Federal Aviation Administration: Financial Management Issues (Testimony,
03/18/99, GAO/T-AIMD-99-122).

Pursuant to a congressional request, GAO discussed the financial
management issues at the Federal Aviation Administration (FAA), focusing
on: (1) FAA's financial management weaknesses; (2) fundamental problems
which FAA must resolve in order to achieve financial accountability; and
(3) corrective measures the agency has under way.

GAO noted that: (1) GAO had previously reported that problems in
accounting for property, plant, and equipment (PP&E) and inventory
affect FAA's ability to efficiently and effectively manage programs that
use these assets and expose the agency to waste, fraud, and abuse; (2)
recently, GAO reported that FAA needs to improve its accountability over
its field spares inventory; (3) four fundamental problems must be
resolved before FAA can achieve the most basic level of financial
accountability: (a) FAA must resolve the basic problems related to
accounting for PP&E, and institute systems, procedures, and controls to
ensure that accountability is maintained on an ongoing basis; (b) FAA
must complete its improvements to its inventory accounting system,
particularly those related to field spares; (c) FAA must implement a
cost accounting system capable of reliably accumulating full project
cost information; and (d) FAA must address its other financial reporting
issues that preclude it from preparing meaningful financial statements;
(4) the Office of Inspector General's audit report on the fiscal year
(FY) 1998 financial statements identified numerous errors and weaknesses
in FAA's process for keeping track of amounts related to PP&E (5) FAA
senior management has indicated that they recognize the urgency of
correcting their financial management deficiencies and has recently
taken steps to address them; (6) a comprehensive effort is being
undertaken to identify all major PP&E assets and to develop accurate,
supportable historical cost information for those assets; (7) FAA is in
the process of establishing a perpetual inventory system for its field
spares and plans to conduct a 100-percent field spares physical
inventory for FY 1999; (8) efforts continue to develop a cost accounting
system that is capable of accumulating the full cost of program
activities on a timely basis; (9) FAA expects to have this system
partially in place in June 1999 with a fully operational system expected
to be in place in 2001; (10) while these actions are a step in the right
direction, FAA is still far from achieving financial accountability; and
(11) until the agency is able to correct its basic accounting
deficiencies and produce a complete set of auditable financial
statements, it will not fulfill its responsibility to the taxpaying
public to be a responsible steward for the billions of dollars it is
provided annually to carry out its mission.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-AIMD-99-122
     TITLE:  Federal Aviation Administration: Financial Management Issues
      DATE:  03/18/99
   SUBJECT:  Internal controls
             Federal agency accounting systems
             Cost control
             Financial management
             Accountability
             Cost accounting
             Inventory control systems
             Federal property management
             Spare parts
             Equipment inventories

             
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AI99122T.book GAO United States General Accounting Office

Testimony Before the Subcommittee on Government Management,
Information and Technology, Committee on Government

Reform, House of Representatives For Release on Delivery Expected
at 2 p. m. Thursday, March 18, 1999

FEDERAL AVIATION ADMINISTRATION

Financial Management Issues

Statement of Linda M. Calbom Director, Resources, Community, and
Economic Development Accounting and Financial Management Issues
Accounting and Information Management Division




GAO/T-AIMD-99-122

  GAO/T-AIMD-99-122

Page 1 GAO/T-AIMD-99-122

Mr. Chairman and Members of the Subcommittee: I am pleased to be
here today to discuss financial management issues at the Federal
Aviation Administration (FAA). In January 1999, we designated FAA
financial management as a high- risk area because of serious and
longstanding accounting and financial reporting weaknesses. These
weaknesses render FAA vulnerable to waste, fraud, and abuse;
undermine its ability to manage operations; and limit the
reliability of financial information provided to the Congress.
Beginning with fiscal year 1994, the Department of
Transportation's Office of the Inspector General (OIG) has audited
FAA's financial statements and has consistently been unable to

determine whether the financial information is reliable. This
pattern of negative financial audit results continues today with
the OIG's recent financial audit report-- a disclaimer of opinion
1 -- on FAA's fiscal year 1998 financial statements. 2 The OIG was
unable to substantiate billions of dollars in major assets, or
determine the accuracy of the reported $9 billion of costs for
FAA's programs. My testimony today will  provide a brief history
of FAA's financial management weaknesses,  discuss the identified
fundamental problems which FAA must resolve in

order to achieve financial accountability, and  highlight
corrective measures the agency has under way.

History of Financial Management Weaknesses

Beginning with fiscal year 1994, the first year that the OIG
performed an audit of FAA's financial statements, significant
problems with FAA's accounting for billions of dollars of
inventory and property, plant, and equipment (PP& E) were
disclosed, including the agency's failure to properly capitalize
the costs of major assets. Because of the pervasive uncertainties
surrounding these major assets, the OIG could not determine the
reliability of the fiscal year 1994 financial statements and
issued a

1 A disclaimer of opinion means that the auditor is unable to form
an opinion on the financial statements. A disclaimer results when
a pervasive material uncertainty exists, or there is a significant
restriction on the scope of the audit. 2 Report on Fiscal Year
1998 Financial Statements, Federal Aviation Administration,
Department of Transportation Office of Inspector General, (FE-
1999- 070) dated March 8, 1999.

Page 2 GAO/T-AIMD-99-122

disclaimer of opinion on those statements. 3 Similar results
occurred for fiscal years 1995 through 1997.

Again in fiscal year 1998, the IG was unable to express an opinion
on the reliability of FAA's financial statements, citing as a
primary reason the inability to verify PP& E reported at a cost of
$11. 9 billion. The OIG reported, as it had for fiscal year 1994,
that PP& E was significantly understated due to FAA's improper
expensing of capital assets. Additionally, the OIG reported other
significant accounting and reporting issues related to the
reliability of FAA's financial statements and the records that
support those statements.

We have previously reported that problems in accounting for PP& E
and inventory affect FAA's ability to efficiently and effectively
manage programs that use these assets and expose the agency to
waste, fraud, and abuse. 4 Recently, we reported that FAA needs to
improve its accountability

over its field spares inventory. 5 Many problems in the PP& E and
inventory accounts result from the lack of a reliable system for
accumulating project cost accounting information. The lack of cost
accounting information limits FAA's ability to make effective
decisions about resource needs and adequately control major
projects, such as its multibillion- dollar air traffic control
(ATC)

modernization program. This mission- critical capital investment
program, aimed at modernizing FAA's aging ATC infrastructure, was
begun in 1981 to combat the strain on the current ATC system,
which has experienced sustained growth and aging equipment.

The modernization program currently consists of over 200 separate
projects estimated to cost over $42 billion through fiscal year
2004. It includes acquisition of new radar and automated data
processing, navigation, and communications equipment, as well as
new computer software, facilities, and support equipment. As these
items are placed in 3 The OIG report specifically disclaimed on
the Statement of Financial Position and stated that its audit work
was limited to that statement because the balances for inventory
and PP& E could not be validated, and those balances materially
affected the other statements presented.

4 Financial Management: Federal Aviation Administration Lacked
Accountability for Major Assets (GAO/AIMD-98-62, February 18,
1998). 5 Financial Management: Briefing on the Federal Aviation
Administration's Inventory Accountability (GAO/AIMD-99-98R, March
3, 1999).

Page 3 GAO/T-AIMD-99-122

service, FAA is required to capitalize them and report them as
property and equipment assets in its financial statements.
However, as the OIG reports have shown, FAA for years has
erroneously expensed many of these

investments to current operations, thereby losing track of the
specific cost of individual assets and the accumulated cost of
major projects. Fundamental Problems Need Resolution

Four fundamental problems must be resolved before FAA can achieve
the most basic level of financial accountability.  First, FAA must
resolve the basic problems related to accounting for property,
plant, and equipment, and institute systems, procedures, and

controls to ensure that accountability is maintained on an ongoing
basis.  Second, FAA must complete its improvements to its
inventory

accounting system, particularly those related to field spares.
Third, FAA must implement a cost accounting system capable of
reliably

accumulating full project cost information.  And, finally, FAA
must address its other financial reporting issues that preclude it
from preparing meaningful financial statements.

I will now discuss each of these issues in a little more detail.
Property, Plant, and Equipment Accountability Is Deficient

During fiscal years 1982 through 1998, FAA spent approximately $26
billion on capital improvement programs; however, as of September
30, 1998, the agency had reported less than $12 billion in gross
property, plant, and

equipment asset costs a difference of $14 billion. Although some
portion of the $14 billion was undoubtedly properly charged to
expense accounts, a significant portion was improperly expensed.
Since fiscal year 1994, the IG has consistently reported that
assets are being inappropriately expensed or

otherwise unaccounted for. 6 During the audit of the fiscal year
1998 financial statements, the OIG specifically identified $1
billion in assets that were not recorded on the balance sheet.
More recently the IG testified that

6 Some of these capital improvement program costs relate to
terminated or cancelled programs that should not currently be
reported as assets. However, because the costs related to these
programs were never fully captured, it is impossible to tell how
much of the $14 billion relates to terminated projects. Other
costs relate to the acquisition of spare parts, which are reported
in a different asset category inventory-- which totaled less than
$1 billion as of September 30, 1998. Further, some costs may be
appropriate expenses because they are for services unrelated to
property acquisition.

Page 4 GAO/T-AIMD-99-122

the total understatement for all equipment could be as much as $10
billion. 7 The OIG's audit report on the fiscal year 1998
financial statements identified numerous errors and weaknesses in
FAA's process for keeping

track of amounts related to PP& E. Specifically, the OIG found
that:  The reported $2.1 billion in the work- in- process account,
which is supposed to be used to accumulate the costs of projects
under

development, could not be substantiated because FAA did not have
an effective process to accumulate and document these costs, nor
to eventually record them in the appropriate PP& E accounts. For
example, FAA was unable to provide supporting documentation for 34
percent of the $887 million in work- in- process items selected
for testing,

including a flight service station with recorded costs of $1.2
million, of which FAA could only provide information for costs of
$123,000.  The work- in- process account included an estimated $1.
3 billion that related to projects that had been completed for at
least 6 months. These

completed project costs should have been moved to the appropriate
property and equipment accounts, with related depreciation expense
being charged to operations. Unrecorded depreciation expense
related to these projects amounted to at least $62 million.  Real
property (land, buildings, and structures), reported at $2.5
billion,

included significant amounts of items that were not properly
valued, or had no support for the values assigned. Additionally, a
number of real property items were identified that were not
recorded at all, while others that were recorded did not currently
exist. For example, FAA was only able to provide supporting
records for $3.6 million of the $20 million recorded for a power
supply system installed in 1992. In another example, FAA's records
included $1 million for a building that

had been demolished over 10 years ago.  Personal property
(equipment), reported at $4.1 billion, was understated

by at least $1 billion due to FAA's long- standing practice of
expensing rather than capitalizing material portions of major
equipment systems. For example, voice switching control systems
with an estimated cost of $1. 1 billion were recorded on the books
at a total cost of $234 million.

7 This statement was made by the Honorable Kenneth M. Mead,
Inspector General of the U. S. Department of Transportation before
the Subcommittee on Transportation and Related Agencies, House
Committee on Appropriations, on March 9, 1999, in his testimony
Federal Aviation Administration: Financing and Cost Control.

Page 5 GAO/T-AIMD-99-122

These deficiencies affect FAA's ability to properly manage these
assets, thus giving rise to potential operational inefficiencies.
For example, mission- critical equipment, such as radar and other
air- traffic- control equipment, may be difficult to locate when
needed, which could exacerbate an emergency situation. Also, asset
theft could go undetected, and funds

could be spent unnecessarily to acquire equipment that is already
on hand. Problems in accounting for property and equipment also
affect FAA's ability to properly maintain these assets, including
estimating maintenance and deferred maintenance funding needs, and
impair long- range planning for future facilities and equipment
needs. Inventory Accountability

Has Improved But Uncertainties Remain

Problems similar to those just discussed for PP& E have also
plagued FAA's inventory accounting, although the amounts involved
have not been as significant. FAA inventory, reported at almost
$820 million as of September 30, 1998, primarily consists of spare
parts located at the FAA Logistics Center in Oklahoma City and at
about 34, 000 field locations (referred to as field spares).

The Logistics Center is the central warehouse for operating
materials and supplies and uses an automated inventory system,
which continuously updates the reported quantities on hand as
parts are received and issued to the field. 8 Although some
ongoing minor issues remain, the accounting for inventory
quantities on hand at the Logistics Center has improved
significantly over the last year, and as of September 30, 1998,
inventory quantities were reasonably stated in the accounting
records. 9

However, the accuracy of FAA's accounting for field spares
quantities remains uncertain. Field spares are mission- critical
parts that support the National Airspace System and are maintained
at locations near the facilities they support. As of September 30,
1998, the reported value of field spares inventory was $338
million. Based on our analysis of the OIG's field spares inventory
workpapers, we were unable to satisfy ourselves about the

accuracy of reported field spares inventory quantities. In
addition, FAA did not have a reliable system in place to track and
control field spares on a continuous basis. In its review of
fiscal year 1998 field spares inventory, 8 This system, commonly
referred to as a perpetual inventory system, updates inventory
quantities at

various points in time, depending on the situation at hand.
Updates may be performed immediately, daily, or on some other
periodic basis. 9 Neither the OIG nor we validated the reported
inventory values as of September 30, 1998.

Page 6 GAO/T-AIMD-99-122

the OIG tested data for 14 sites with a recorded value of $14
million, and found numerous errors in inventory recordkeeping. For
example:

 At one site, FAA had not recorded $106,000 of communication
equipment spares for newly commissioned systems.  At another site,
11 items valued at over $39,000 that support new

systems were not included in the records, while 21 items valued at
about $67,000 could not be located.  At a third site, numerous
errors resulting from inaccurate or incomplete recordkeeping
totaled $380,000.

The lack of physical controls over field spares increases the risk
that theft or loss could go undetected. Additionally, inaccurate
information about field spares could result in shortages of
critical parts or unnecessary ordering of parts already on hand.
The latter situation may lead to excess or obsolete stock
requiring storage, control, and other activities that consume
operating resources.

Cost Accounting Implementation Delays Have Pervasive Effects

The inadequacy of FAA's cost accounting system has been identified
by GAO, 10 the OIG, and others as a weakness that prevents the
agency from having reliable and timely information about the full
cost of program activities. The objective of a cost accounting
system is to provide this information by accumulating basic
financial cost data, such as contractor invoices and agency labor
and overhead costs, and allocating these costs, by category, to
the applicable program activities. Although FAA originally
expected that a cost accounting system would be fully implemented
by October 1, 1998, this objective was not met. It subsequently
revised this goal to implementation of a partially operational
system by December 31, 1998, and a fully operational system by
March 31, 1999. FAA now projects

partial implementation in June 1999 and full systems
implementation by March 31, 2001. 11 10 Air Traffic Control:
Improved Cost Information Needed to Make Billion Dollar
Modernization Investment Decisions (GAO/AIMD-97-20, January 22,
1997). 11 Statement of Federal Financial Accounting Standards No.
4, Managerial Cost Accounting Standards, (SFFAS No. 4), effective
in fiscal year 1998, requires agencies to accumulate and report
the full costs of their activities. FAA officials told us that the
cost accounting system they are implementing goes well beyond the
requirements of SFFAS No. 4 and that they believe they will be in
compliance with SFFAS No. 4 for fiscal year 1999.

Page 7 GAO/T-AIMD-99-122

The lack of reliable and timely information about the costs of
program activities limits the ability of FAA management and other
decisionmakers to use past costs to help estimate future costs in
preparing and reviewing budgets, to control and reduce costs, and
to identify and avoid waste. For example, without reliable cost
information, FAA and other decisionmakers may not be able to
effectively

 compare, during the budgeting process, expected costs with
expected benefits, identify activities that add value, and make
fully informed decisions about whether to expend resources for
activities that are not cost effective;

 compare and identify the causes of cost changes over time;
identify and reduce excess capacity costs (the cost to maintain a
level of service that may not be needed), if any;

 choose among alternative actions such as whether to perform a
project in- house or contract it out, to accept or reject a
proposal, or to continue or eliminate a product or service; and
compare costs of similar activities and find causes for cost
differences,

if any. The lack of reliable cost information also limits the
ability of FAA management and other decisionmakers to establish
fees for services based on the cost of the services provided. The
Federal Aviation Reauthorization Act of 1996 (Public Law 104- 264)
directed FAA to establish user fees not to exceed $100 million for
selected services, including aircraft overflight, and to directly
relate these fees to the costs of providing the service rendered.
A recent federal court decision, which resulted in FAA refunding
$12 million in fees already collected, reemphasized that these
fees must be based on cost. 12

Reporting Weaknesses Undermine the Usefulness of Financial
Statements

Audited financial statements are designed to provide a public
report of how taxpayer money provided to a given agency was spent.
This information can then be linked with performance measures such
that taxpayers can be apprised of what they received for their
money. Further linkage of this information to budgetary accounts
could also provide some level of

assurance over the amounts reported in the budget as actual
expenditures, which are considered in determining budgeted amounts
for future years.

12 Asiana Airlines, et al., Petitioners v. Federal Aviaiton
Administration and Barry Valentine, Acting Administrator, 134 F.
39 393 (D. C. Cir. January 30, 1998).

Page 8 GAO/T-AIMD-99-122

However, until basic accountability over the amounts reported in
the financial statements is achieved, none of these benefits can
be realized. FAA lacks this basic accountability. In addition to
the accounting and reporting weaknesses already discussed,

the OIG's audit disclosed the following deficiencies in the fiscal
year 1998 financial statements.

 The Statement of Net Cost 13 could not be substantiated because
it could not be determined if expenses were charged to appropriate
accounts, whether total expenses charged to the accounts were
accurately accumulated, and whether administrative overhead
expenses were accurately included.

 Material items included in the Statement of Budgetary Resources,
14 including the $7.2 billion reported unobligated balance, could
not be substantiated.  A difference of $877 million between the
Statement of Budgetary

Resources and the Statement of Net Cost could not be explained.
FAA's accounting system was not able to generate the required
financial

statements, and the agency made 349 adjustments to its accounting
records, totaling $51 billion, in the process of manually
preparing the statements.

These conditions, which are indicative of the inability of FAA's
systems to support financial management and to efficiently prepare
reliable, auditable financial statements, along with the other
significant recordkeeping deficiencies discussed above, mean that
FAA faces significant challenges in order to meet its goal of a
clean audit opinion for fiscal year 1999.

Corrective Measures Are Under Way

FAA senior management has indicated that they recognize the
urgency of correcting their financial management deficiencies and
have recently taken steps to address them, including the
following.

13 The Statement of Net Cost presents the cost of major lines of
business, which are intended to relate to FAA's performance
measures.

14 The Statement of Budgetary Resources shows what budgetary
resources were available to spend during the year, how much was
spent, and how much remained obligated and unobligated at year-
end.

Page 9 GAO/T-AIMD-99-122

 A comprehensive effort is being undertaken to identify all major
PP& E assets and to develop accurate, supportable historical cost
information for those assets.  The agency is in the process of
establishing a perpetual inventory

system for its field spares and plans to conduct a 100 percent
field spares physical inventory for fiscal year 1999.  Efforts
continue to develop a cost accounting system that is capable of

accumulating the full cost of program activities on a timely
basis. As previously discussed, FAA expects to have this system
partially in place in June 1999 with a fully operational system
expected to be in place in 2001. While these actions are a step in
the right direction, FAA is still far from achieving financial
accountability. Until the agency is able to correct its basic
accounting deficiencies and produce a complete set of auditable

financial statements, it will not fulfill its responsibility to
the taxpaying public to be a responsible steward for the billions
of dollars it is provided annually to carry out its mission.

Mr. Chairman, this concludes my statement. I would be happy to
answer any questions that you or the Members of the Subcommittee
may have.

(913853) Lett er

Page 10 GAO/T-AIMD-99-122

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