oversight of Depot		 
Maintenance Operations and System Implementation Efforts	 
(30-JUN-05, GAO-05-441).					 
                                                                 
The Army depot maintenance activity group received about $2.6	 
billion of orders in fiscal year 2004 to repair helicopters,	 
combat vehicles, and air defense systems. To perform this work,  
the group operates under the working capital fund concept, where 
customers are to be charged the anticipated costs of providing	 
goods and services to them. GAO was asked to determine (1) if	 
prices charged by the group have increased and, if so, why; (2)  
how the group allocates gains or losses incurred at the 	 
individual depot level; and (3) if the group exceeded its	 
allowable carryover ceilings and the reasons for exceeding the	 
ceilings. GAO was also asked to determine if the Army encountered
problems implementing a new system, the Logistics Modernization  
Program (LMP), at the Tobyhanna Army Depot.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-05-441 					        
    ACCNO:   A28579						        
  TITLE:     Army Depot Maintenance: Ineffective Oversight of Depot   
Maintenance Operations and System Implementation Efforts	 
     DATE:   06/30/2005 
  SUBJECT:   Aircraft maintenance				 
	     Allocation (Government accounting) 		 
	     Army bases 					 
	     Army facilities					 
	     Budget activities					 
	     Budget administration				 
	     Cost analysis					 
	     Defense capabilities				 
	     Equipment maintenance				 
	     Maintenance costs					 
	     Military cost control				 
	     Prices and pricing 				 
	     Weapons systems					 
	     Army Logistics Modernization Program		 
	     Army Working Capital Fund				 
	     Abrams Tank					 
	     Apache Helicopter					 
	     Black Hawk Helicopter				 
	     M1 Tank						 
	     AH-64 Helicopter					 

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GAO-05-441

United States Government Accountability Office

GAO	Report to the Chairman, Subcommittee on Defense, Committee on

                    Appropriations, House of Representatives

June 2005

ARMY DEPOT MAINTENANCE

Ineffective Oversight of Depot Maintenance Operations and System Implementation
                                    Efforts

                                       a

GAO-05-441

[IMG]

June 2005

ARMY DEPOT MAINTENANCE

Ineffective Oversight of Depot Maintenance Operations and System Implementation
Efforts

  What GAO Found

GAO identified four management weaknesses that are impairing the
efficiency and effectiveness of Army depot maintenance operations. The
activity group's average sales price increased from $111.87 per hour for
fiscal year 2000 to $147.07 per hour for fiscal year 2005-a 31 percent
increase (21 percent if adjusted for inflation). An increase in material
costs was the major driver of the sales price increase. The Army has
identified some causes of the higher material costs such as increased
material usage to rebuild certain weapon systems under the Army's
recapitalization program and higher prices that it pays suppliers for
parts, but it has not completed a comprehensive analysis of material cost
increases. As a result, the Army has not been able to take proactive steps
to control rising material costs.

GAO analysis showed that in setting future prices, the Army spread depot
maintenance reported gains and losses across all depots rather than
allocating them to the individual depot that incurred the gains or losses.
While DOD policy does not specify how to allocate gains and losses at the
depot level, this practice does not provide the right incentives to the
depots to set prices correctly in the budget. If one depot consistently
incurred losses, the Army would increase the prices at other depots to
help recoup its losses. As a result, the depot incurring the losses is not
held accountable for operating on a break-even basis. The end result of
this practice is that customers of depots with consistent losses are, in
effect, subsidized by customers of depots with consistent gains.

GAO analysis also showed that the reported carryover (work not completed
at fiscal year end) exceeded DOD's carryover ceilings from fiscal year
1996 through fiscal year 2003. Too much carryover could result in an
activity group receiving funds from customers in one fiscal year but not
performing the work until subsequent fiscal years. Factors contributing to
carryover exceeding the ceilings include depots receiving new orders at
fiscal year-end and not being able to obtain parts needed in a timely
manner.

Finally, the Army continued to encounter problems implementing a new
system intended to improve depot operations. GAO previously reported on
these problems in May 2004, and noted that the Army's inadequate
requirements management and system testing were primary contributing
factors to the problems. These problems are preventing the Tobyhanna Army
Depot from accurately reporting on its financial operations, which, in
turn, adversely impacts the depot's ability to accurately set prices.
GAO's current review found that the Army has not put into place an
effective management process to help ensure that the problems with the
system are resolved. While the Army developed a process that identified
the specific steps that should be followed in addressing the problems
identified, the process was not followed. Until the underlying causes of
the problems are corrected, other depots implementing LMP will encounter
similar problems.

United States Government Accountability Office

Contents

  Letter

Results in Brief
Background
Depot Maintenance Prices Increased Due to Increasing Material

Costs Method of Allocating Gains and Losses Does Not Provide Incentive

For Depots to Set Prices Correctly Army Has Consistently Exceeded
Carryover Threshold Tobyhanna Army Depot Continues to Experience
Difficulty With

LMP Conclusions Recommendations for Executive Action Agency Comments and
Our Evaluation

1 2 6

8

16 17

24 35 35 37

Appendixes

          Appendix I: Scope and Methodology 39 Appendix II: Comments from the
                Department of Defense 42 Appendix III: GAO Contacts and Staff
                                                           Acknowledgments 46

Tables Table 1:

Table 2: Table 3: Table 4:

Table 5:

Table 6: Table 7:

Factors Responsible for the Increases in the Army Depot
Maintenance Activity Group's Composite Sales Price
between Fiscal Years 2000 and 2005 10
Depot Base Operations and Maintenance Mission Rates
Per Direct Labor Hour for Fiscal Year 2001 14
Depot Base Operations and Maintenance Mission Rates
Per Direct Labor Hour for Fiscal Year 2005 15
Fiscal Year-End Actual Reported Carryover from Fiscal
Year 1996 through 2001 Consistently Exceeded DOD's
3-month Standard 19
Dollar Amount of Reported Actual Carryover for Fiscal
Years 2002 and 2003 That Exceeded Allowable
Amounts 20
Differences in Selected AccountBalancesReported in SDS
and LMP as of June 30, 2003 28
Example of Incorrect Unit Costs in New System 29

Contents

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separately.

A

United States Government Accountability Office Washington, D.C. 20548

June 30, 2005	

The Honorable C. W. Young	Chairman, Subcommittee on Defense	Committee on
Appropriations	House of Representatives	

Dear Mr. Chairman:	

The Army depot maintenance activity group supports combat readiness
by	providing services necessary to keep Army units operating worldwide.
   	From fiscal year 2000 through fiscal year 2004, the group
employed	between 10,000 and 13,000 people and received approximately $1.4
billion 	to $2.6 billion in new orders each year to repair and overhaul a
wide range 	of assets, including helicopters such as the Apache and
Blackhawk; combat 	vehicles such as the Abrams tank; air defense systems
such as the Patriot	missile; electronics; and inventory items for the
Army, other military 	services, and foreign governments. Many of these
weapons systems are 	used to support the Army's current effort in Iraq and
Afghanistan. 	According to Army officials, to perform the work needed in
support of the	global war on terrorism, the number of direct labor hours
of work	increased from 11.6 million in fiscal year 2002 to an estimated
19.3 million 	for fiscal year 2005-a 66 percent increase. The group
operates under the 	working capital fund concept, where customers are to
be charged for the 	anticipated full cost of goods and services. The group
performs its 	operations primarily at five depots-the Tobyhanna Army
Depot, 	Tobyhanna, Pennsylvania; the Letterkenny Army Depot,
Chambersburg,	Pennsylvania; the Corpus Christi Army Depot, Corpus Christi,
Texas; the	Anniston Army Depot, Anniston, Alabama; and the Red River Army
Depot, 	Texarkana, Texas.	

Over the past several years, we have performed work on specific
activity	groups within the Navy and Air Force working capital funds for
your 	subcommittee. These reports have discussed several issues including
   	(1) the prices charged customers; (2) whether the activity groups
realized 	gains or incurred losses; (3) work not completed by the end of
the fiscal	year, generally referred to as carryover; and (4) system
initiatives. The 	congressional defense committees have used our Defense
Working Capital 	Fund work in reviewing Department of Defense (DOD)
budgets.	

As requested and agreed to with your office, our objectives of
this	assignment were to determine (1) if the prices charged by the Army
depot	

maintenance activity group have increased and, if so, why; (2) how the
Army depot maintenance activity group allocates reported gains or losses
incurred at the individual depot level; (3) if the Army depot maintenance
activity group exceeded its allowable carryover ceilings1 and, if so, the
reasons for exceeding the ceilings; and (4) if the Army encountered
problems with the implementation of a new system, called the Logistics
Modernization Program (LMP), at the Tobyhanna Army Depot. Our review was
performed from June 2004 through April 2005 in accordance with U.S.
generally accepted government auditing standards. Most of the financial
information in this report is budget data obtained from official Army
budget documents. The accounting data used in this report were obtained
from official Army accounting reports. To assess the reliability of the
data, we (1) reviewed and analyzed the factors used in determining the
prices and (2) interviewed Army officials knowledgeable about the data. We
determined that the data were sufficiently reliable for the purposes in
this report. 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 Deputy
Comptroller for Program Budget are reprinted in appendix II.

Results in Brief
We identified four management weaknesses that are impairing the efficiency
and effectiveness of Army depot maintenance operations. These weaknesses
include (1) ineffective actions to control increasing material costs, (2)
not allocating reported gains or losses incurred by a specific depot to
that depot, (3) exceeding ceilings on work carried over at fiscal year
end, and (4) problems fielding a new system that is intended to provide
timely and accurate logistical and financial information.

Despite rising prices over the past several years, Army depot maintenance
officials have not taken effective actions to control material costs-the
primary cost factor driving up the prices during the time frame covered by
our work. Our work showed that the Army depot maintenance activity group's
average sales price for work increased 31 percent (21 percent if

1DOD policy establishes a ceiling for the amount of work that can be
carried over from one fiscal year to the next.

adjusted for inflation) between fiscal years 2000 and 20052 primarily due
to increasing material costs. According to the activity group's budget
documents, the average price per direct labor hour of work accomplished
(composite sales price)3 increased from $111.87 per hour for fiscal year
2000 to $147.07 per hour for fiscal year 2005. Because of the price
increase, the activity group's customers will pay about $400 million more
for work in fiscal year 2005 than they would have paid in fiscal year
2000. Material costs accounted for the majority of the sales price
increase from fiscal year 2000 to fiscal year 2005, accounting for over
100 percent4 of the activity group's sales price increase. Army depot
maintenance officials provided evidence showing increasing material costs
were caused, in part, by increased (1) material usage to rebuild selected
weapon systems to likenew condition under the Army's recapitalization
program and (2) prices that the activity group pays its suppliers for
repair parts. However, Army depot maintenance officials have not completed
a comprehensive analysis to determine (1) how much of the increase was due
to increased material usage under the recapitalization program versus
price increases and (2) whether they have identified all of the reasons
for the material increases. As a result, the Army has not been able to
take proactive steps to control rising material costs.

In setting future prices to break even, the Army spread depot maintenance
reported gains and losses across all depots, rather than allocating
reported losses or gains incurred by a specific depot to that depot. While
DOD policy does not specify how to allocate gains and losses at the depot
level, this practice does not provide the right incentives to the depots
to set prices correctly in the budget. In the past, if one depot
consistently incurred losses, the Army would increase the prices at other
depots to help recoup its losses. As a result, the depot incurring the
losses is not held accountable for operating on a break even basis. For
example, the Red River Army

2 Using the Gross Domestic Product price index updated in January 2004, if
the fiscal year 2000 composite sales price is converted to fiscal year
2005 dollars, the composite sales price would be $121.15 and the increase
would be 21 percent.

3 The composite sales price is the average price that customers must pay
for a direct labor hour of work and is used for budgeting purposes. The
average price includes labor, material, and overhead costs. For actual
work performed, the activity group develops individual sales prices, such
as the price per hour to perform work on the Apache helicopter, and bills
customers based on those individual prices.

4 Other cost factors included in developing the sales price decreased
resulting in material costs accounting for over 100 percent of the sales
price increase.

Depot reported an accumulated loss for 4 of the past 5 fiscal years,
including fiscal years 2002, 2003, and 2004. For these 3 fiscal years, the
reported accumulated losses ranged from $18 million to about $48 million,
indicating that Red River's customers were not charged enough for the
goods and services provided to them. On the other hand, the Tobyhanna Army
Depot-which had a reported revenue that ranged from $259 million to $406
million from fiscal years 2000 to 2004-reported an accumulated gain for
each fiscal year from fiscal year 2000 through fiscal year 2004, ranging
from $31 million to $169 million, indicating that their customers have
been charged too much for goods and services. The end result of this
practice is that customers of depots with consistent losses are in effect
subsidized by customers of depots with consistent gains.

We also found that the Army depot maintenance activity group's actual
reported carryover exceeded DOD's carryover ceilings from fiscal year 1996
through fiscal year 2003. The activity group's reported actual carryover
did not exceed the allowable amount for fiscal year 2004. We reviewed the
Army's fiscal year 2004 carryover calculation and validated that the
Army's calculation was done in accordance with DOD's new carryover policy.
Too much carryover could cause an activity group to receive funds from
customers in one fiscal year but not perform the work until well into the
next fiscal year or subsequent fiscal years. In the past, the Congress has
reduced the services' budgets because of excessive carryover, including a
reduction in the Army's fiscal year 2003 Operation and Maintenance
appropriation by $48 million. Factors contributing to the four depots that
exceeded their carryover ceilings included depots receiving new orders at
fiscal year-end and depots being unable to obtain material needed to
perform repair work in a timely manner. Furthermore, even though the
Army's reported carryover amount exceeded the ceilings, we found that the
Army understated its reported actual carryover for fiscal years 2002 and
2003. As a result, fiscal year 2003 carryover was understated by $95
million. According to Army officials, the understatement occurred because
DOD provided verbal guidance that was unclear when DOD revised its
carryover policy. Based on its interpretation of this guidance, the Army
only included actual carryover on orders received in the current year but
did not include carryover related to orders received in prior years in
calculating its reported actual carryover for fiscal years 2002 and 2003.

Finally, management oversight weaknesses are evident in the Army's efforts
to implement its new LMP system, which is intended to improve the
efficiency and effectiveness of depot operations. We previously reported
on LMP implementation problems in May 2004 and noted that the Army's

inadequate requirements management and system testing were primary
contributing factors to the problems occurring. These problems continue to
prevent the Tobyhanna Army Depot from accurately reporting on its
financial operations, including gains and losses, which, in turn,
adversely affected the depot's ability to accurately set customer sales
prices. For example, Army officials believe their fiscal year-end 2003 and
2004 annual operating result is overstated by about $125 million due to,
among other things, miscellaneous gains being reported in LMP when no such
gains occurred. On our current review, we found that the Army has not put
into place an effective management process to help ensure that the
problems identified with LMP are resolved. While the Army and Computer
Sciences Corporation (CSC), the contractor responsible for developing and
implementing LMP, developed a process that identified the specific steps
that should be followed to address known problems, the process was not
followed. Until the Army institutes a process that ensures the underlying
causes of problems are identified and corrected, other depots implementing
LMP will encounter similar problems.

We are making recommendations to the Department of Defense to (1) develop
a systematic methodology for analyzing material cost increases and take
action to reduce costs, (2) allocate depot gains and/or losses to the
individual depots if a trend shows that an individual depot consistently
realizes gains or incurs losses, (3) continue to comply with the carryover
policy by not exceeding the ceiling, and (4) improve the management and
reporting of carryover to decision makers by clarifying guidance for
calculating carryover. We are also making recommendations to implement
existing management procedures to resolve identified problems resulting
from the implementation of LMP and to delay system implementation at the
four remaining depots until the problems encountered by the Tobyhanna Army
Depot are resolved.

In its comments on a draft of this report, DOD concurred with all nine of
the recommendations. Specifically, the Army has added guidance stating
that gains and losses should be allocated to the individual industrial
installations if a several year trend shows that an installation has
consistently realized gains or losses. Further, the Under Secretary of
Defense (Comptroller) will issue guidance clarifying the present carryover
policy concerning the calculation of actual carryover as well as the
allowable amount of carryover. Finally, the Army concurred with our
recommendations on LMP and recognizes that it can not move forward with
future deployments to other depots until critical problems identified at
the Tobyhanna Army Depot are corrected.

Background
The Army depot maintenance activity group is part of the Army Working
Capital Fund, a revolving fund that relies on sales revenue rather than
direct appropriations to finance its operations. DOD policy requires
working capital fund activity groups to (1) establish sales prices that
allow them to recover their anticipated costs from their customers and (2)
operate on a break even basis over time-that is, to not make a gain nor
incur a loss, which is referred to as a zero accumulated operating result
(AOR). 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 during the
year-regardless of when the work is actually accomplished or what costs
are actually incurred. For depot maintenance activity groups, DOD policy
also requires that as long as adequate cash balances are maintained,
unbudgeted operating losses or gains of $10 million or more per activity
group will be recouped or returned, as appropriate. This will occur in the
current fiscal year or, in the case of fourth quarter losses or gains, in
the first quarter of the next fiscal year.

Developing accurate sales prices is challenging since the process to
determine the prices begins about 2 years in advance of when the work is
actually ordered and performed. In essence, the activity group's budget
development has to coincide with the development of its customers' budgets
so that they both use the same set of assumptions. To develop prices, the
activity group estimates (1) labor, material, overhead, and other costs
based on anticipated demand for work as projected by customers; (2) total
direct labor hours for each type of work performed, such as helicopters,
tanks, and repairable inventory items; (3) the workforce's productivity;
and (4) savings due to productivity and other cost-avoidance initiatives.
In order for an activity group to operate on a break even basis, it is
extremely important that the activity group accurately estimate the work
it will perform and the costs of performing the work. Higher-than-expected
costs or lower-than-expected customer demand for goods and services can
cause the activity group to incur losses. Conversely, lower-than-expected
costs or higher-than-expected customerdemand forgoods andservices can
result in gains. With sales prices based on assumptions that are made as
long as 2 years before the prices go into effect, some variances between
expected and actual costs are inevitable.

New Depot Maintenance System Expected to Improve Financial Data

We have previously reported that DOD has had long-standing problems in
preparing accurate working capital fund financial reports. For example, in
its fiscal years 2003 and 2004 Principal Financial Statements, the Army
acknowledged that its financial management and feeder systems that DOD
relied on to provide evidence supporting the Army Working Capital Fund
financial statements did not comply with federal financial management
system requirements, generally accepted accounting principles, and the
U.S. Government Standard General Ledger at the transaction level. As a
result of such deficiencies, the DOD Inspector General (who is required by
31 U.S.C. sec. 3521(e)(1) to conduct an audit of said financial
statements) was unable to express an opinion on the reliability of the
Army Working Capital Fund's financial statements for fiscal years 1993
through 2004.

To help improve the Army depot maintenance activity group's operations,
including financial management, in February 1998, the Army Materiel
Command began an effort to replace systems that are at least 30 years old
that manage inventory and depot maintenance operations with LMP. According
to the Army, LMP is intended to transform the Army Materiel Command's
logistics operations in six core processes, one being financial
management. LMP is to, among other things, improve accounting and
reporting on billions of dollars worth of Army weapons systems through
fully integrated single-source transaction entry, online/real-time data,
and U.S. Standard General Ledger compliance. Further, LMP is intended to
bring the logistics community to the point of achieving favorable audit
opinions on financial statements. LMP became operational at the U.S. Army
Communications and Electronics Command and Tobyhanna Army Depot in July
2003. The Army plans to implement LMP at the other four depots. In May
2004,5 we reported on the Army's lack of adequate management oversight
over LMP implementation and the problems being encountered after it became
operational in July 2003. As discussed later in this report, the Army
continued to experience significant LMP implementation problems at the
Tobyhanna Army Depot that inhibited the depot from accurately reporting on
its financial results of operations, which adversely affected the depot's
ability to accurately set customer sales prices.

5 GAO, DOD Business Systems Modernization: Billions Continue to Be
Invested with Inadequate Management Oversight and Accountability,
GAO-04-615 (Washington, D.C.: May 27, 2004).

Army Merged Its Depot Maintenance and Ordnance Activity Groups

Beginning with fiscal year 2005 (October 2004), the Army established a new
Army Working Capital Fund activity group by merging its depot maintenance
and ordnance activity groups. The new activity group-the Industrial
Operations activity group-consolidated the existing five Army depots and
the Army ordnance activities. These two activity groups perform different
types of work. The depots repair and overhaul a wide range of assets such
as helicopters and tanks, whereas the ordnance activities, among other
things, manufacture and sell munitions and large caliber weapons critical
to the Army's execution of its warfighting mission. The ordnance activity
group also provides ammunition stockpile management for all services
within DOD as well as for foreign military customers. Among the benefits
of consolidation cited by the Army is that the merger of the two activity
groups will (1) create a more integrated business perspective that
encourages cooperation and partnership, (2) eliminate duplication of
effort associated with preparing and defending two separate budget
submissions for essentially the same type of service, and (3) focus
capital investments on the good of the business entity rather than on the
good of the individual installations.

We reviewed the Army Working Capital Fund fiscal year 2006/2007 budget
document submitted to the Congress in February 2005. The budget document
does not provide information on the Army depot maintenance activity group.
Instead, the budget document consolidates the information on the depot
maintenance and ordnance activity groups. This consolidation of
information is discussed later in this report.

Depot Maintenance Prices Increased Due to Increasing Material Costs

Our work showed that the Army depot maintenance activity group's average
sales price for work increased 31 percent (21 percent if adjusted for
inflation) between fiscal years 2000 and 2005.6 The activity group's
budget documents showed that the average price per direct labor hour of

6 Using the Gross Domestic Product price index updated in January 2004, if
the fiscal year 2000 composite sales price is converted to fiscal year
2005 dollars, the composite sales price would be $121.15 and the increase
would be 21 percent.

work accomplished (composite sales price)7 increased from $111.87 per hour
for fiscal year 2000 to $147.07 for fiscal year 2005. We found that
material costs accounted for the majority of the sales price increase from
fiscal year 2000 to fiscal year 2005, accounting for over 100 percent of
the group's sales price increase. Army depot maintenance officials
provided evidence showing increasing material costs were caused, in part,
by increased (1) material usage to rebuild selected weapon systems to
likenew condition under the Army's recapitalization program and (2) prices
that the activity group pays its suppliers for repair parts. However, Army
depot maintenance officials have not completed a comprehensive analysis to
determine (1) how much of the increase was due to the recapitalization
program versus price increases and (2) whether they have identified all of
the reasons for the material cost increases. As a result, the Army has not
been able to take proactive steps to control rising material costs.

Factors Causing Army Depot Maintenance Prices to Increase

The composite sales price that the Army depot maintenance activity group
charged its customers increased from $111.87 per direct labor hour in
fiscal year 2000 to $147.07 per direct labor hour in fiscal year 2005 - a
$35.20 difference or 31 percent increase. As shown in table 1, our
analysis of the factors that make up the activity group's composite price
showed that direct material, overhead, and direct labor account for all of
the costs making up the composite price increase charged customers. Table
1 also shows that

o
Budgeted material costs were by far the most significant of the factors
($65.23 per direct labor hour) making up the composite sales price in
fiscal year 2005 (44 percent of the fiscal year 2005 composite sales
price). Additionally, material costs increased by $36.14 and accounted for
over 100 percent of the increase in the group's sales prices between
fiscal year 2000 and fiscal year 2005 because other cost factors
decreased.

o
Budgeted overhead costs were the second largest cost factor ($49.47 per
direct labor hour) making up the composite sales price for fiscal year

7 The composite sales price is the average price that customers must pay
for a direct labor hour of work and is used for budgeting purposes. The
average price includes labor, material, and overhead costs. For actual
work performed, the activity group develops individual sales prices, such
as the price per hour to perform work on the Apache helicopter, and bills
customers based on those individual prices.

2005 (34 percent of the fiscal year2005 composite salesprice). However,
the overhead rate increased by only $3.98 during this time period. A large
portion of the budgeted overhead costs is associated with operating and
maintaining the installations.

o
Budgeted labor costs were the third largest cost factor ($30.84 per direct
labor hour) making up the composite sales price for fiscal year 2005 (21
percent of the fiscal year 2005 composite sales price). The labor costs
were less than half the material costs' portion of the composite price for
fiscal year 2005. Depot officials noted that the labor cost increases were
primarily due to factors beyond the activity group's control, such as
mandated cost-of-living annual salary increases for federal employees. As
a result, we did not perform an in-depth review of the labor costs
increases between fiscal year 2000 and fiscal year 2005.

o
Budgeted direct other costs (costs for contracts and travel) were the
fourth largest cost factor (down $1.84 to $4.99 per direct labor hour)
making up the composite sales price for fiscal year 2005. We did not
perform an in-depth review of these costs since they decreased between
fiscal year 2000 and fiscal year 2005.

o
All other budgeted cost factors included in developing the composite sales
price decreased from $3.91 in fiscal year 2000 to a negative $3.46 in
fiscal year 2005. The negative amount is due to the return of prior gains
in setting the prices.

Table 1: Factors Responsible for the Increases in the Army Depot
Maintenance Activity Group's Composite Sales Price between Fiscal Years
2000 and 2005

                                Fiscal year Fiscal year     
                                       2000 2005            
                     Factor   rate per hour   rate per hour Dollar difference 
            Direct material          $29.09          $65.23            $36.14 
                      costs                                 
             Overhead costs           45.49           49.47              3.98 
         Direct labor costs           26.55           30.84              4.29 
         Direct other costs            6.83            4.99            (1.84) 
            All other costs            3.91          (3.46)            (7.37) 
            Total composite         $111.87         $147.07            $35.20 
                      sales                                 
                      price                                 

Source: GAO analysis of Army Materiel Command and depot data on stabilized
rates.

Spiraling Material Costs Are Primary Cause of Price Increases, but Further
Analysis Is Needed

The Army Has Identified Some Causes of Material Cost Increases

Although table 1 shows that several factors contributed to the increase
that occurred in the composite hourly sales price for fiscal years 2000
through 2005, higher budgeted material costs was by far the most
significant factor. Material costs increased 124 percent, from $29.09 per
direct labor hour in fiscal year 2000 to $65.23 per direct labor hour in
fiscal year 2005. While Army depot maintenance officials provided evidence
on why the activity group's overall material costs have increased, they
have not performed a comprehensive analysis of material costs to determine
(1) how much of the increase was due to the recapitalization program
versus price increases and (2) whether they have identified all of the
reasons for the material cost increases.

Army depot maintenance officials stated that the activity group's higher
material costs can be attributed, to a large extent, to (1) increased
material usage to rebuild certain weapon systems to like-new condition, as
required by the Army's recapitalization program;8 and (2) price
growth-what the activity group pays various suppliers for material and
component parts it uses to repair weapon systems and other items. For
example:

o
Due primarily to the recapitalization program, the depot maintenance
activity group raised the sales price for the repair of the Patriot
missile air defense system antenna mast group from $398,612 in fiscal year
2002 to $744,784 in fiscal year 2004, an increase of $346,172 or 87
percent. Under this program, the depots automatically replaced more parts
than they did previously under a traditional weapon system overhaul. This
resulted in an increase in material costs. For example, under the fiscal
year 2002 recapitalization pilot program, the Letterkenny Army Depot
automatically replaced 142 parts on an individual antenna mast group. By
fiscal year 2004, the number of parts automatically replaced by
Letterkenny increased to 1,938 or 1,264 percent.

o
Due to increased prices paid to suppliers for component parts used in
repairs, the cost to repair radar sets used for the Patriot missile has
increased significantly. Depot maintenance officials estimated that for

8 Recapitalization is the rebuild and selected upgrade of currently
fielded weapons systems to ensure operational readiness and rebuild to
like-new condition. The objectives of this program are to (1) extend the
service life of selected weapon systems; (2) reduce the rate of growth of
operation and support costs for recapitalized weapon systems; (3) improve
the reliability, maintainability, safety, and efficiency of the weapon
systems; and (4) enhance the warfighting capabilities of recapitalized
weapon systems where needed.

one Patriot missile radar set, they replace approximately 1,500 of the
5,463 active radar antenna elements when they repair it. In January 2003,
depot maintenance was purchasing the antenna elements for $724 apiece from
the supplier. About 15 months later, the purchase price for a single
element increased about 43 percent to $1,038. As a result, the stabilized
sales price for repairing the radar set increased from $6,450,330 in
fiscal year 2003 to $7,284,751 in fiscal year 2004, an increase of
$834,421 or 13 percent in 1 year.

o
Due to the recapitalization program, the depot maintenance activity group
raised its sales price for the repair of the Chinook helicopter from
$4,431,953 in fiscal year 2003 to $6,754,808 in fiscal year 2005, an
increase of $2,322,855 or 52 percent. The material component of the sales
price increased from $2,661,481 in fiscal year 2003 to $4,060,000 in
fiscal year 2005-an increase of $1,398,519 or 60 percent of the total
sales price increase. Corpus Christi Army Depot officials stated that
material costs increased because under the recapitalization program the
depot is required to (1) replace more parts 100 percent of the time during
maintenance and (2) follow tighter inspection criteria, which results in
parts being repaired or replaced more frequently. For example, the depot
increased the number of helicopter parts required to be replaced during
maintenance by 217 when it implemented the recapitalization program.

o
Due primarily to the recapitalization program, the depot maintenance
activity group raised the sales price for the repair of the engine used in
the Armored Vehicle Launch Bridge, a folding portable bridge that is
transported on the top of a tank chassis, and the M88 Hercules Recovery
Vehicle, used to recover tanks. More specifically, the Anniston Army Depot
increased the price for the engine from $58,559 in fiscal year 2003 to
$95,451 in fiscal year 2005, an increase of $36,892 or 63 percent. During
this same time period, the materials costs increased by $38,749 or 120
percent from $32,183 to $70,932. Since they anticipate repairing about 336
of these engines in fiscal year 2005, the impact of the increased material
costs is about $13 million.

o
Due primarily to increased prices paid to suppliers for component parts,
the cost to overhaul one type of Bradley Fighting Vehicle increased from
$409,964 in fiscal year 2003 to $549,291 in fiscal year 2005, an increase
of $139,327 per vehicle or 34 percent. A major cause of this increase was
the material cost growth of $30,280 per vehicle. One example of a part
contributing to the higher material costs is the price of a gyroscope used

on the vehicle increasing from $11,486 in fiscal year 2003 to $19,381 in
fiscal year 2005. Further, the price of two transmission parts increased
from about $1,300 each to $10,092 each over the same time period.

Army Has Not Performed a One of the primary goals of the working capital
fund is to focus the

Comprehensive Analysis of attention of all levels of management on the
total costs of carrying out DOD

Material Cost Increases
business operations such as depot maintenance. That is, working capital
fund operations are intended to operate like a business by developing and
using effective methods to control operating costs. We found that the Army
depot maintenance activity group has not achieved that goal nor attempted
to, at least in part, as it pertains to controlling material costs.
Specifically, the activity group has not performed a comprehensive
analysis to determine (1) how much of the increase was due to the
recapitalization program versus supplier price increases and (2) whether
they have identified all of the reasons for material cost increases. Such
an analysis is frequently used for manufacturing processes, for example,
to determine if material usage has increased and, if so, to determine the
impact on material costs.

We believe that a comprehensive analysis of material costs is warranted
because the activity group's material costs account for over 44 percent of
the group's fiscal year 2005 composite sales price and have increased by
124 percent between fiscal year 2000 and fiscal year 2005. Depot
maintenance officials at the five Army depots and the Army Materiel
Command told us that they did not perform such analyses. In fact,
officials at one depot told us it was not necessary for them to perform
analyses on material cost increases because they believe they know what
their primary materialcost drivers are:the recapitalization program
previously discussed and increased prices being paid to one of their parts
suppliers. We agree with these two reasons. However, without performing a
comprehensive analysis, the depot cannot quantify the extent to which the
causes contribute to the higher material costs and does not know if all
major causes have been identified. Perhaps most important, absent these
data, DOD does not have the necessary information to try to mitigate costs
related to usage rates, unit prices, or other causes.

Army Depot Maintenance As illustrated in table 1, our analysis showed that
budgeted overhead costs Overhead Represents the were the second largest
factor making up the fiscal year 2005 composite Second Largest Cost Factor
sales price. Overhead costs consist of two broad cost categories: base

operations and maintenance mission. Base operations overhead
includesAffecting Prices costs necessary to maintain the installations
that support the Army depots

and other base tenants and include security, fire protection, building
maintenance, resource management, and personnel and community activities.
Maintenance mission overhead includes indirect costs that can be directly
attributed to supporting the depots' maintenance mission, such as
supervision, indirect material, general engineering, and mid-level
management and administrative expenses, but cannot be tied to a specific
cost center. Tables 2 and 3 illustrate the breakout of the depots' base
operations and maintenance mission overhead rates per direct labor hour as
a percentage of the depots' total overhead rates for fiscal years 2001 and
2005.9

 Table 2: Depot Base Operations and Maintenance Mission Rates Per Direct Labor
                           Hour for Fiscal Year 2001

                                            Fiscal year 2001   
                                              maintenance      
                   Fiscal year 2001 base        mission        
                        operations                             
                               Percent of           Percent of 
     Army depot      Rates overhead total Rates overhead total Total overhead 
                                                                        rates 
    Letterkenny                 $32.73 39            $51.70 61         $84.43 
     Red River                   30.86 50             31.04 50          61.90 
Corpus Christi                25.39 41             36.34 59          61.73 
      Anniston                   17.27 42             23.92 58          41.19 
     Tobyhanna                   17.69 54             14.90 46          32.59 

Source: Individual Army depots and GAO analysis.

As illustrated in tables 2 and 3, base operations overhead costs
represented a significant portion of the depots' total overhead rate per
direct labor hour for fiscal years 2001 and 2005. In fiscal year 2001,
base operations overhead as a percentage of the total overhead rate ranged
from 39 percent at the Letterkenny Army Depot to 54 percent at the
Tobyhanna Army Depot. In fiscal year 2005, base operations still made up a
significant portion of the individual depots' total overhead rates: a
range of 28 percent at the Anniston Army Depot to 52 percent at the Red
River Army Depot.

9 Fiscal year 2000 base operations and maintenance mission overhead data
were not available for all depots.

 Table 3: Depot Base Operations and Maintenance Mission Rates Per Direct Labor
                           Hour for Fiscal Year 2005

                                            Fiscal year 2005   
                                              maintenance      
                   Fiscal year 2005 base        mission        
                        operations                             
                               Percent of           Percent of 
     Army depot      Rates overhead total Rates overhead total Total overhead 
                                                                        rates 
    Letterkenny                 $24.78 47            $28.08 53         $52.86 
     Red River                   28.80 52             26.86 48          55.66 
Corpus Christi                14.35 31             31.32 69          45.67 
      Anniston                   14.73 28             37.22 72          51.95 
     Tobyhanna                   18.71 41             26.51 59          45.22 

Source: Individual Army depots and GAO analysis.

Tables 2 and 3 show that maintenance mission overhead was also a
significant cost factor making up the individual depots' total overhead
rate per direct labor hour for fiscal years 2001 and 2005. In fiscal year
2001, maintenance mission overhead as a percentage of the total overhead
rate ranged from 46 percent at the Tobyhanna Army Depot to 61 percent at
the Letterkenny Army Depot. By fiscal year 2005, these percentages ranged
from 48 percent at the Red River Army Depot to 72 percent at the Anniston
Army Depot. Some maintenance mission overhead costs involve payments to
organizations external to the depots, such as payments to the Defense
Finance and Accounting Service for accounting and financial services. We
also found that from fiscal year 2001 to fiscal year 2005, the maintenance
mission overhead rate increased at only two of the depots-those that had
the lowest rates in fiscal year 2001. An official at Anniston Army Depot
stated that increased quality assurance operations that required hiring
additional engineers and higher subordinate command management fees
primarily caused the maintenance mission rate increase. An official at
Tobyhanna Army Depot stated that increased LMP, Defense Logistics Agency,
and Defense Finance and Accounting Service fees caused part of the
increase in its maintenance mission rate. Further, in fiscal year 2002,
the Army Materiel Command directed the depots to reclassify certain base
operations costs as maintenance mission to properly allocate overhead
costs to maintenance mission.

Method of Allocating Gains and Losses Does Not Provide Incentive For
Depots to Set Prices Correctly

In setting future prices to break even, the Army spread depot maintenance
reported gains and losses across all depots, rather than allocating
reported losses or gains incurred by a specific depot to that depot. While
DOD policy does not specify how to allocate gains and losses at the depot
level, this practice does not provide the right incentives to the depots
to set prices correctly in the budget. If one depot consistently incurred
losses, the Army would increase the prices at other depots to help recoup
the losses. As a result, the depot incurring the losses is not held
accountable for operating on a break even basis. For example, the Red
River Army Depot reported an accumulated loss for 4 of the past 5 years,
including fiscal years 2002, 2003, and 2004. For these 3 fiscal years, the
reported accumulated losses ranged from $18 million to about $48 million,
indicating that Red River's customers were not charged enough for the
goods and services provided to them. Because of the continual reported
losses, the Tank-automotive and Armaments Command-the major subordinate
command that directs Red River-sent a team to Red River to determine why
the depot reported $29 million of losses during fiscal year 2003. The team
found that Red River did not develop accurate budget estimates and
underestimated various costs that it incurred including salaries,
material, and overhead.

On the other hand, the Tobyhanna Army Depot-which had a reported revenue
that ranged from $259 million to $406 million from fiscal years 2000 to
2004-reported an accumulated gain for each fiscal year from fiscal year
2000 through fiscal year 2004, ranging from $31 million to $169
million.10Likewise, the Anniston Army Depot reported an accumulated gain
for fiscal years 2002 through 2004 ranging from $30 million to $123
million, indicating that it has been charging its customers too much for
goods and services. Tobyhanna officials stated that over the last few
years, they wanted to reduce their prices more than was allowed by the
Army Materiel Command to return these gains to customers. Tobyhanna
officials said that their sales prices were inflated to offset losses at
other depots.

Due to its recent business merger of depot maintenance and ordnance
activity groups beginning in fiscal year 2005, it is even more important
for the Army to allocate gains and losses incurred by a specific activity
to that activity. This new activity group is called the industrial
operations activity group. In the past, the depot maintenance activity
group did a much larger

10 LMP implementation problems at the Tobyhanna Army Depot affected its
fiscal year 2003 and 2004 AOR. LMP problems are discussed later in this
report.

business than the ordnance activity group. The Army depot maintenance
activity group received $2.6 billion in new orders in fiscal year 2003,
while the ordnance activity group received $832 million of new orders.
These orders were financed with appropriations in different proportions.
For example, in fiscal year 2003, 41 percent and 7 percent of the depot
maintenance orders were financed with operation and maintenance
appropriations and procurement appropriations, respectively. On the other
hand, 58 percent and 15 percent of the ordnance orders were financed with
operation and maintenance and procurement appropriations, respectively. If
the Army continues its current practice of allocating gains and losses
across all activities, customers of activities that make a gain will
continue to subsidize customers of activities that incur a loss. Further,
because ordnance activities are financed with several appropriations in
different proportions than depot maintenance activities, spreading gains
and losses across all activities could result in an inequitable allocation
of the gains and losses to and from these appropriations.

Army Has Consistently Exceeded Carryover Threshold

In addition, the Army did not comply with DOD's carryover policy. We found
that the Army depot maintenance activity group's actual reported carryover
(1) consistently exceeded DOD's 3-month carryover standard from fiscal
year 1996 through fiscal year 2001 and (2) continued to exceed the
allowable amount of carryover as calculated under DOD's revised carryover
policy for fiscal years 2002 and 2003. The activity group's reported
actual carryover did not exceed the allowable amount for fiscal year 2004.
We reviewed the Army's fiscal year 2004 carryover calculation and
validated that the Army's calculation was done in accordance with DOD's
new carryover policy. 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 fiscal years. In
the past, the Congress has reduced the services' budgets because of
excessive carryover, including a $48 million reduction in the Army's
fiscal year 2003 Operation and Maintenance appropriation. Factors
contributing to carryover exceeding the ceilings included depots receiving
new orders at fiscal year-end and depots not being able to obtain material
needed to perform repair work in a timely manner. Furthermore, although
the Army's reported carryover amount exceeded the ceilings, we found that
the Army understated its reported actual carryover for fiscal years 2002
and 2003. For example, fiscal year 2003 carryover was understated by $95
million. According to Army officials, the understatement occurred because
DOD's verbal guidance was unclear. Based on its interpretation of this
guidance, the Army only included actual carryover on orders received in
the current

year but did not include carryover related to orders received in prior
years in calculating its reported actual carryover for fiscal years 2002
and 2003.

What Is Carryover and Why Is It Important

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. Carryover consists of both the
unfinished portion of work started but not completed, as well as requested
work that has not yet commenced. Some carryover is necessary at fiscal
year-end if working capital funds are to operate efficiently and
effectively. For example, if customers do not receive new appropriations
at the beginning of the fiscal year, carryover is necessary to ensure that
the working capital fund activities have enough work to ensure a smooth
transition between fiscal years. Too little carryover could result in some
personnel not having work to perform at the beginning of the fiscal year.
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 carryover, DOD can use its resources in the most
effective manner and minimize the "banking" of funds for work and programs
to be performed in subsequent years.

In 1996, DOD established a 3-month carryover standard for all working
capital fund activities except for the contract portion of the Air Force
depot maintenance activity group.11 In May 2001, we reported12 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. According to the
Office of the Under Secretary of Defense (Comptroller) and Army officials,
based on our recommendation, in December 2002, DOD provided verbal
guidance concerning its new carryover policy for working capital fund
activities. Subsequently, DOD included its revised carryover policy in its

11 The Air Force is the only military service that included 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 taking its contract depot
maintenance operation out of the working capital fund and plans to
complete this action by the end of fiscal year 2007.

12 GAO, Defense Working Capital Fund: Improvements Needed for Managing the
Backlog of Funded Work, GAO-01-559 (Washington, D.C.: May 30, 2001).

DOD Financial Management Regulation 7000.14-R, Volume 2B, Chapter 9, dated
June 2004, which eliminated the 3-month standard for allowable carryover.
Under the new policy, the allowable amount of carryover is to be based on
the outlay rate13 of the customers' appropriations financing the work.
This meant that in determining allowable carryover, the first year outlay
rate would be used for new orders received in the current year (first year
of the work order). According to the DOD regulation, this new metric
allows for an analytical-based approach that holds working capital fund
activities to the same standard as general fund execution and allows for
more meaningful budget execution analysis.

Army Reports Showed That Tables 4 and 5 show that the Army depot
maintenance activity group's the Depot Maintenance actual reported
carryover (1) consistently exceeded DOD's 3-month Activity Group
Consistently carryover standard from fiscal year 1996 through fiscal year
2001 and

(2) continued to exceed the allowable amount of carryover as
calculatedExceeded Carryover Ceiling under DOD's revised carryover policy
for fiscal years 2002 and 2003.

Table 4: Fiscal Year-End Actual Reported Carryover from Fiscal Year 1996
through 2001 Consistently Exceeded DOD's 3-month Standard

                Fiscal year Reported actual months of carryover

1996

1997

1998

1999

2000

2001

Source: GAO-01-559 and fiscal year 2003 Army Working Capital Fund budget
estimate dated February 2002.

13 The amount of allowable carryover using the outlay rate follows. For
example, customers order $100 of work, which is financed with a specific
appropriation. If the outlay rate for this appropriation at the
appropriation level is 60 percent, then this would result in the depot
maintenance activity group being allowed to carry over $40 ($100 - $60
[$100 x 60 percent] = $40).

Table 5: Dollar Amount of Reported Actual Carryover for Fiscal Years 2002
and 2003 That Exceeded Allowable Amounts

                              Dollars in millions

                                FY 2002 FY 2003

                       Allowable carryover $548.2 $854.4

                     Reported actual carryover 584.3 981.5

                 Carryover above allowable amount $36.1 $127.1

Source: Fiscal years 2004 and 2005 Army Working Capital Fund budget
estimates dated February 2003 and February 2004, respectively.

Officials at the four depots that exceeded their carryover ceilings
informed us that reported actual year-end carryover exceeded the allowable
amount because some depots received and accepted work late in the fiscal
year and some depots could not obtain the material needed in a timely
manner, so that less work was performed than planned. While other work can
be substituted for items awaiting parts, this shifting of the repair work
does have a negative effect on the amount of work accomplished. The
following examples illustrate these two reasons regarding why work was not
performed by fiscal year-end.

o
On September 26, 2003-the last week of the fiscal year-the Red River Army
Depot accepted a customer work order for $17.9 million to overhaul 41
Bradley Fighting Vehicles. Because the depot did not begin work on this
order until October 2003, the entire $17.9 million had to be carried over
into fiscal year 2004 and was included in the depot's fiscal year-end 2003
reported actual carryoveramount. According to Red River Army Depot
officials, their command told them to accept this order to enable the
obligation of operation and maintenance funds before they expired at
year-end.

o
In January 2002, the Red River Army Depot accepted a customer work order
financed with about $3.1 million of operation and maintenance funds to
overhaul 25 25-ton cranes. Upon starting the work, depot officials said
they discovered that many of the parts needed for the overhaul were no
longer readily available, thus requiring the depot to research where the
parts could be obtained. This delayed the overhaul work, which caused
about $3.1 million to be included in the depot's fiscal year-end 2002
reported actual carryover and was carried over into fiscal year 2003. At
the end of fiscal year 2003, almost $1.4 million of the work was still not
completed and was carried over into fiscal year 2004.

In fact, at the start of fiscal year 2004, none of the 25 cranes had been
completed. In November 2003, the first 2 cranes were completed, with 16
more being completed by the end of fiscal year 2004. The remaining 9
cranes, with about $470,000 of work, were carried over into fiscal year
2005 and finally completed by November 2004. Thus, due to the
unavailability of repair parts, uncompleted work on this order was
included in the depot's carryover balance at the end of fiscal years 2002,
2003, and 2004.

o
On September 26, 2003, the Tobyhanna Army Depot accepted an order for
about $2.7 million that was financed by operation and maintenance funds to
repair a ground mobile navigation radar. Since the depot accepted the
order late in the fiscal year, the depot was unable to schedule and begin
the repair work until November 2003. As a result, this $2.7 million order
was carried over into fiscal year 2004. In addition, because of delays in
completing a modification upgrade to a component on the radar, not all
repair work on the radar was completed in fiscal year 2004, resulting in
about $1.2 million of the order, or 44 percent, being carried over into
fiscal year 2005.

o
In May 2003, the Tobyhanna Army Depot accepted a $3.6 million order that
was financed by operation and maintenance funds to repair three Firefinder
radar antennas. The depot received the radar antennas in June 2003 but was
unable to complete the repair work by the end of the fiscal year because
it did not receive the other necessary repair parts. For example, the
depot did not receive completed sets of sentinel components and beam
steering units from the parts supplier until June 2004. As a result, the
depot reported over $3 million in fiscal year 2003 carryover and about
$2.3 million in fiscal year 2004 carryover.

o
On August 24, 2004, the Corpus Christi Army Depot accepted an order
totaling about $3.1 million that was financed by operation and maintenance
funds to repair a Black Hawk helicopter. Even though the depot did not
have the material needed to repair the helicopter, it accepted the work
order late in the fiscal year. In September 2004, the depot ordered the
material to make the repairs. Although the depot accepted the order and
ordered the material in fiscal year 2004, it did not begin the repair work
until November 2004, when it received the material. As a result, the depot
reported almost the entire $3.1 million as carryover at the end of fiscal
year 2004.

o
On September 5, 2003, the Letterkenny Army Depot accepted a $5 million
order that was financed by operation and maintenance funds for the repair
of the Patriot Missile Air Defense System launching stations in support of
the war in Iraq and Afghanistan. During the week of September 19, 2003,
the depot began repairing the stations. Since the launching stations were
received during the last month of the fiscal year, the depot was unable to
complete repairs on the stations by the end of fiscal year 2003. This
resulted in the depot reporting about $3.7 million as carryover at the end
of fiscal year 2003. The depot completed its repair on the launching
stations in September 2004.

Reported Actual Carryover Was Understated in Fiscal Years 2002 and 2003
Because Prior Year Orders Were Not Included

The Army understated its reported actual carryover for fiscal years 2002
and 2003 because it interpreted DOD's new carryover guidance as requiring
only the inclusion of customer orders received in the current year when
calculating carryover. As a result, the Army did not include customer
orders received in prior years. For example, the dollar amount of reported
actual carryover was understated by $95 million at the end of fiscal year
2003 because carryover related to orders received in fiscal year 2002 and
prior years was not included. Army officials at headquarters, the Army
Materiel Command, and the depots acknowledged that the actual carryover
figures did not include carryover related to prior year orders. As a
result, the Army reported to the Congress that its actual carryover
exceeded the allowable amount by $127 million in fiscal year 2003 as shown
in table 5, when it actually exceeded the allowable amount by $222
million.

DOD changed its carryover policy in December 2002 and stated that the
revised carryover methodology would be adopted for the first time in the
fiscal year 2004 budget, which affected the way the fiscal year 2002
reported actual carryover amount, as well as the fiscal years 2003, 2004,
and 2005 budgeted amounts, were to be calculated. However, DOD did not
issue detailed written procedures for calculating actual carryover until
June 2004. Army headquarters officials stated that prior to the issuance
of the written guidance in June 2004, the new carryover calculation was
based on verbal instructions that the Army received from the Office of the
Under Secretary of Defense (Comptroller). The Army interpreted the new
guidance to include only actual carryover on orders received in the
current year and instructed the Army Materiel Command to calculate
carryover accordingly. The Army Materiel Command then provided this
guidance to the depots. For example, on March 4, 2003, the Army Materiel
Command provided carryover guidance for the development of the fiscal year
2005 budget and specified that the amount of actual carryover was to be
based

on new orders only and not to include actual carryover related to prior
year orders. When DOD issued the revised DOD regulation in June 2004, Army
officials realized that they were not calculating reported actual
carryover correctly and changed their methodology in developing the fiscal
year 2006 depot maintenance budget so that the actual carryover
calculation would include prior year orders and be in accordance with
DOD's written guidance.

Current DOD Policy on Calculating Allowable Carryover Unclear

In addition to the problem of not including work related to prior year
orders when reporting actual carryover, problems also existed with
determining the amount of allowable carryover. As previously stated, in
June 2004, DOD revised the DOD Financial Management Regulation 7000.14-R,
Volume 2B, Chapter 9 to formalize the December 2002 carryover policy.
However, this regulation did not contain specific instructions for
determining allowable carryover for work not completed on prior year
orders. To clarify its June 2004 written guidance, DOD again provided the
Army verbal guidance on calculating the allowable carryover amount for
worknot completed on prioryearorders. Based on the verbalguidance, the
Army used the first year outlay rate for both (1) current year orders and
(2) work not completed on prior year orders. We questioned this
methodology for calculating allowable carryover with officials from the
Army and the Office of the Under Secretary of Defense (Comptroller), and
why they were applying the first year outlay rates to prior year orders
instead of the applicable second or third year outlay rates. By using only
the first year rates, the Army was allowed more carryover. After
discussing our concerns with Office of the Under Secretary of Defense
(Comptroller) and Army depot maintenance officials, they changed the way
they were calculating allowable carryover. Specifically, the Army
calculated the allowable amount of carryover that was included in the Army
Working Capital Fund fiscal year 2006 budget by applying the first year
outlay rate of the appropriation financing the order for current year
orders only. For illustrative purposes, if the Army depot maintenance
activity group received $100 of new orders in fiscal year 2006 and the
outlay rate was 60 percent, then the allowable amount of carryover would
be $40.

In discussing this matter with officials from the Office of the Under
Secretary of Defense (Comptroller), they acknowledged that the current
written guidance on calculating allowable carryover was unclear. They
stated that they have since provided verbal guidance to the Army on how to
calculate the allowable amount. Specifically, the allowable amount of
carryover is to be calculated by applying the first year outlay rate of
the

appropriation financing the current year orders. The officials also stated
that work not completed in the first year of the order is not to be
included in the calculation because it is expected to be completed by the
end of the second year of the order for the Army depot maintenance
activity group. The officials informed us that they plan to issue written
guidance on this matter.

Tobyhanna Army Depot Continues to Experience Difficulty With LMP

Since its implementation in July 2003, LMP has not been able to provide
timely and accurate information needed for the economical and efficient
operations of the Tobyhanna Army Depot. As we reported in May 2004,14 the
Army's inadequate management of its requirements and system testing
activities before LMP was fielded were the primary contributing factors to
the problems experienced at Tobyhanna since fiscal year 2003. These
problems are continuing to prevent the Tobyhanna Army Depot from
accurately reporting on its financial operations, which, in turn,
adversely impacts the depot's ability to accurately set customer sales
prices. While the Army developed a reasonable approach that was to be
followed in addressing system problems that must be resolved for LMP to
provide the intended capabilities, the Army has not been able to
effectively implement those processes. As a result, the Army was unable to
provide evidence to show that the corrective actions adequately address
the problems experienced during LMP implementation. Until the Army
effectively implements its stated management processes to address the
numerous problems impeding the efficient and effective operation of LMP at
the Tobyhanna Army Depot, future deployments can expect to experience
similar, significant disruptions in their depot maintenance operations.

Prior GAO Report Identified LMP Problems

In our May 2004 report, we pointed out that the Army had not effectively
managed its implementation of LMP. This report noted that after LMP was
deployed in July 2003, operational difficulties at the Tobyhanna Army
Depot resulted in inaccurate financial management information. More
specifically, the depot was not (1) producing accurate workload planning
information, (2) generating accurate customer bills, and (3) capturing all
repair costs, which impeded the Army's ability to calculate accurate
future

14 GAO, DOD Business Systems Modernization: Billions Continue to Be
Invested with Inadequate Management Oversight and Accountability,
GAO-04-615 (Washington, D.C.: May 27, 2004).

repair prices. As noted in the report, Army program officials acknowledged
that requirements and testing defects were factors contributing to the
operational problems.

Requirements represent the blueprint that system developers and program
managers use to design, develop, and acquire a system. Improperly defined
or incomplete requirements have been commonly identified as a cause of
system failure, resulting in systems not meeting their costs, schedules,
or performance goals. Further, because requirements provide the foundation
for system testing, requirement defects, such as those noted during our
review relating to specificity and the ability to determine the
relationship between requirements (commonly referred to as traceability),
preclude an entity from implementing a disciplined testing process. That
is, requirements must be complete, clear, and well documented to design
and implement an effective testing program. Absent this, an organization
is taking a significant risk that its testing efforts will not detect
significant defects until after the system is placed into production.
Industry experience indicates that the sooner a defect is recognized and
corrected, the cheaper it is to fix.

In our May 2004 report, we noted that LMP's requirements (1) lacked the
specific information necessary to understand the required functionality
that was to be provided and (2) did not describe how to determine
quantitatively, through testing or other analysis, whether the systems
would meet the Army's needs. We continue to believe that one reason that
users have not been provided with the intended systems capabilities is
because of the breakdown in the requirements management process. As a
consequence, the Army has implemented error-prone, time-consuming manual
workarounds as a means to minimize disruption to critical operations. As
discussed in the next section, our current work demonstrated that
Tobyhanna's financial management operations continued to be affected by
LMP system problems.

LMP Adversely Affected Tobyhanna Army Depot's Financial Management
Operations

Since the Army has not corrected LMP's system problems, the Tobyhanna Army
Depot continues to experience financial management challenges. These
system problems include the depot's inability to (1) report net operating
results that are reliable, (2) properly recognize revenue and bill
customers, (3) reconcile balances that were converted from the depot's
legacy finance and accounting system, the Standard Depot System (SDS), to
LMP, and (4) produce reliable cost information because LMP contains
incorrect unit prices and unit of issue data. These problems adversely

affected Tobyhanna's ability to accurately set customer sales prices and
develop reliable budgets for its depot maintenance operations.

Net Operating Results Reported According to an Army headquarters budget
official, the fiscal year-end 2003

by LMP Were Not Reliable

LMP Did Not Always Properly Recognize Revenue and Bill Customers

and 2004 net operating results were overstated by $74.7 million and $50
million, respectively, due to problems with the implementation of LMP.
Research performed by Tobyhanna finance and accounting personnel showed
that the fiscal year 2003 net operating result was overstated for a number
of reasons including (1) the recording of $35.2 million of miscellaneous
gains in LMP that did not occur and (2) an overstatement of $39.5 million
of revenue in LMP. For example, the $35.2 million of gains recorded in LMP
should have been reversed because LMP did not correctly (1) account for
material charged to jobs ($10.4 million), (2) process transactions related
to the movement of assets and material at the depot ($11.8 million), (3)
account for inventory variance account balances ($12 million), and (4)
account for material returned for credit ($1 million). In the Army Working
Capital Fund budget for fiscal year 2006/2007, the Army plans to revise
the accumulated operating results for fiscal year 2005 by adjusting it
downward by the $124.7 million overstatement. Since the accumulated
operating result is one factor used in developing prices, this adjustment
will affect future prices.

Shortly after LMP wasimplemented in July 2003,Tobyhanna officialsbegan
identifying problems related to the system's ability to accurately
recognize revenue and bill customers for goods and services provided. As
of January 2005, the Army had not corrected the problems associated with
revenue recognition and billing of customers. For example, Tobyhanna
officials identified 837 work orders with accumulated costs for work
performed totaling over $44.8 million in September 2004. However, no
revenue was recognized for the work performed and, as a result, customers
were not billed for the corresponding amount. For one of the 837 work
orders, our analysis showed that the depot began incurring costs in May
2004 and had total accumulated costs of $2.6 million as of September 2004.
Tobyhanna officials informed the contractor of this problem in September
2004. In December 2004, the contractor told depot officials that it had
corrected the problem. However, the contractor corrected the problem for
the one order but did not correct the problems with the remaining 836
orders. Further, the contractor did not determine the root cause of the
problem, and the depot continued to find the same problem with other
orders. Once a problem is identified, it is critical that it be
investigated, the root cause identified in order for a systematic solution
to be developed, and that the

solutions be effectively tested to ensure that they address the
fundamental problem and do not introduce additional problems.

Another problem related to billing customers involves the Defense Finance
and Accounting Service (DFAS) and the process used to close customer work
orders. As part of this process, Tobyhanna sends completed work orders to
DFAS to be closed out so DFAS can bill customers for any authorized funds
(customer's orders) that remain unbilled. DFAS uses LMP data to perform
this final billing. On September 16, 2004, Tobyhanna identified 38 orders
where the work was completed and sent this information to DFAS for final
billing and to close out the orders. However, DFAS was not able to perform
the final billings and close out these orders because no sales order data
(commonly referred to as a customer order) were recorded in LMP for these
38 orders. In September 2004, the Army told the contractor and DFAS about
the problem of closing out orders. Rather than fixing the root cause of
the problem, DFAS agreed to manually bill the customers and close the
orders. According to Tobyhanna officials, the problem will continue since
the root cause of the problem was not identified and fixed.

Account Balances Were Not Tobyhanna Army Depot encountered problems in
converting data from the

Reconciled When Tobyhanna legacy system to LMP. Specifically, when
Tobyhanna converted from its

Converted to LMP
legacy finance and accounting system, SDS, to LMP in July 2003, the June
30, 2003, ending account balances in SDS did not reconcile to the
beginning account balances in LMP. According to Tobyhanna officials, the
account balances should have been the same. However, the officials did not
perform a detailed analysis to determine why the account balances did not
reconcile because they (1) were too busy identifying other problems with
the implementation of LMP and (2) lacked the detailed information to do
the analysis. Tobyhanna officials informed the contractor that the
balances were not reconciling in September 2003. However, as of January
2005- about 18 months after the implementation of the system-the account
balances in the two systems still could not be reconciled. Table 6
provides the account balances shown in SDS and LMP for five selected
accounts that should have been the same but were different as of June 30,
2003.

Table 6: Differences in Selected Account Balances Reported in SDS and LMP
as of June 30, 2003

                              Dollars in millions

                                  Account title   SDS        LMP   Difference 
               Accounts receivable - government  $15.6   $(4.6)         $20.2 
           Operating material and supplies, net   3.8       69.6       (65.8) 
                      Accounts payable - public  (9.9)   (24.9)          15.0 
                   Obligations - funds received  716.9     804.9       (88.0) 
                Reimbursements earned (revenue)  218.7     206.8         11.9 

Source: SDS and LMP general ledger balances as of June 30, 2003.

Accurate account balances are important because the amounts are used to
produce official financial reports such as the income statement-which
include revenues, expenses, and annual and accumulated operating
results-that are used to prepare future budgets. For example, the fiscal
year 2004 operating result is one factor used in developing the fiscal
year 2006 prices. If the information on revenue, costs, and net operating
results is unreliable, this could adversely affect the reliability of
Tobyhanna's customer sales prices. Tobyhanna officials told us that in the
past, they were able to reconcile the information contained in SDS to the
DFAS official financial reports, including the income statement. This
provided them some assurance that the financial reports were correct.
However, since the implementation of LMP, they have not been able to
reconcile the data in LMP to the DFAS official reports.

DFAS officials acknowledged that there should not be differences between
ending account balances in SDS and beginning account balances in LMP.
However, because of unreconciled differences between the two systems, DFAS
included a footnote in the depot maintenance activity group's fiscal years
2003 and 2004 year-end financial reports and stated that LMP conversion
problems affected revenue earned, orders received from customers, and
billings. As of the end of fiscal year 2004-over 1 year after
conversion-DFAS was still unable to quantify the effect on revenue.

LMP Contained Erroneous Unit Prices and Unit of Issue

LMP did not always contain the correct unit price or unit of issue15 for
certain materials, resulting in excess material being ordered and
incorrect prices being charged to jobs. Since LMP contained the wrong
values for the quantity of issue and price, Tobyhanna received quantities
of parts and supplies for use in repairing military assets that were far
greater than intended. Further, these parts and supplies were charged to
jobs at higher prices than the depot officials thought were being charged.
Tobyhanna officials informed us that they have experienced unit-price and
unit-ofissue problems with LMP since its implementation in July 2003 and
that these problems continued as of January 2005, causing erroneous cost
information that distorts the depot's financial reports, including net
operating results. The following are two examples illustrating problems
that Tobyhanna experienced while using LMP to place orders for parts and
supplies.

o
LMP did not contain the correct price for screws, wing nuts, and locking
washers. According to the officials, if depot maintenance personnel had
not identified these errors, the customer requesting this work would have
been charged over $2.8 million for the wing nuts, screws, and locking
washers, which were actually worth about $400. In fiscal year 2002,
Tobyhanna received a work order from the Army to repair High Mobility
Multipurpose Wheeled Vehicles. In reviewing the work on this order in May
2004, Tobyhanna officials determined that the job had been assessed with
costs totaling $2,846,686 for plain wing nuts, screws, and locking washers
instead of costs totaling $411.04 as shown in table 7.

  Table 7: Example of Incorrect Unit Costs in New System Costs assessed to job
                                  Actual costs

    Item description    Quantity Unit costs     Total    Unit costs     Total 
       Wing nuts             449   $4,214    $1,892,086        $0.42  $188.58 
         Screws            5,000         138   690,000        0.0392   196.00 
    Locking washers          900         294   264,600        0.0294    26.46 
         Total                               $2,846,686               $411.04 

Source: Tobyhanna Army Depot.

15 DOD defines unit of issue as the quantity of an item, such as each
number, dozen, gallon, pair, pound, ream, set, or yard.

These officials informed us that they identified the problem with this
order because they knew that the wing nuts, screws, and locking washers
could not possibly cost $2.8 million. The officials stated that they were
aware of only two possible reasons for these errors: (1) the contractor
who developed LMP input incorrect unit-of-issue and/or price data into the
system or (2) the unit-of-issue and/or price data did not transfer
correctly from the SDS legacy system to LMP.

o
In another case, Tobyhanna officials stated that they did not realize
until June 2004-almost 1 year after LMP was implemented-that LMP contained
the wrong unit of issue for washers, which resulted in the system
multiplying each order for washers placed with DLA by a factor of 100.
This occurred because when the data were converted, the lowest unit of
issue for the item was 100, while the shop floor employees requisitioned
the items by individual item. For example, when a requisition for 800
washers was processed by the system, the system converted the 800 to
80,000 by multiplying the number ordered (800) times the unit of issue
applicable for that order (100). Tobyhanna officials informed us that they
had so many flat washers in inventory that it took about three truckloads
to return the excess to the Defense Logistics Agency.

The Army and the contractor acknowledged that there is a unit-of-issue and
unit-price problem. In January 2005, they identified over 7,600 items in
LMP whose base unit of measure was incorrect. According to the officials,
correcting this problem is not simple in all cases. For example, once the
inventory item has been used in the system, those transactions for the
item need to be reversed before the change can be made in the system that
shows the correct base unit-of-issue value. The officials also noted that
some of these items have literally thousands of transactions against them,
since these problems have been present since the system was deployed in
July 2003.

To avoid the unit-of-issue and unit-price problem that occurred at
Tobyhanna Army Depot, Army and contractor officials stated that it is
critical to clean up the base unit-of-issue problems before the system is
deployed at other sites. Accordingly, they have undertaken a program for
the second deployment sites to help ensure that the items they will be
adding to LMP that are not presently in the system have the proper base
unit-of-issue values. Based on reports provided by the project office, a
great deal of progress has been made on this initiative. For example,
between August and November 2004, the number of items at Corpus Christi
Army

Depot with base unit-of-issue problems had dropped by 67 percent from 180
items to 60 items. It will be critical for Army to ensure that this
activity is completed prior to converting the legacy data into LMP.

Army's Efforts to Resolve LMP Problems Have Been Ineffective

We found that the significant flaws in requirements and testing management
that adversely affected the initial development and implementation of LMP
also hampered efforts to correct the operational difficulties experienced
at Tobyhanna. To address these recurring problems, the Army and its
contractor, Computer Sciences Corporation (CSC), developed a reasonable
approach that was to be followed in addressing 722 stabilization
items-system problems identified by the Army that must be resolved for LMP
to provide the intended capabilities. The ability to effectively implement
the necessary project management processes (commonly referred to as
disciplined processes)16 is a key factor in reducing the project risks to
acceptable levels17 and is the best indicator of a project's ability to
meet its cost, schedule, and performance objectives. However, the Army has
not been able to effectively implement those processes. Accordingly, the
Army lacks reasonable assurance that (1) system problems experienced
during the initial deployment and causing the delay of future deployments
have been corrected and (2) LMP is capable of providing the promised
system functionality.

The Army and its contractor developed specific steps that were to be
followed in addressing the stabilization items. From an overall
perspective, the Army's described approach is aligned with steps one would
anticipate to see in a project such as LMP. For the most part, each
corrective action was to include the following steps:

o
Developing and documenting the requirements that were needed to resolve
the problem being corrected and the test steps that should be followed to
validate that a corrective action had been properly implemented, where
appropriate.

16 Disciplined processes include a wide range of activities including
project planning and management, requirements management, risk management,
quality assurance, and testing.

17 Acceptable levels refer to the fact that any systems acquisition effort
will have risks and will suffer the adverse consequences associated with
defects in the processes. However, effective implementation of disciplined
processes reduces the possibility of the potential risks actually
occurring and prevents significant defects from materially affecting the
cost, timeliness, and performance of the project.

o
Requiring an Army and CSC official to sign off on each corrective action.
This sign off was used to help provide assurance that (1) the corrective
action adequately addressed the problem identified in the stabilization
item and was defined in the requirements document and (2) adequate testing
had been performed.

o
Establishing an oversight board to review the corrective actions and
ensure the stated processes had been followed, such as ensuring (1) proper
documentation had been developed and (2) adequate testing had been
conducted to provide reasonable assurance that the corrective action
addressed the problem. Based on a review of the actions taken to address
the problem, the oversight board would make a decision on whether the
corrective action should be loaded into the production system. The
oversight board included Army and CSC personnel.

To ascertain if the Army's stated corrective action processes were being
adhered to, we selected 80 of the 276 stabilization items for review that
were shown as completed as of May 2004. Of the 80 items, we found that 32
items had been either merged with another corrective action or
cancelled-meaning they should not have been included in the stabilization
item inventory. For the remaining items,18 our analysis identified
numerous instances in which the stated processes were not being followed.
As a result, the Army was unable to provide evidence to show us that the
stabilization items had been corrected. Our analysis disclosed the
following:

o
The requirements documentation was inadequate or nonexistent for 24 items.
As previously noted, the lack of adequately defined requirements was one
of the primary reasons LMP experienced problems when it was initially
deployed in July 2003. Further, since requirements represent the blueprint
that system developers and program managers use, it is unclear how the
individuals assigned to correct a given problem would know exactly what
needed to be fixed, e.g., the detailed business rules that needed to be
implemented.

o
Testing documentation was insufficient for 33 items. In some cases, while
there was documentation related to testing, the requirement had

18 Five of the remaining 48 items related to training, documentation, and
data issues and, therefore, there were no requirements or testing related
to these items. Our analysis is based on a review of 43 stabilization
items.

not been properly defined. Therefore, one could not ascertain if testing
was properly conducted. For example, without documentation defining the
business rules that should be used, a tester cannot develop the types of
tests to ensure those business rules are implemented. As discussed
previously, we found numerous problems with the implementation of the
business rules that should be used for recognizing revenue and billing.

Documentation is one means available to indicate that the stated processes
are being followed. Without the appropriate documentation, the Army does
not have reasonable assurance that all of the required steps are being
followed and cannot validate that a stabilization item has been corrected.
Further, if a planned corrective action does not resolve a stated problem,
the documentation, particularly for requirements and testing, can be used
to ascertain if the requirement was properly defined. In terms of testing,
the documentation would help indicate if the test was properly designed
based upon the stated requirement and if all of the attributes were tested
as required.

The following are specific examples of cases in which the problem
resolution process was not followed and, therefore, the Army did not have
reasonable assurance and could not demonstrate to us that these
stabilization items were resolved:

o
One corrective action related to labor charges was shown as completed in
July 2004. However, the Army could not provide documentation to
substantiate that (1) requirements were developed, (2) government approval
was received, and (3) oversight board approval was obtained. Although a
testing document was provided, it was impossible to determine its adequacy
since a corresponding requirements document was not available for review.

o
Another corrective action designed to resolve inaccurate entries in the
general ledger was shown as completed on July 30, 2004. However, the Army
could not provide documentation that indicated that the requirements were
developed, testing was performed, and government approval was received. In
addition, we found a note that indicated approval by the oversight board
was not necessary, but no one could explain why the board's approval was
not needed.

In discussing these issues with Army officials, they acknowledged that
although the problem resolution process was documented in May 2004, it

was not until October 2004 that all items that were submitted to the
oversight board were required to contain the requisite documentation. To
ascertain if the project had effectively implemented the disciplined
processes over other corrective actions subsequent to this later time
frame, we reviewed 14 "trouble tickets"-specific LMP output problems
identified by Tobyhanna users-that were reported as completed from October
2004 through January 2005. These trouble tickets were be resolved with
essentially the same process used for stabilization items discussed
previously. For example, the problems identified by Tobyhanna were
expected to be reviewed to determine the causes and, if the problems were
caused by the system, the following steps should be taken and documented:
(1) identify the cause of the problem and the corrective action that
needed to be taken (requirements), (2) perform adequate testing to ensure
that the problem was fixed and did not adversely affect other LMP
functionality, and (3) obtain approval by the contractor and LMP staff. In
each case, we found that documentation was not available to validate that
the process had been followed and the problem resolved. Examples are
discussed below.

o
In October 2004, a program was developed and placed into operation to
address billing problems reported by Tobyhanna. However, it did not fix
the problem and generated so many errors that the resulting bills could
not be released to the customers. In fact, because of the number of errors
produced by this "fix," a stabilization item to clean up the erroneous
data was generated. LMP officials stated they were unsure why this
happened. Because of the large number of errors generated, it was clear
that adequate testing had not been performed on this program before it was
placed into production.

o
As noted previously, one of the major problems with LMP is its inability
to properly recognize revenue and bill customers. One cause of this
problem is that, in some cases, the system did not include an estimated
value for the planned costs of customer orders that were being processed
by Tobyhanna. When this condition occurred, improper amounts of revenue
were being recognized and improper bills prepared. The Army recognized
this problem early in the LMP deployment and developed a "fix" in
September 2003. However, we found the problem was still continuing as late
as January 2005, and the Army did not know why the September 2003
corrective action was not working as planned. If the Army had implemented
the necessary disciplined processes, it would have likely been able to (1)
identify the cause of the initial problem and (2) determine why the
September 2003 corrective action

was not working. In one case, this problem generated revenue of over $2.8
million that should not have been recognized, and in another case a
customer was improperly billed for over $1 million.

Conclusions
The Army depot maintenance group has not always achieved the goals
envisioned under the working capital fund concept-that is, to operate like
a business by developing and using effective methods to control operating
costs, charging customers prices that result in break-even status at
yearend, and ensuring that accurate and timely information is available to
manage and report on financial management operations. Specific examples of
management weaknesses in this area include the lack of proactive steps to
control rising material costs, overcharging certain depot maintenance
customers, and excessive amounts of year-end carryover, which could result
in an activity group receiving funds from customers in one fiscal year but
not performing the work until well into subsequent fiscal years, thus
tying up funds for lengthy periods that could otherwise be put to more
beneficial near-term use. Finally, DOD's inability to develop and
implement systems solutions on time and with the promised capability
appears to be a critical impediment in the planned transformation of depot
operations. Flaws in the early stages of system development, including
inadequate requirements management and system testing, are now manifested
in significant LMP implementation problems at Tobyhanna. The failure to
resolve these problems will continue to impede operations at Tobyhanna,
and future deployment locations can expect to experience similar
significant disruptions in their operations.

Recommendations for
To improve the business operations of the Army Working Capital Fund, we
are making the following nine recommendations-two recommendations

Executive Action
to the Secretary of Defense and seven recommendations to the Secretary of
the Army:

Analyzing Cost Increases
We recommend that the Secretary of the Army direct the Commander, Army
Materiel Command, to develop and implement a systematic process for
analyzing the depot maintenance activity group's material cost increases
due to the price paid for material and material usage that would enable
the Army to specifically identify and quantify all material cost drivers
and take proactive steps to control these rapidly increasing material
costs.

Allocating Gains or Losses
We recommend that the Secretary of the Army direct the Commander, Army
Materiel Command, to allocate depot gains and/or losses to the individual
depots if a several-year trend shows that an individual depot consistently
realizes gains or incurs losses.

Reducing Excessive Carryover

We recommend that the Secretary of Defense take the following actions:

o
Direct the Under Secretary of Defense (Comptroller) to clarify DOD's
written guidance for calculating carryover so that the actual amount of
carryover associated with current and prior year orders is required to be
included in the reported amount provided to the Congress and DOD.

o
Direct the Under Secretary of Defense (Comptroller) to issue written
guidance that specifies that only current year orders are used in
calculating the allowable amount of carryover for the Army depot
maintenance activity group.

We recommend that the Secretary of the Army direct the Commander, Army
Materiel Command, to continue to comply with DOD's policy on not exceeding
the year-end ceilings on the amount of year-end carryover ceilings.

                          Improving LMP Implementation

We recommend that the Secretary of the Army direct the Commander, Army
Materiel Command to take the following actions:

o
Delay implementation of LMP at the four remaining depots until the
problems encountered by the Tobyhanna Army Depot with the system are
resolved.

o
Implement the existing management procedures for ensuring the complete
resolution of identified problems resulting from the implementation of
LMP.

o
Reconcile all general ledger account balances between the legacy systems
and LMP as of the date the Army deploys the system at the four depots that
have not yet implemented the system.

o  Correct unit of issue and material pricing errors in LMP.

Agency Comments and Our Evaluation

DOD provided written comments on a draft of this report. While DOD
concurred with all the recommendations, it noted that our report did not
fully address the effects of the Global War on Terrorism and the impact it
had on maintenance workload at the Army depots. According to DOD, support
for the war more than doubled the depot workload driving up personnel and
material costs. As stated in our report, we agree that the war on
terrorism has affected the depots' workload and impacted material and
personnel costs. However, the war on terrorism does not affect the Army's
(1) practice of spreading gains and losses across all depots, (2)
calculation of reported actual carryover and the allowable amount of
carryover, and (3) development of LMP. Regarding increasing material
costs, we agree that the war does affect overall material costs. However,
material costs per direct labor hour more than doubled from $29.09 in
fiscal year 2000 to $65.23 in fiscal year 2005 and accounted for over 100
percent of the sales price increase that occurred during this same time
period. Because of this significant increase, we still believe that the
Army needs to identify all material cost drivers and take proactive steps
to control them.

In its comments, DOD concurred with the nine recommendations in the draft
report. For most of the recommendations, DOD identified specific actions
it will take to implement them. For example, DOD believes the Army should
make every effort to control the growth of material costs. While DOD
believes the increase in material costs are, in part, related to wartime
demand increases, the Army will determine the factors affecting pricing.
Also, the Army indicated that it has updated its budget formulation
guidance stating that gains and losses should be allocated to the
individual industrial installations if a several year trend shows that an
installation has consistently realized gains or losses. Further, the Under
Secretary of Defense (Comptroller) will issue guidance clarifying the
present carryover policy concerning the calculation of actual carryover as
well as the allowable amount of carryover. Finally, the Army concurred
with our recommendations on LMP and recognized that it cannot move forward
with future deployments to other depots until critical problems identified
at the Tobyhanna Army Depot are corrected.

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,
   	Secretary of the Army, 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,
Managing 	Director, at (202) 512-9505 or [email protected], or William M.
Solis, Director, 	at (202) 512-8365 or [email protected], or Keith Rhodes,
Director, at (202)	512-6412 or [email protected]. Key contributors to this
report are listed in 	appendix III.	

Sincerely yours,	

Gregory D. Kutz	Managing Director, Forensic Audits and Special
Investigations	

William M. Solis	Director, Defense Capabilities and Management	

Keith A. Rhodes	Chief Technologist, Applied Research and Methodology
Center	for Engineering and Technology	

Appendix I

Scope and Methodology	

To determine if the prices charged by the Army depot maintenance activity
group have increased and, if so, why, we obtained and analyzed budget
documents that provided information on cost factors such as material
costs, overhead costs, and labor costs used in developing the prices from
fiscal year 2000 to fiscal year 2005. We determined the reasonableness of
the figures by reviewing and analyzing the cost factor data at each depot
and the Army Materiel Command. We determined which factors caused the
prices to increase the most and discussed the reasons for the price
increases with officials at the Army Materiel Command and the five Army
depots. In addition, we met with Army Materiel Command and depot officials
to determine what actions they were taking to identify the causes for
increasing material costs-a significant factor causing the majority of the
prices to increase from fiscal year 2000 to fiscal year 2005. We also
obtained information on the impact of increasing material costs on
repairing certain weapon systems such as the Patriot missile, Chinook
helicopter, and Bradley fighting vehicle. To assess the reliability of the
data, we (1) reviewed and analyzed the factors used in determining the
prices and (2) interviewed Army officials knowledgeable about the data. We
determined that the data were sufficiently reliable for the purposes in
this report.

To determine how the Army depot maintenance activity group allocated
reported gains or losses from fiscal year 2000 through fiscal year 2004,
we obtained and analyzed budget documents and accounting reports that
provided information on prices, revenue, costs, annual operating results,
and accumulated operating results for the depot maintenance activity group
as well as the individual depots. When the activity group or depots
reported gains or losses, we met with officials to determine (1) why the
prices charged customers resulted in a reported gain or a loss and (2)
whether the activity group allocated reported gains or losses incurred by
a specific depot to that depot. When reported gains or losses were not
allocated to the specific depot incurring them, we met with Army officials
to determine why not.

To determine if the Army depot maintenance activity group exceeded its
carryover ceilings in the past and the reasons for exceeding the ceiling,
we obtained and analyzed (1) the allowable amount of carryover for fiscal
years 1996 through 2004 and (2) reported actual year-end carryover data
for fiscal years 1996 through 2004. We also reviewed our prior report
(GAO-01559) on carryover, which provided information on the allowable
amount of carryover as well as reported actual year-end carryover data.
When the reported actual carryover exceeded the carryover ceiling, we met
with

Appendix I Scope and Methodology

responsible budgeting and/or accounting officials at the Army depots and
the Army Materiel Command to ascertain why. We also reviewed customer
orders to determine why the work was not completed on these orders by the
end of the fiscal year. Further, through a review of documentation and
discussions with officials at Army headquarters, the Army Materiel
Command, the depots, and the Office of the Under Secretary of Defense
(Comptroller), we determined (1) whether the Army was implementing DOD's
new carryover policy and (2) how allowable carryover and actual reported
carryover were being calculated under the new carryover policy.

To determine if the Army encountered problems with the implementation of
LMP at the Tobyhanna Army Depot, we (1) identified problems reported by
system users at the Tobyhanna Army Depot to the system developers and
implementers (Army Materiel Command and CSC), (2) analyzed actions taken
by the Army and its contractor to resolve reported system problems, (3)
analyzed system stabilization plan to determine whether system problems
were sufficiently identified and understood to allow proper problem
resolution, (4) analyzed Army's project management processes to determine
whether underlying root causes of system problems were identified and
appropriate system solutions were developed to resolve reported system
problems, and (5) analyzed Tobyhanna's financial reports produced by the
legacy system and LMP at the time of conversion to LMP to determine
whether differences in account balances were identified and reconciled. We
also met with officials from Tobyhanna Army Depot, Defense Finance and
Accounting Service, CSC, and Army Materiel Command to discuss LMP problems
we found with the implementation of LMP. We also reviewed our prior report
(GAO-04-615), which provided information on problems found with LMP's
development and implementation at Tobyhanna and at the Communications and
Electronics Command.

We performed our work at the headquarters, Office of the Under Secretary
of Defense (Comptroller) and the Office of the Secretary of the Army,
Washington, D.C.; Army Materiel Command, Virginia; the Tobyhanna Army
Depot, Tobyhanna, Pennsylvania; the Letterkenny Army Depot, Chambersburg,
Pennsylvania; the Corpus Christi Army Depot, Corpus Christi, Texas; the
Anniston Army Depot, Anniston, Alabama; and the Red River Army Depot,
Texarkana, Texas. We also visited Computer Sciences Corporation,
Moorestown, New Jersey, the contractor responsible for developing and
implementing LMP, to discuss with company officials the problems being
experienced with the implementation of LMP at the Tobyhanna Army Depot.
Most of the financial information in this report is

Appendix I Scope and Methodology

budget data obtained from official Army budget documents. The accounting
data used in this report were obtained from official Army accounting
reports. We conducted our work from June 2004 through April 2005 in
accordance with U.S. generally accepted government auditing standards. 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 printed in appendix II.

                                  Appendix II

                    Comments from the Department of Defense	

Appendix II
Comments from the Department of Defense

Appendix II
Comments from the Department of Defense

Appendix II
Comments from the Department of Defense

Appendix III

                     GAO Contacts and Staff Acknowledgments

GAO Contacts	Gregory D. Kutz, (202) 512-9505 William M. Solis, (202)
512-8365 Keith Rhodes, (202) 512-6412

Acknowledgments	Staff who made key contributions to this report were
Richard Cambosos, Francine DelVecchio, Chris Martin, Keith McDaniel, Mike
Peacock, Janine Prybyla, Greg Pugnetti, Chris Rice, Hal Santarelli, Darby
Smith, and Ron Tobias.

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