Department of Defense: Progress in Financial Management Reform
(Testimony, 05/09/2000, GAO/T-AIMD/NSIAD-00-163).

Pursuant to a congressional request, GAO discussed the Department of
Defense's (DOD) financial management reform, focusing on the challenges
and initiatives that are in place or planned.

GAO noted that: (1) challenges include DOD's inability to: (a) properly
account for and report billions of dollars of inventory and property,
plant, equipment, and national defense assets, primarily weapon systems
and support equipment; (b) estimate and report material amounts of
environmental and disposal liabilities and their related costs; (c)
determine the liability associated with post-retirement health benefits
for military employees; (d) accurately report the net costs of its
operations and produce accurate budget data; and (e) provide adequate
controls over sensitive computer information; (2) DOD has hundreds of
initiatives under way to address these key challenges, with many of the
planned fixes designed to result in a one-time, year-end number for
financial statement purposes; (3) however, achieving an unqualified or
clean financial audit opinion, while an important milestone, is not the
final goal and must be accomplished through real improvements in the
underlying financial management systems and operations that affect DOD's
ability to manage its day-to-day activities effectively; and (4) the
substantial efforts needed to work around DOD's serious systems and
control weaknesses to derive year-end balances will not produce the
timely and reliable financial and performance information DOD needs to
manage its operations every day.

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

 REPORTNUM:  T-AIMD/NSIAD-00-163
     TITLE:  Department of Defense: Progress in Financial Management
	     Reform
      DATE:  05/09/2000
   SUBJECT:  Financial management systems
	     Reporting requirements
	     Internal controls
	     Financial statement audits
	     Accountability
	     Performance measures
	     Inventory control
	     Defense budgets
	     Financial records
IDENTIFIER:  DOD Contract Property Management System
	     Army Working Capital Fund
	     DOD Base Realignment and Closure Account
	     DOD Defense Property Accountability System
	     Air Force Equipment Management System
	     Defense Integrated Financial System
	     DOD Defense Reform Initiative
	     DOD Defense Information Assurance Program

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   * For Release on Delivery
     Expected at
     2 p.m.

Tuesday,

May 9, 2000

GAO/T-AIMD/NSIAD-00-163

department of defense

Progress in Financial Management Reform

        Statement of Jeffrey C. Steinhoff

Acting Assistant Comptroller General

Accounting and Information Management Division

Testimony

Before the Subcommittee on Government Management, Information and
Technology, Committee on Government Reform, House of Representatives

United States General Accounting Office

GAO

Mr. Chairman and Members of the Subcommittee:

I appreciate the opportunity to discuss the status of financial management
at the Department of Defense (DOD). This is the third year that we have
participated in such a hearing before this Subcommittee, and we believe that
your sustained commitment to financial management reform governmentwide and
at DOD, in particular, has resulted in the steady improvement we have seen
across government. At the same time, as we testified before the Subcommittee
on March 31, 2000, on the results of our review of the fiscal year 1999
Financial Report of the U.S. Government, significant financial systems
weaknesses, problems with fundamental recordkeeping and financial reporting,
incomplete documentation, and weak internal controls, including computer
controls, continue to prevent the government from accurately reporting a
significant portion of its assets, liabilities, and costs. Material
financial management deficiencies identified at DOD, taken together,
continue to represent the single largest obstacle that must be effectively
addressed to achieve an unqualified opinion on the U.S. government's
consolidated financial statements. DOD's vast operations-with an estimated
$1 trillion in assets, nearly
$1 trillion in reported liabilities and a reported net cost of operations of
$378 billion in fiscal year 1999-have a tremendous impact on the
government's consolidated reporting.

To date, no major part of DOD has yet been able to pass the test of an
independent audit; auditors consistently have issued disclaimers of opinion
because of pervasive weaknesses in DOD's financial management systems,
operations, and controls. Such problems led us in 1995 to put DOD financial
management on our list of high-risk areas vulnerable to waste, fraud, abuse,
and mismanagement, a designation that continued in last year's update.
Lacking such key controls and information not only hampers the department's
ability to produce timely and accurate financial information, but also
significantly impairs efforts to improve the economy and efficiency of its
operations. Ineffective asset accountability and control adversely affect
DOD's visibility over weapon systems and inventory, and unreliable cost and
budget information affects DOD's ability to effectively measure performance,
reduce costs, and maintain adequate funds control. We have worked closely
and constructively with the DOD Inspector General (IG) and the military
service audit agencies to help provide further clarification of the scope
and magnitude of the department's problems and recommendations to correct
them.

DOD has made genuine progress in many areas throughout the department, both
larger steps forward and smaller incremental improvements. We have seen a
strong commitment by the DOD Comptroller and his counterparts in the
military services to addressing long-standing, deeply rooted problems. For
example, significant areas of improvement include (1) increased
accountability over property, plant, and equipment, (2) more complete
reporting of environmental and disposal liabilities, (3) increased
understanding and documentation of the Fund Balance With Treasury
reconciliation process, and (4) development of a detailed concept of
operations included in the department's Financial Management Improvement
Plan. At the same time, DOD has a long way to go. Major problems
remain-problems that are pervasive, deeply rooted, and complex in nature. My
testimony today outlines DOD's most difficult financial management
challenges and describes the initiatives that are in place or planned to
address many of them. These challenges include DOD's inability to

   * properly account for and report (1) billions of dollars of inventory
     and property, plant, and equipment and (2) national defense assets,
     primarily weapon systems and support equipment;
   * estimate and report material amounts of environmental and disposal
     liabilities and their related costs;
   * determine the liability associated with post-retirement health benefits
     for military employees;
   * accurately report the net costs of its operations and produce accurate
     budget data; and
   * provide adequate controls over sensitive computer information.

DOD has hundreds of initiatives under way to address these key challenges,
with many of the planned fixes designed to result in a one-time, year-end
number for financial statement purposes. However, achieving an unqualified
or "clean" financial audit opinion, while an important milestone, is not the
final goal and must be accomplished through real improvements in the
underlying financial management systems and operations that affect DOD's
ability to manage its day-to-day activities effectively. The substantial
efforts needed to work around DOD's serious systems and control weaknesses
to derive year-end balances will not produce the timely and reliable
financial and performance information DOD needs to manage its operations
every day.

To achieve what the Comptroller General has referred to as the "end
game"-systems and processes that routinely generate good financial
information for management purposes-will require a major systems and
reengineering effort. In this regard, the lessons learned from DOD's Year
2000 experience can prove to be a valuable teacher. Specifically, the
successful Year 2000 effort demonstrated that DOD can resolve complex,
entitywide problems through top management leadership working across
functional lines. Similarly, our Executive Guide: Creating Value Through
World-class Financial Management notes that building a sound financial
management organization begins with leadership that clearly defines and
communicates the organization's mission and vision for the future. Finally,
I will discuss actions DOD is taking to address training its personnel and
the importance of having a strong human capital investment strategy.

Control and Accountability Over Assets Impaired

Accountability Over Inventory and Related Property Remains a Concern

DOD's inability to account for and control its huge investment in
inventories effectively has been an area of major concern for many years.
Audit results for fiscal year 1999 again demonstrate that DOD does not know
the actual amount and value of inventory for which it is responsible due to
three critical deficiencies: (1) physical controls over inventory are
inadequate, (2) DOD does not capture all inventories in its records, and
(3) reported inventory values are questionable. DOD recognizes the
seriousness of this problem and has a number of initiatives under way to
address these issues, as well as several broad initiatives intended to
simplify the complicated processes it currently uses to account for
inventory.

Physical Controls Over Inventory

We, the DOD Inspector General, and the audit services have repeatedly
reported on weak controls over DOD supply inventory. The Defense Logistics
Agency's (DLA) distribution depots store approximately 75 percent of DOD's
consumable and repairable items. DLA is responsible for conducting physical
counts of inventory in its depots and measuring and ensuring inventory
record accuracy. In June 1999, we reported on significant control weaknesses
in DLA's inventory count process that affected the integrity of the physical
counts and the reliability of the reported inventory record accuracy.
Specifically, 14 DLA distribution depots we visited had reported accuracy
rates below DLA's goal of 95 percent and error rates of up to 28 percent,
with only 2 depots having accuracy rates above 90 percent. Similar
weaknesses continue. During the fourth quarter of fiscal year 1999, only two
of DLA's 20 distribution depots reported accuracy rates above 90 percent,
and overall accuracy was reported at 83 percent, with error rates ranging
from 6 percent to 28 percent.

DLA has a number of initiatives under way to address the inventory accuracy
issue. For example, during 1999, DLA initiated the development of a
statistical sampling plan to measure the dollar accuracy of DLA-owned
inventory. DLA is working with us and the DOD audit community in the design,
implementation, and execution of the plan. After refining the plan to
address any problems encountered in applying this approach to valuing DLA
inventories, DOD plans to expand the statistical sampling plan to include
the valuation of the assets it stores for the military services. Further,
section 347 of the Strom Thurmond National Defense Authorization Act for
Fiscal Year 1999 requires the secretary of each military department to set
up a schedule to implement best commercial inventory practices for secondary
supply items by 2003. The statute defines commercial best practices as
including those that will enable the military departments to reduce
inventory levels while improving responsiveness to user needs. While not
specifically initiated to address this new requirement, DLA's recent
contract with the University of Arkansas to examine private sector business
practices, including obtaining data on performing and controlling physical
counts, should help the department identify and implement commercial best
practices in this area.

Physical control weaknesses have also been reported for military service
locations that hold inventory. For example, for fiscal years 1997 and 1998,
Navy auditors reported 23 percent and 14 percent error rates, respectively,
for the Supply Fund storage locations they visited. Because of these poor
results and acknowledgment by Navy management that better results could not
be expected for fiscal year 1999, Navy auditors limited their tests for the
fiscal year 1999 audit. The Naval Audit Service performed limited physical
inventory counts at nine selected non-Supply Fund locations to determine if
internal controls were in place and functioning well enough to be relied
upon to provide accurate and complete inventory records. Results at seven of
the nine locations visited indicated that controls were not in place or were
not functioning as designed. For example, three of the locations visited had
error rates in excess of 10 percent.

Control weaknesses over inventory can lead to inaccurate reported balances,
which could affect supply responsiveness and purchase decisions, and result
in a loss of accountability. For example, during a December 1999 visit to
one Army ammunition depot, we found weak internal controls over
self-contained, ready-to-fire, handheld rockets, a sensitive item requiring
strict controls and serial number accountability. As detailed in our
recently issued report, we and depot personnel identified 835 quantity and
location discrepancies associated with 3,272 rocket and launcher units
contained in two storage igloos. The depot had more items on hand than shown
in its records because of control weaknesses over receipt of items, and, in
some cases, the records had location errors. Depot management responded
immediately to our findings, and the depot subsequently accounted for and
corrected the inventory records of all the rocket and launcher units.
Regarding this problem, we identified potentially systemic weaknesses in
controls and lack of compliance with federal accounting standards and
inventory system requirements and made recommendations to the Army to
establish and verify operating procedures to help ensure that systemic
weaknesses are corrected.

Inventory Visibility

Over the years, we have reported billions of dollars of materials that were
not "visible" to managers-that is, they were not captured in DOD's central
visibility records and therefore managers did not know they existed and
could not ensure accountability. These kinds of omissions adversely affected
the department's financial reporting and its reporting to the Congress on
inventory reductions. Further, the lack of complete visibility over
inventories increases the risk that responsible inventory item managers may
request funds to obtain additional, unnecessary items that may be on-hand
but not reported. Recent audit results indicate that these problems
continue. Examples of these visibility issues include the following.

   * In recent years, we and the audit services have reported weak controls
     over inventory in transit. For example, the Air Force Audit Agency
     (AFAA) reported in 1998 that the Air Force did not accurately account
     for inventory items being shipped from one location to another and did
     not know the value of this inventory. In addition, the Army Audit
     Agency reported for fiscal year 1999 that the Army could not determine
     the value of in-transit inventory and that audit trails did not exist.
     We reported in 1999 that the Navy had not followed established internal
     control procedures to notify inventory mangers of inventory shipments
     or receipts and instead had reported these items as lost during
     shipment. As a result, the Navy lost visibility of $3 billion of
     in-transit inventory over the past 3 years. In our February 2000
     follow-up report, we reported that the majority of the items that the
     Navy reported as lost were delivered and that there was no evidence of
     theft in the shipments we reviewed. However, we also found that the
     inventory process was vulnerable and that Navy may have made
     procurements during this period for some of these items on hand but not
     visible to item managers. For example, a commercial repair facility in
     Singapore received 3 shipments of 67 generators (valued at $593,620)
     for Navy aircraft that were written off in fiscal year 1997 as an
     in-transit loss. In October 1999, the Navy purchased 88 generators
     (valued at $1.2 million) and initiated purchase orders for an
     additional 145 generators (valued at $1.9 million) Among other items
     not visible to inventory managers were classified and sensitive items,
     such as aircraft guided-missile launchers, and unclassified items, such
     as cockpit video recorders.

On September 14, 1999, the department submitted a plan to the Congress
containing 18 proposed actions, performance measures, and implementation
schedules. DOD's overall objective is to achieve 100 percent visibility of
inventory in transit at all times. As discussed in our February 2000 report
on the results of our analysis of DOD's plan, DOD's proposed actions in this
area represent a necessary first step to improvement, but the plan does not
adequately address how the department will overcome underlying weaknesses
that have led to the lack of control over inventory shipments. In any case,
the department's efforts to implement the plan are ongoing and are expected
to take several years to complete.

   * The Naval Audit Service reported that the Navy did not include material
     turned into stores in its fiscal 1999 financial statements because the
     inventory was not processed promptly and therefore had not been
     recorded in the inventory system. At one distribution depot, the Navy
     had a backlog of materials turned into that depot of an estimated
     122,000 line items as of September 30, 1999. This represented a backlog
     of approximately 10 months, according to the Deputy Commander of the
     depot. These items were not recorded in any inventory record and were
     therefore not visible to the item managers for management and planning.
     This backlog could result in the Navy purchasing items that it does not
     need because item managers do not have information on all items that
     are already on hand.
   * In its fiscal year 1999 financial reporting, the Navy included for the
     first time, several key categories of inventory, such as sponsor-owned
     material valued at $5.5 billion and inventory items at redistribution
     sites valued at $600 million. At the same time, deficient logistics
     systems continue to impair the Navy's ability both to maintain
     visibility and prepare reliable financial reports for these assets
     effectively. For example, one command could only estimate a value for
     its sponsor-owned inventory because it did not have a system in place
     to capture and report this material. The command's estimate of $2
     billion represented over a third of the Navy's reported $5.5 billion of
     sponsor-owned material. Further, while the Navy's inclusion of several
     key inventory categories has substantially improved the completeness of
     its inventory reporting, not all categories of Navy inventory are yet
     included. Specifically, Navy auditors reported in February 2000 that
     the Navy's fiscal year 1999 reporting omitted
     $9.2 billion of shipboard inventories because logistical systems could
     not fully support the required accounting methodology. Lacking
     effective financial management systems that can provide the information
     needed to produce financial reports, various Navy commands rely on data
     calls and error-prone manual reentry of inventory data. For example,
     one Navy command did not report any inventory. However, after a
     follow-up review by Navy auditors, the command reported inventory of
     $550 million. During fiscal year 1999, the Navy began an effort to
     identify and evaluate the logistics systems used to account for and
     control its inventories. The Navy established a working group of senior
     Navy financial and program managers and audit community representatives
     to address this issue. To start, the working group is focused on
     evaluating existing systems to identify opportunities to consolidate
     and substantially reduce the number of systems. In the next phase, the
     group is to work on improving the asset visibility and financial
     reporting capabilities of the remaining systems.
   * Air Force auditors could not verify the accuracy of $2.9 billion in
     inventory in the hands of contractors. The Air Force extracted that
     amount from the Contract Property Management System for financial
     reporting. However, the auditors could not determine whether the $2.9
     billion of inventory shown in the system was reliable because the
     system did not provide a sufficient audit trail.

DOD is making efforts to improve its inventory management and ability to
report reliable inventory levels to the Congress and in financial
statements. DOD's Total Asset Visibility initiative is designed among other
things to, link inventory information systems to improve asset visibility
and provide the capability for inventory redistribution among DOD
components. Our recent work has shown that DOD has made limited progress in
achieving departmentwide asset visibility. Specifically, we reported the
Department's implementation plan for its Total Asset Visibility initiative
did not address DOD-wide problems with systems critical to the initiative's
successful implementation. The Secretary of Defense's 2000 Annual Report to
the President and the Congress incorporated a Total Asset Visibility goal of
90 percent. The longer term Total Asset Visibility goal is 100 percent
visibility by 2004.

Inventory Valuation

DOD has long-standing problems accumulating and reporting the full costs
associated with working capital fund operations that provide goods and
services in support of the military services, its primary customers. The
foundation for achieving the goals of these business-type funds is accurate
cost data, which are critical for management to operate efficiently, measure
performance, and maintain national defense readiness.

Federal accounting standards require inventories to be valued based on
historical costs or a method that approximates historical costs. Valuation
is of particular importance to capture the cost of operations in DOD working
capital funds, which in turn is critical to the usefulness of related
performance measures. DOD working capital funds charge their customers for
the support operations provided, including administrative and overhead
costs. Every dollar that the military services spend inefficiently on DOD
working capital fund purchases results in fewer resources available for
other defense spending priorities. Simply stated, working capital fund
overcharges could result in the military services using more Operations and
Maintenance appropriations in the current year than anticipated;
undercharges could result in unanticipated future pricing increases and
additional funding requests.

DOD systems do not capture the information needed to report historical cost.
Instead, inventory records and accounting transactions are maintained at a
latest acquisition cost or a standard selling price. Because systems do not
capture historical costs, DOD working capital funds have attempted to
estimate historical cost through the use of a spreadsheet application. This
methodology takes general ledger data at standard price values or latest
acquisition values and revalues the general ledger data to estimated
historical costs. This methodology is dependent, therefore, on accurate
general ledger data. Auditors have previously reported that the logistical
systems and general ledger systems are not integrated. As a result, large
adjustments are necessary to bring general ledger records into agreement
with logistical records. For example, for fiscal year 1999, the Navy
recorded $1.5 billion, the Army recorded $3.8 billion, and the Air Force
recorded $15.5 billion in adjustments to bring general ledger records into
agreement with logistical records. To illustrate the magnitude of these
adjustments, the Air Force Supply Fund revenue for the year was only $10.2
billion.

Further, the Naval Audit Service reported that an error in the valuation
methodology in 1998 resulted in overstating the cost of goods sold by
$1.2 billion. The Navy was unable to correct this error in applying the
methodology in 1999. Moreover, even if general ledger data are accurate, the
valuation methodology may lack the necessary precision to produce a reliable
estimate of cost of goods sold. For example, the Navy methodology revalued
inventory from $34 billion (selling price) to
$16 billion (historical cost estimate). A 5-percent error in this estimate
would result in a misstatement of $900 million in the Navy's Supply Fund
reported net operating loss of $976 million and reported inventory of
$15.8 billion for fiscal year 1999.

Army auditors reported for fiscal year 1998 that they were unable to audit
the Army's application of the methodology because there was insufficient
documentation to support the calculation. Further, Army auditors reported
that inventory balances at year-end improperly included inventory losses of
$5.1 billion and inventory gains of $4.5 billion. Such gains and losses
should be recognized in the net cost of operations in the period in which
they occurred. In fiscal year 1999, Army auditors reported that these
problems continued to exist and that removing these period costs are
necessary before an accurate estimate of historical cost can be developed.

Further complicating the inventory valuation issue, inventory levels
reported to the Congress are reported at latest acquisition cost. Although
latest acquisition cost data may be important for budget projection and
purchase decisions, this information may not be appropriate for performance
measurement. Latest acquisition cost can substantially differ from the cost
paid for the item. To illustrate how this occurs, assume a military service
had 10 items that cost $10 each, so each item would be valued at $10, or at
$100 in total. However, if the service then purchased 1 new item at $25, all
11 items would be valued based upon the latest purchase price of $25, or
$275 in total. The Commander of Air Force Materiel Command recently
testified that such valuation practices distort DOD's progress toward
reducing inventory levels. The Commander stated the following.

"Each year, inventories of old spare parts were increased in value to
reflect their latest acquisition price (the normal commercial practice is to
deflate, not inflate, the value of long term assets). Many supply managers
who faithfully disposed of unneeded inventory were surprised at the end of
the year to see their total inventory value increase. As a result, they were
subject to great pressure to further reduce inventory levels. . . .The new
spares were needed but funding restrictions prevented purchase of these
parts for several years."

Overall, the effect of increasing prices can be demonstrated by noting that
the Air Force's $32.6 billion of inventory at latest acquisition cost is
revalued to $18.3 billion to reflect estimated historical costs.

Accurate inventory cost data are also important to measuring operational
performance. A key performance measure is net operating results, the
difference between revenue and expenses related to that revenue. Net
operating results are an important factor in setting prices charged to
customers. Navy management has acknowledged that due to unreliable inventory
cost data, the reported net operating results for the supply fund are
unreliable and cannot be used in the price-setting process. Several
initiatives are ongoing to address inventory valuation issues, as noted in
the following section.

Broad Simplification Initiatives

In addition to the specific initiatives discussed previously, DOD has a
number of broad-based initiatives that are intended to simplify its
complicated processes for accounting for inventory. Initiatives such as
these, if effectively implemented, could help achieve the kind of
wide-ranging process changes throughout the department that will result in
long-term improvements in this area.

   * The Air Force has begun an initiative to revise current inventory
     systems to capture historical costs. Senior Air Force financial
     management officials believe that historical cost data by inventory
     item provide the best information by which to manage the supply fund
     business. A working group of Navy senior financial and logistical
     managers is also considering the benefits of moving to a historical
     cost system.
   * One impediment to valuing inventory at historical cost is establishing
     a beginning value for DOD inventory. Much of DOD inventory has been on
     hand for many years, and supporting documents may not be available
     within DOD systems. We are currently working with DOD officials to
     evaluate procurement data available within DOD and other sources to
     address this issue.
   * The Air Force is considering the adoption of private sector practices
     to account for repairables, which represent the majority of supply fund
     inventory. The Air Force had a contractor review DOD inventory
     accounting and valuation processes versus those of the private sector.
     The contractor concluded that adoption of private sector practices,
     including the use of historical cost, would simplify accounting
     transactions. For example, under DOD's current accounting procedures,
     logistical actions, such as transfers of inventory between locations,
     changes in condition code, and turn-in of an asset for repair, result
     in adjustments to the financial systems. Under private sector
     practices, the same transactions would be recorded in the logistical
     systems but not in the financial systems because they have no impact on
     inventory valuation. The contractor estimated that adoption of such
     private sector accounting practices would eliminate 155 million general
     ledger transactions currently processed by the Air Force. This is an
     estimated 78 percent reduction over current Air Force accounting
     practices for these types of logistical actions.
   * The Army has initiated an effort to consolidate supply fund inventory
     into a single stock fund. The Single Stock Fund initiative will
     integrate separately managed wholesale and retail stock fund
     inventories into a single Army stock fund. By October 2000,
     stock-funded supplies owned and managed by installations-currently
     retail stock fund-are expected to become wholesale assets to be managed
     by the Army Material Command. This initiative is intended to improve
     the acquisition and distribution of supply items by eliminating
     numerous inefficiencies, such as duplicative levels of stock and
     several automated systems managing the same inventory, and a lack of
     central item manager visibility over inventory at Army bases and
     installations. Further, this initiative will eliminate multiple points
     of sale and credit, billings, and general ledgers, thus reducing the
     number of accounting transactions. Army financial managers expect
     significant dollar savings to result from this initiative, although
     program officials have not yet estimated those savings.
   * Similarly, in an effort to improve visibility and financial management
     of inventory, the Navy changed ownership of over $2 billion of
     shipboard repairables from general fund commands to the supply fund
     during 1998 and 1999. This change provides central visibility and
     transaction-based reporting of this inventory.

General PP&E Amounts Are Still Unreliable But Efforts Are Underway to
Address Deficiencies

To address accountability and financial reporting issues, DOD has begun
several initiatives over the past year. Due to the department's enormous
size and complexity, however, most of its PP&E initiatives are still in
process and have not yet fully affected its operations or the reliability of
amounts reported.

Real Property

DOD's real property represented more than 70 percent of its reported PP&E
for fiscal year 1999. Last year, DOD took a step forward to address one of
its long-standing PP&E problems, the valuation of its beginning real
property balances. Specifically, the department obtained contractor
assistance in validating its recorded real property amounts (or recommending
ways to develop auditable values), compiling reported PP&E data, and helping
to maintain accurate property records. The contractor sampled and surveyed
nearly 1,300 real properties, estimated a current replacement cost for each,
deflated that cost back to the property's acquisition date, and compared the
deflated replacement cost to the cost recorded in DOD's property database.
All major DOD components except for the Corps of Engineers were included in
this effort.

The contractor has finished its work and reported the results of its
validation effort. Because we and the DOD audit community have not yet
completed our reviews of the contractor's work, we cannot address the
methodology or conclusions at this time. It is our understanding that the
valuation effort has provided results at a DOD and servicewide level (Army,
Navy, and Air Force) but not at lower levels that are used for reporting,
such as the Army Working Capital Fund or DLA. Therefore, the results may not
support determining the cost of many DOD activities or the calculation of
user fees and other reimbursable charges.

As agreed, the contractor's valuation effort was limited to real property on
DOD's books at September 30, 1998. Therefore, in order to evaluate the
reliability of recorded values at September 30, 1999, DOD auditors needed to
test real property transactions-additions, deletions, and modifications-that
occurred during that fiscal year. Having valuation results as of September
30, 1998, will not be useful to DOD if it cannot maintain a reliable balance
going forward. Component audit tests showed that DOD continues to lack the
necessary systems and processes to ensure that its real property assets are
promptly and properly recorded in real property databases. For example,
auditors found the following deficiencies.

   * Real property transactions are not promptly recorded. As reported, Army
     auditors reviewed about $408 million in real property addition,
     deletion, and modification transactions recorded during fiscal year
     1999 and determined that $113 million of those transactions should have
     been posted in prior fiscal years. Army auditors also identified $43
     million in unrecorded real property transactions. Air Force auditors
     identified backlogs of unprocessed real property transactions totaling
     approximately $781 million at 46 of the 99 locations audited. In
     addition, Air Force auditors found that real property constructed under
     multi-facility construction contracts was not always recorded until
     construction was completed on all facilities under the contract. Navy
     auditors also found that real property assets were not being recorded
     when construction was completed. Because Navy activities did not
     consider contracts complete for purposes of removing assets from
     construction-in-progress until the final payment was made, auditors
     found over $55 million of unrecorded new construction or improvement
     costs at two locations.

Navy auditors also found that Base Realignment and Closure (BRAC) funded
property transactions were not always recorded in Navy databases. While
costs associated with closing activities should be expensed, some costs
incurred to realign activities should be capitalized, such as new
construction or major improvements. Navy auditors identified millions of
dollars of newly constructed or improved assets paid for by BRAC funds that
were not captured in the Navy's accountability and financial reporting
databases. For example, the $4.3 million renovation costs associated with a
building that the Naval Audit Service moved into in June 1999 and
$18.4 million in capital improvements at the Naval Facilities Engineering
Command (NAVFAC) headquarters building were not recorded in the Navy's
database.

   * Sufficient controls over processing and reporting real property amounts
     did not exist. For example, Navy auditors found that reconciliations
     between accountability and financial reporting systems are not always
     performed. Navy auditors identified over $10 million in discrepancies
     between the Navy working capital fund accountability and financial
     reporting records at one location and noted a more than $13 million
     difference at another location. Air Force auditors found that
     acquisition costs reported by the Air Force for fiscal year 1999 were
     overstated by
     $3.4 billion due to compilation errors related to the costs of
     buildings and other structures at 15 installations. In addition, Air
     Force auditors could not obtain supporting documentation for about $1.8
     billion of the Air Force's $2.8 billion of construction-in-progress
     amounts reported for fiscal year 1999.

DOD must quickly address the problems that the auditors identified during
their fiscal year 1999 testing related to backlogs and the proper recording,
reconciling, and reporting of new property transactions. Until DOD has the
systems and processes in place to maintain accurate, up-to-date property
records, any valuation baseline will not be sustainable and accountability
for real property will not be ensured.

Personal Property

As discussed in our testimony last year, the most important issue related to
personal property is the accuracy of the underlying accountability records.
DOD's draft accountability regulations support this position and require
that all assets valued at $2,500 or more be in property databases for
accountability purposes. Also in line with this, the DOD Comptroller and the
military services have redirected their personal property efforts to first
ensure the accuracy and sustainability of personal property databases before
attempting to address any valuation issues. The audit community and the
Office of Management and Budget have agreed to and support this approach as
prudent and consistent with the goals of the Chief Financial Officers Act.

DOD and the military services have recognized that major changes, such as
implementation of standard automated systems and operating procedures, are
necessary to ensure accountability and financial control of personal
property. To move toward these goals, the military services general fund
activities, which are responsible for most personal property reported by
DOD, have begun implementing short-term initiatives over the past year, such
as performing or testing personal property inventories, providing training
to personnel responsible for maintaining the data, and developing procedures
and controls to ensure the reliability of future transaction processing.

For example, the Department of the Navy has been working to ensure the
reliability of its personal property records by standardizing its personal
property processes and procedures and actively implementing the Defense
Property Accountability System (DPAS) at locations worldwide. Over the past
year, the Marine Corps has performed and reconciled the results of
wall-to-wall physical inventories of assets valued at $2,500 or more and has
fully implemented DPAS at 30 sites. The benefits of the wall-to-wall
inventories are easily understood when you consider that at one location
alone, the number of assets recorded in the accountability database
increased by over 35 percent, which added 478 items to the originally
reported 1,375 items, while the dollar amount increased by 28 percent, or
about $700,000 more than the beginning value of $2.4 million. The Navy's
efforts to conduct inventories and implement DPAS at Navy sites are still
ongoing.

The Army and Air Force general fund activities are also beginning to focus
on accountability. The Army has begun to implement DPAS to report its
personal property. However, during fiscal year 1999, it temporarily
suspended implementation of DPAS at some of its major installations due to
problems encountered in converting logistical data from existing databases.
As a result, as it had for fiscal year 1998, the Army relied on data calls
to obtain information on equipment balances for financial reporting because
it had no central system. Although the percentage of units responding to the
Army's data calls increased from 78 percent for fiscal year 1998 to
approximately 97 percent for fiscal year 1999, only
$857 million was reported for equipment-an over $800 million decrease from
the prior year. Army officials were unable to explain this 48 percent
decrease. To address these problems, the Army remains committed to DPAS and
hopes to complete its implementation at general fund sites by the end of
fiscal year 2000. They have also hired a contractor to test the accuracy of
the assets reported in DPAS.

Rather than implement DPAS, the Air Force has chosen to modify its three
personal property systems, the primary one being the Air Force Equipment
Management System (AFEMS), to meet accountability and reporting requirements
for assets that individually equal or exceed DOD's financial reporting
capitalization threshold of $100,000. Over the past year, the Air Force has
added data fields to AFEMS to establish detailed records for these higher
valued assets. Also, during fiscal year 1999, Air Force activities verified
the existence of assets recorded in AFEMS that were valued at $100,000 or
more. Assets in AFEMS that were less than DOD's $100,000 capitalization
threshold, but exceeded DOD's $2,500 accountability threshold, were not
included in this verification effort. As of March 2000, personal property
assets that did not meet DOD's $100,000 financial reporting threshold
accounted for over 99 percent of the total number of personal property
assets recorded in AFEMS and approximately 45 percent (or $6.4 billion) of
the total reported personal property value. Many of these assets are
"pooled" in AFEMS rather than controlled at a serial number level, which may
impede any efforts to ensure that assets below $100,000 are recorded in the
database for visibility and accountability purposes. Air Force officials
have indicated they have initiated a change in their systems and processes
to eliminate these pools and provide individual accountability for items
over $2,500. In addition, they have hired contractors to validate that the
existing assets are properly reflected in AFEMS.

Although issues such as DOD's capitalization threshold, depreciation
periods, and systems integration do not affect current personal property
efforts as long as those efforts focus on accountability consistent with DOD
regulations, they do affect financial control and reporting for both real
and personal property. To begin addressing some of these issues, DOD hired
contractors to advise the department on appropriate capitalization
thresholds and depreciation periods for real and personal property. The
contractors have issued their reports concurring with DOD's current $100,000
threshold for financial reporting and depreciation periods, but they noted
that the databases they analyzed may not have been appropriate, complete,
and accurate. For example, as we previously discussed, the Marine Corps'
wall-to-wall inventories have identified significant numbers of assets not
included in their personal property databases. In addition, the databases
that were analyzed may not have included approximately $20 billion of
personal property held by contractors-an amount that was not reported in
DOD's financial statements but which represents more than half the gross
value for personal property that was reported for fiscal year 1999. The
contractors also recommended that if adjustments are made to the underlying
databases or if data integrity is improved, DOD should reevaluate the
study's results. We have not yet reviewed the contractors' work but we agree
that the limitations they cite could directly affect the materiality and
appropriateness of the recommended capitalization threshold and the effect
of the current depreciation periods. To ensure that the contractors'
recommendations are appropriate, DOD needs to evaluate the accuracy of the
databases that were used and analyze the full impact of property excluded
from the study.

Although each of the services has various short-term initiatives to improve
accountability, long-term sustainability and efficiency require systems
integration-acquisition and payment systems must be linked with property
accountability systems. The Navy, recognizing the usefulness of system
interfaces to maintain accountability and financial control, has established
a working group with DOD's DPAS office to begin developing electronic
interfaces in accordance with the financial management systems requirements
of the Federal Financial Management Improvement Act of 1996. The Army also
has efforts under way and systems under development to provide needed
interfaces. The Air Force has asked audit personnel to review its property
systems under development and ensure that required integration is considered
during development. To support these efforts, DOD has established a Property
System Implementation Steering Committee, chaired by the Director of
Acquisition Resources and Analysis, to emphasize property issues affecting
the department and begin addressing those issues.

Problems Persist With Data and Reporting on National Defense Assets

Beginning with fiscal year 1998, DOD was required by federal accounting
standards to report its national defense assets in a stewardship report,
which is treated as required supplementary information in its financial
statements, rather than on its balance sheet. The reported cost of this
equipment in fiscal year 1997-the last year for which such information was
reported on its balance sheet-was more than $600 billion. In its fiscal year
1999 financial report, DOD did not report on its national defense assets in
accordance with accounting standards. Instead of reporting total costs of
these assets as required by the standards, DOD reported quantities only for
major weapons systems and real property, and yearly disbursements for items
bought with procurement funds. This reporting is based in part on proposed
amendments to the accounting standards, but the amendments were not passed
when voted on in October 1999. In addition, DOD continues to experience
problems in accumulating and reporting accurate information on its national
defense equipment, as well as foreign sales activity related to these
assets. The military services have made some improvements on these issues
and are continuing to work toward more reliable logistical data for these
assets.

Incomplete Data and Financial Reporting

Information on national defense assets remains a concern because, for fiscal
year 1999, (1) it is incomplete and (2) activity during the year is not
properly recorded.

The national defense asset quantities reported for fiscal year 1999 are
incomplete primarily for two reasons. First, DOD policy instructed the
services to report only certain categories of national defense assets and
specifically excluded two of the major categories-support principal end
items, such as aircraft engines and radars, and mission support equipment,
such as nontactical vehicles and cryptographic systems. As a result,
thousands of different types of support equipment costing billions of
dollars were not reported anywhere in DOD's financial report. For example,
the Army reported quantities for only 279 types of equipment out of more
than 1,600 types. Unreported items include

   * Army communication equipment with an estimated value of $5.7 billion,
   * Navy aircraft engines with an estimated value of $7.6 billion, and
   * over 2,300 Air Force electronics systems pods that attach to aircraft,
     with costs ranging from over $1 million to $5 million each.

Second, some items may not have been reported because they are not recorded
in any centralized asset visibility system. Because the services cannot
identify all of their assets through a centralized system, each service had
to supplement its automated data with manual procedures to collect the
information. For example, the Army again conducted an Army-wide data call as
it had in fiscal year 1998 to capture items not reported in its centralized
systems. Items identified as a result of this data call that were not
included in the Army's centralized systems included 56 airplanes, 32 tanks,
and 36 Javelin command-launch units. The Air Force had to use manual
procedures to compile its missile data from a number of different systems
and to try to avoid double counting and/or omissions. The Navy had to obtain
data on ballistic missiles from inventory control personnel who maintain
local spreadsheets on the missiles at two Navy facilities. The use of manual
procedures, such as data calls, results in less reliable information because
it is dependent on individuals responding promptly and accurately. For
example, only 78 percent of Army units responded to a data call in time for
its fiscal year 1998 reporting. Although this percentage increased to 97
percent for fiscal year 1999, the reliability of the information from the
data call was not tested. Furthermore, the necessity for manual procedures
prevents DOD from having visibility over all of its assets and the
day-to-day information needed to effectively manage its operations. For
example, DOD's lessons learned studies from Operation Desert Storm
highlighted combat support problems associated with tracking the status and
location of personnel and supplies. As previously mentioned, DOD has a goal
of 100 percent visibility over its assets by 2004.

The services have historically been unable to maintain information on
additions and deletions for most of their national defense assets. While
some progress has been made toward improving this data, auditors found that
much of it was still unreliable for fiscal year 1999. Reliable information
on additions and deletions is an important internal control to ensure
accountability over assets. Without integrated accounting, acquisition, and
logistics systems to provide accounting controls over asset balances, this
control is even more important. For example, acquisition personnel should be
able to review information on additions to ensure that all assets acquired
are reported in logistics systems. If such a control is not in place, DOD
cannot have assurance that all items purchased are received and properly
recorded.

Further, since October 1998, we have issued four reports identifying
internal control weaknesses in DOD's foreign military sales program that
includes sales of national defense assets and services to eligible foreign
countries. Most recently, on May 3, 2000, we reported that the Air Force did
not have adequate controls over its foreign military sales to ensure that
foreign customers were properly charged. Specifically, our analysis of data
contained in the Defense Finance and Accounting Service's Defense Integrated
Financial System as of July 1999, indicated that the Air Force might not
have charged FMS customer trust fund accounts for $540 million of delivered
goods and services.

In performing a detailed review of $96.5 million of these transactions, we
found that the Air Force was able to reconcile about $20.9 million. However,
of the remaining $75.6 million, the Air Force had either

   * failed to charge customer accounts ($5.1 million, 22 transactions);
   * made errors, such as incorrectly estimating delivery prices ($44
     million, 11 transactions); or
   * could not explain differences between the recorded value of delivered
     goods and services and corresponding value of changes to customer
     accounts. ($26.5 million or 19 transactions).

Improvement Initiatives

Each military service has taken some actions to improve its national defense
asset data. Some of these actions are short-term solutions, while others are
intended to provide longer term, permanent improvements in the way the data
are maintained. For example, the Navy is currently taking a servicewide
inventory of all of its aircraft engines to improve its data for these
assets. While this might result in accurate data for a given point in time,
longer term-both with respect to the design of the systems and to basic
transaction processing-logistics system changes are needed to ensure that
the data remain accurate. An ongoing, longer-term improvement effort
involves a new working group that is trying to improve ship and boat data.
The group is developing new software and has developed new guidance for
managing ship and boat information, including guidance for an annual
inventory validation and for boat disposals. In another effort intended to
improve all of the Navy's national defense asset data, the Navy has hired a
contractor to evaluate its systems, methods, processes, and procedures used
to account for its national defense assets.

The Army has made several short-term improvements in its national defense
asset information and is also developing a long-term solution. Most of the
short-term efforts stemmed from lessons learned during the fiscal year 1998
financial reporting process. For example, the Army improved its method for
determining which assets should be reported as national defense, and it
gained a better understanding of the types of information available in its
myriad logistics systems. These lessons learned should help it develop
needed systems improvements in the future, including the development of its
Logistics Integrated Database (LIDB), which is intended to eventually
replace and/or integrate many of its existing logistics systems. Army
logistics officials have commented that the efforts taken to comply with the
reporting requirements for national defense assets have been very beneficial
to the Army because the process has resulted in more accurate property
records which are used for procurement and deployment decisions.

The Air Force acknowledged that it was not able to identify all of its
national defense assets for fiscal year 1999, but it is working to improve
several of its logistics systems. It has reported that it is developing
interfaces for all of its munitions systems so that manual procedures will
not be necessary in the future to develop accurate missile data. It also
expects to have complete, reliable information on all of its electronics
systems pods in one logistics system by the end of this fiscal year.

Each of the services also made some progress toward improving information on
additions and deletions activity during the year. For example, according to
Air Force auditors, the Air Force now has accurate additions and deletions
for its aircraft engines. The Army has considered a number of different
options for tracking additions and deletions to its equipment, and while it
does not yet have a solution in place, Army officials expect to have a plan
to incorporate this information into their new Logistics Integrated Database
by June 30, 2000. The Navy has developed new forms to better document
additions and deletions for its boats and new procedures for documenting the
transfer or disposal of aircraft engines.

In addition to the services' individual efforts, DOD is continuing to
undertake initiatives to improve departmentwide asset visibility and
tracking. The department's Global Combat Support System (GCSS) strategy-its
approach to providing the technological base needed to rapidly deploy
support to the warfighter-incorporates a number of such initiatives. For
example, its Total Asset Visibility (TAV) initiative is intended to provide
department-level access to timely and accurate information on the status,
location, and movement of all assets, including national defense assets.

Because of the recognized problems with national defense asset information,
and the lack of an audit requirement for these assets, the audit community
in the past year focused on supporting and reviewing improvement efforts,
rather than conducting any significant tests of data and systems. Under the
National Defense Authorization Act for Fiscal Year 2000, the DOD Inspector
General is required to review national defense asset data submitted to the
Congress for fiscal year 1999. Such a review should help determine the
success of DOD's improvement efforts so far, as well as identify those areas
requiring further improvement.

Improvements in Environmental/
Disposal Liability Reporting But Additional Issues Need to Be Addressed

DOD still faces significant challenges in this area. Specifically, (1) all
potential liabilities were not considered, (2) estimates need to be refined
to ensure that assumptions and methodologies are consistently applied, and
(3) support for the basis of reported estimates continues to be inadequate.
To ensure that the reported amounts of environmental and disposal
liabilities are complete and reliable, adequately reflecting DOD's
obligation to clean up and dispose of hazardous and other wastes, DOD will
need to address these issues. While DOD has made great progress toward
developing more complete estimates of these costs, until these efforts are
complete, the Congress will not know the full extent of future resource
requirements necessary to fund cleanup and disposal efforts based on current
laws and policies.

DOD reported approximately $80 billion in estimated liabilities in its
fiscal year 1999 financial statements, including for the first time
approximately $34 billion for training range cleanup and nearly $11 billion
for disposal of nuclear-powered aircraft carriers and submarines. For fiscal
year 1998, only $34 billion was reported for estimated environmental
liabilities. The time frame in which the fiscal year 1999 estimates were
developed did not permit the audit community to perform adequate audit
procedures to determine their reasonableness. DOD's failure to report these
costs in prior years was among the most significant deficiencies that we
previously reported to this Subcommittee.

Potential Liabilities Not Considered in Current Year Estimate

To date, DOD has focused on those liabilities expected to involve the
largest amounts (nuclear weapons systems and training ranges). Going
forward, DOD will need to address estimates for other weapons systems and
conventional munitions. DOD needs to analyze the potential liability for
disposing of these types of items and determine whether these estimates
would be significant and thus need to be reported. If so, it will need to
develop methodologies to support such estimates. Further, DOD has just begun
to consider the significance of costs associated with the ultimate
disposition of ongoing operations.

The Congress has also recognized the potential for significant costs
associated with disposal. The National Defense Authorization Act for Fiscal
Year 1995 required that the Secretary of Defense analyze the environmental
costs of major defense acquisitions as part of the life-cycle costs of the
programs. However, recent IG audits of several major weapons systems
programs, including the Black Hawk helicopter and F-15 aircraft, have found
that life-cycle cost estimates did not include costs for demilitarization,
disposal, and associated cleanup. These disposal cost estimates are
important to consider before proceeding with a major acquisition because
this information can contribute to the ongoing dialogue on funding
comparable weapons systems. Compliance with the Fiscal Year 1995 Defense
Authorization Act would also provide data critical to ensuring more complete
and reliable financial statement reporting. In addition, the Senate
Committee on Appropriations has required that DOD develop disposal cost
estimates for munitions.

DOD must also ensure consistent application of methods and assumptions
regarding aircraft disposal cost estimates. The Navy's financial statements
included an initial estimate of $331 million in fiscal year 1999 for
disposal of fixed-wing and rotary-wing aircraft. However, although it
reported twice as many aircraft as the Navy, the Air Force has not yet
reported environmental and disposal liabilities for these weapons systems.

We are working with the department to identify other weapons systems that
might have significant cleanup and disposal liabilities and approaches for
estimating those liabilities. For example, the department's costs to dispose
of conventionally powered ships would be at least $2.4 billion, based on
applying the Navy's estimated average cost of $500 per ton of displacement
used to estimate disposal costs for its inactive fleet. In addition, we
previously estimated that the conventional munitions disposal liability for
Army alone could exceed $1 billion.

With regard to ongoing operations, costs of cleaning up and disposing of
assets used in these operations may be significant. Significant
environmental and disposal costs are to be recognized over the life of the
related assets to capture the full cost of operations. We are working with
DOD to assess whether operations, such as landfills and utilities (including
wastewater treatment and power generation facilities), will ultimately have
significant environmental costs associated with closure. For example,
Edwards Air Force Base officials provided us with a landfill closure cost
estimate of approximately $8 million. In addition, post-closure maintenance
costs, such as monitoring in excess of $200,000 annually for 30 years, are
not included in this estimate. To provide some perspective on the potential
scope of these operations, the Army alone reported 65 landfills that, based
on the Air Force estimated cost data, could cost nearly $1 billion to close
and monitor.

Further, environmental and disposal costs must also be considered in the
department's plans to analyze its more than 2,000 utility systems for
privatization. If these costs prove significant to DOD, they should be
considered in any cost-benefit analyses developed by the department in
deciding to retain or privatize these functions.

Cleanup and Disposal Cost Estimates Need to Be Refined

The training range cleanup liability is comprised primarily of cost
estimates for active, inactive, and closed Navy/Marine Corps ranges of
approximately $31 billion. The Navy reported this to be a minimum estimate
based on assumptions of "low" contamination and cleanup/remediation to
"limited public access" levels, for uses such as livestock grazing or
wildlife preservation but not for human habitation. Based on these
assumptions, the Navy used a cost factor of $10,000 per acre. Although the
Army also has significant exposure for training range cleanup liabilities,
it reported only $2.4 billion for ranges on formerly used defense sites and
closed ranges on active installations. The Army assumed one closed training
range per base for the active installations. However, because the Army has
not developed a complete range inventory nor recorded any liability for
active or inactive ranges, this approach may have significantly understated
its liability. To illustrate the potential magnitude of Army training range
cleanup, applying the cost factor used by the Navy to estimated range
acreage of the Army's National Training Center at Ft. Irwin, California,
would result in a cleanup cost estimate of approximately $4 billion for that
installation alone.

DOD has cited the lack of guidance on the scope of range cleanup
requirements as an impediment to reporting the cost of cleaning up the
ranges. In this regard, DOD has been working with the Environmental
Protection Agency (EPA) for several years to finalize the Range Rule that
will provide a framework for developing an inventory of ranges and assessing
the level of cleanup required. After finalizing this rule, DOD will need to
develop specific implementation guidance to ensure consistent application
across the military services. This guidance will need to address the
assumptions to be applied in estimating cleanup costs, including those
related to risk levels and cleanup thresholds.

Cost estimates should also be refined for changes in cleanup/disposal
schedules. For example, DOD reported a liability of approximately
$8.9 billion in its fiscal year 1999 financial statements for chemical
weapons disposal. Initial estimates to comply with the United
Nations-sponsored Chemical Weapons Convention were based on a 2007
completion date. However, we recently reported that while 90 percent of the
stockpile could be destroyed by the 2007 deadline, schedule slippages
associated with the remaining 10 percent are likely to occur because of
additional time required to validate, certify, and obtain approval of
technologies to dispose of the remaining stockpile of chemical weapons.
These schedule slippages will likely result in additional program costs.
Historically, schedule delays have been found to increase direct costs such
as labor, emergency preparedness, and program management.

Support for the Basis of Estimates Remains Inadequate

Progress in Estimating Military Post-Retirement Health Care Liability

In last year's testimony, we reported that DOD's estimated retiree health
benefits liability was unreliable because DOD did not have accurate and
complete cost data on which to base its calculation, used old and incomplete
historical claims data, and relied on unsupported clinic workload data
related to outpatient visits. Although these problems still exist, the
Office of Actuary and Office of Health Affairs have made meaningful progress
in improving the processes and underlying data on which the liability
estimate is based. For example, the liability reported in fiscal year 1998
was based on 1994 claims data-a 4-year lag-while the 1999 liability was
based on 1997 data-a 2-year lag. Moreover, the 1998 liability used
outpatient claims data from only 15 of 121 MTFs while the 1999 liability had
outpatient information for all MTFs. Better and more complete data resulted
in a $37.5 billion decrease, nearly 17 percent, in DOD's estimated liability
for retiree health benefits. These kinds of improvements in claims and
workload data will also benefit DOD's ability to manage its health care
programs, make health care-related decisions, such as whether to outsource
certain medical treatments or provide them in MTFs, and evaluate legislative
options regarding benefit changes.

To help focus improvement efforts, the Office of Actuary recently conducted
a thorough analysis of the various factors that affect the magnitude and
reliability of its actuarial estimate. The analysis identified assumptions
regarding future interest rates and medical trends, program withdrawal and
death rates, and measures of current cost and services provided as the key
drivers of the future cost of health care benefits. This type of analysis is
important because it shows that, for example, if current MTF costs change by
only 1 percent, DOD's future liability will change by more than a billion
dollars.

Despite the sensitivity of the liability to current costs, DOD has had to
use obligations in its calculation and for making many program decisions
because it does not have actual cost information for its MTFs. However,
budget obligations do not reflect the full cost of providing health care
because they do not include, among other things, civilian employee
retirement benefits that are paid directly out of the Civil Service
Retirement and Disability Fund rather than by DOD or depreciation costs for
medical facilities and equipment. In addition, health program budget
obligations attributable to wartime readiness are not distinguishable from
those associated with peacetime care. Consistent with our prior advice, DOD
now agrees that full cost should be used to estimate the retirement health
benefits liability and plans to do so for fiscal year 2000. To this end,
representatives from Health Affairs, the Comptroller's Office, Office of
Actuary, DOD Inspector General and GAO have established a Full Cost Working
Group, which has begun addressing the completeness and accuracy of recorded
costs as well as determining the portion of health care costs associated
with retirees. In addition to improving the liability estimate, DOD needs
reliable cost data to properly allocate health care resources, decide
whether to outsource certain services, set third-party billing and
interagency cost rates, and benchmark its health care delivery system with
those of other providers.

The proper allocation and growth rate of pharmacy costs are other factors
that could have a significant impact on future retiree health care costs.
For purposes of calculating the liability, DOD has been making the
assumption that its patient population uses pharmacy resources equally;
however, preliminary evidence suggests that retirees use more outpatient
pharmacy resources than nonretirees. Furthermore, pharmacy costs are
increasing at a faster rate than other medical costs, yet DOD has been
applying the same medical trend rate to all outpatient costs. We estimated
that DOD pharmacy costs increased 13 percent from 1995 through 1997, while
its overall health care costs increased 2 percent for that period. DOD is
currently analyzing the effect of separately estimating the pharmaceutical
component of the health benefits liability. This analysis will be even more
important if legislation currently being proposed, which includes increased
pharmacy benefits for retirees eligible for Medicare, is enacted.

DOD and its auditors have identified other needed improvements in patient
care and demographic data. DOD has been using examples of blatant data
errors, such as negative costs for some surgery clinics and obstetrics
services provided to male patients, to stress to its own staff and to health
care contractors the importance of its improvement efforts. Similarly, the
DOD IG has reported that workload data are problematic-medical services
cannot be validated either because medical records are not readily available
or outpatient visits are not adequately documented. The DOD IG also reported
that MTF outpatient visits are often double counted and that many telephone
consultations have been incorrectly counted as visits, perhaps due to the
lack of standardized appointment types. An accurate count of patient visits
by clinic and type is necessary for DOD to make the proper allocations of
medical personnel, supplies, and funding.

To address access and workload shortcomings, DOD recently issued a letter
directing MTFs to ensure that medical records are readily available and has
begun moving toward standardized appointment types and to electronic patient
records that would be accessible by all MTFs. DOD also established a Data
Quality Integrated Program Team, which is currently considering other data
quality improvements. In addition, DOD has developed procedures for
reconciling financial, workload, and labor hours to the data sources. When
fully and effectively implemented, these procedures should improve the
reliability of underlying data used in managing DOD's health care programs.

DOD Net Cost Information Is Unreliable

DOD needs reliable systems and processes to appropriately capture the
required cost information from the hundreds of millions of transactions it
processes each year. To do so, DOD must perform the basic accounting
activities of entering these transactions into systems that conform to
established systems requirements, properly classifying transactions,
analyzing data processed in its systems, and reporting in accordance with
requirements. As discussed later, this will require properly trained
personnel, simplified processes, systems supporting operational and
accounting needs, and a disciplined approach for accomplishing these steps.

Because it does not have the systems and processes in place to reliably
accumulate costs, DOD is unable to account for several significant costs of
its operations, as discussed in this testimony. Specifically, the accuracy
of the department's reported operating costs was affected by DOD's inability
to

   * properly value and capitalize its facilities and equipment,
   * properly account for and value its inventory,
   * identify the full extent of its environmental and disposal liability,
   * determine its liability associated with post-retirement health care for
     military personnel, and
   * complete the reconciliation of its records with those of the Department
     of the Treasury.

In addition, DOD did not have adequate managerial cost accounting systems in
place to collect, process, and report its $378 billion in total reported
fiscal year 1999 net operating costs by program area consistent with federal
accounting standards. Instead it used budget classifications such as
military construction, procurement, and research and development to present
its cost data. In general, the data DOD reported in its financial statements
represented disbursement data for those budgetary accounts, adjusted for
estimated asset purchases and accruals. For financial reports other than the
financial statements, DOD typically uses obligation data as a substitute for
cost. As discussed later in this testimony, DOD budget data are also
unreliable.

To manage DOD's programs effectively and efficiently, its managers need
reliable cost information. This information is necessary to (1) evaluate
programs, such as by measuring actual results of management's actions
against expected savings or determining the effect of long-term liabilities
created by current programs, (2) make economic choices, such as whether to
outsource specific activities and how to improve efficiency through
technology choices, (3) control costs for its weapons systems and business
activities funded through the working capital funds, and
(4) measure performance.

The lack of reliable, cost-based information hampers DOD in each of these
areas as illustrated by the following examples.

   * DOD is unable to provide actual data to fully account for the costs
     associated with functions studied for potential outsourcing under OMB
     Circular A-76. We recently reported on a long-standing concern over how
     accurately DOD's in-house cost estimates used in A-76 competitions
     reflect actual costs.
   * DOD has acknowledged that its Defense Reform Initiative efforts have
     been hampered by limited visibility into true ownership costs of its
     weapons systems. Specifically, the department cited inconsistent
     methods used by the military services to capture support cost data and
     failure to include certain costs as limiting the utility of existing
     weapons system cost data. DOD has also acknowledged that the lack of a
     cost accounting system is the single largest impediment to controlling
     and managing weapon systems costs, including costs of acquiring,
     managing, and disposing of weapon systems.
   * DOD has long-standing problems accumulating and reporting the full
     costs associated with its working capital fund operations, which
     provide goods and services in support of the military services. Cost is
     a key performance indicator to assess the efficiency of working capital
     fund operations. For example, we recently reported that the Air Force's
     Air Mobility Command-which operated using a working capital fund-lacked
     accurate cost information needed to set rates to charge its customers
     and assess the economy and efficiency of its operations. We separately
     reported that Air Force depot maintenance officials acknowledged that
     they lack all the data needed to effectively manage their material
     costs. As a result, DOD is unable to reliably assess the economy and
     efficiency of its business-like activities financed with working
     capital funds.

Reliability of Budget Data Impaired

DOD auditors were unable to complete their audits of the Statements of
Budgetary Resources because they found that obligated balances were not
correct, disbursements were not properly recorded, and Fund Balances with
Treasury remained unreliable. In addition to the specific improvement
initiatives referred to in this section, the ultimate resolution of DOD's
long-standing problems in maintaining reliable budgetary data will depend on
the process improvements, enhanced training, and systems efforts discussed
later in this testimony.

Obligated Balances Were Incorrect and Unsupported

   * The Army Audit Agency found that internal controls over the recording
     of obligations were not adequate to ensure that amounts reported in the
     Army's General Fund Statement of Budgetary Resources for fiscal year
     1999 were accurate. In a sample of 60 transactions, the auditors found
     that 21 could not be supported.
   * For fiscal year 1999, audit results show that the Air Force Working
     Capital Fund had $211 million of obligations out of approximately
     $1 billion tested, that is 700 out of 2,526 transactions that were
     incorrect, inadequately supported, or not supported. In addition, Air
     Force's general fund audit continued to identify inaccurate or
     unsupported obligated balances as of September 30, 1999. Specifically,
     Air Force auditors identified an estimated $1.3 billion in inaccurate
     or unsupported obligated balances. However, this represents a
     significant improvement over the prior year when an estimated $4
     billion in obligated balances were inaccurate or unsupported.

   * In addition to auditors' reports, the Department of the Navy identified
     its unliquidated and invalid obligations as a material management
     control weakness in its fiscal year 1999 annual assurance statement
     issued pursuant to the Federal Managers' Financial Integrity Act. For
     example, the Navy reported that within the Operation and
     Maintenance-Navy appropriation, some activities were not verifying that
     only valid obligations were entered into the accounting system. As a
     result, funding may have been available but not used. In addition, the
     Navy had more than $1 billion in expired budget authority that was
     allowed to cancel at the end of fiscal year 1999, including more than
     $750 million that had been obligated but not disbursed. According to
     Treasury data, at the end of fiscal year 1999, the department had $3.8
     billion in expired budget authority that canceled.

Further, major Navy commands were deobligating funds from subordinate
commands without the subordinate's knowledge and approval. As a result,
valid obligations could have been deobligated. These procedures demonstrate
a lack of adequate internal controls over the obligation process, which is
intended to ensure that liabilities are recognized against available funding
and that overspending does not occur.

Disbursements Not Properly Recorded

The DOD Comptroller's Office stated in the fiscal year 1999 financial
statements that the elimination of problem disbursements is one of the
department's highest financial management priorities. DOD has reported
progress in resolving problem disbursements. As of September 30, 1999, DOD
reported $10.5 billion in problem disbursements, including in-transits, as
compared with about $17.3 billion in problem disbursements reported at the
end of fiscal year 1998.

Of the $10.5 billion, DOD reported that about $1.5 billion were problem
unmatched disbursements and negative unliquidated obligations (NULOs) over
180 days old. DOD's problem disbursement policy requires that obligations be
recorded for amounts paid that are unmatched to a recorded obligation or
exceed recorded obligated balances after 180 days. However, the policy makes
an exception if sufficient funds are not available for obligation. In that
case, DOD's policy permits the department to delay recording an obligation
or adjustment until the funds cancel-up to 5 years after expiration of the
account. DOD believes that by delaying the recording of the obligation,
funds will become available-for example, through de-obligation-thus
permitting the obligation to be recorded without incurring a potential
Antideficiency Act violation and ensuing investigation. If DOD had recorded
this $1.5 billion after the transactions remained unmatched for 180 days,
the related account balances would have reflected potential Antideficiency
Act violations and required an investigation and report to the Congress.

An agency may not avoid the requirements of the Antideficiency Act,
including its reporting requirements, by failing to record obligations or to
investigate potential violations. To ensure sound funds control and
compliance with the Antideficiency Act, an agency's fund control system must
record transactions as they occur. We and the DOD IG have previously
reported on this issue and recommended that DOD revise its problem
disbursement policies and procedures to ensure that accurate and reliable
balances are maintained.

Finally, due to improper and unsupported DOD payments, such as the problem
disbursement issues previously discussed, the true magnitude of DOD's
payment problems is unknown. For example, our work continues to identify
problems with overpayments and erroneous payments to contractors. For fiscal
years 1994 through 1999, defense contractors returned over $5.3 billion to
the DFAS Columbus Center, including $675 million during fiscal year 1999,
due to contract administration actions and payment processing errors.

Frequent Adjustments Affect Reliability

In the National Defense Authorization Act for Fiscal Year 1991, the Congress
changed the government's account closing procedures. The intent of the
changes was to impose the discipline of the Antideficiency Act and the bona
fide needs rule to expired appropriations and to ensure that expired
appropriations do not remain open on the government's books indefinitely.
Under the account closing law, 31 U.S.C. 1551-1558, agencies must continue
to account for the obligated and unobligated balances of their
appropriations for 5 years after the expiration of their period of
availability. At the end of 5 years, appropriation balances, both obligated
and unobligated, are canceled. After that time, they are no longer available
for obligation, obligation adjustment, or expenditure for any purposes.
Because these accounts are no longer available for disbursement, they are
not reported as part of DOD's Fund Balance with Treasury or in the
department's Status of Funds reports to OMB or the Congress.

Subsequent to the amendment of the account closing law, DOD requested that
Treasury reopen hundreds of closed accounts to permit the posting of
adjustments. Treasury asked us whether it had authority to correct reporting
or accounting errors in closed accounts. In 1993, we determined that
Treasury had authority to correct these errors. However, our decision
emphasized that "Treasury's authority to correct the accounts relates only
to obvious clerical errors such as misplaced decimals, transposed digits, or
transcribing errors that result in inadvertent cancellations of budget
authority, and is not meant to serve as a palliative for deficiencies in
DOD's accounting systems." The decision also concluded that Treasury may
adjust canceled appropriations to record disbursements that were in fact
made before the cancellation. However, Treasury can make these adjustments
only if DOD can establish that a disbursement was a liquidation of a valid
obligation, recorded or unrecorded, that was properly chargeable against a
closed account.

Adjusting disbursements previously recorded to current or expired accounts
by moving those transactions to canceled accounts can change balances
available for obligation in the current accounts or obligated balances in
expired accounts. Since the 1991 account closing law was enacted, DOD has
requested that Treasury reopen 333 closed accounts, restoring a total of $26
billion. These accounts remained open as of September 30, 1999. By
comparison, all other federal agencies combined have requested that Treasury
reopen 21 closed accounts, restoring a total of $5 million. According to
Treasury's records, DOD made $576 million in net adjustments to canceled
accounts in fiscal year 1999. DOD has indicated that it has controls in
place to ensure that adjustments to canceled accounts are proper. We expect
to begin a review in this area to ensure that DOD's adjustments to closed
accounts comply with the account closing law and the 1993 Comptroller
General decision.

Fund Balance With Treasury Remains Unreliable

DOD made the reduction of differences a high priority in its short-term
improvement plans last year. DFAS began standardizing the reconciliation
procedures and adjusting the differences. This effort resulted in a drop in
the absolute value of unresolved differences from $9.6 billion at September
30, 1998, to $7.3 billion at September 30, 1999. In addition, some DOD
components have significantly improved the process and reduced the amount of
unreconciled differences. The Army's Corps of Engineers, Civil Works, formed
special teams to research and resolve differences identified by Treasury on
a monthly basis. The efforts of these special teams resulted in a
substantial reduction in unreconciled differences. For example, the absolute
value of unreconciled differences for the Corps of Engineers at September
30, 1999, was $64 million-down from $423 million on September 30, 1998.

Although some of these unreconciled differences may be due to the timing of
transaction processing at Treasury versus DOD, an aging of the difference
demonstrates that reconciliation issues remain. For example, although $4.8
billion of the absolute difference is less than 60 days old, $1.2 billion is
60 days to 1 year old, and $1.3 billion is over 1 year old. Differences over
60 days old are generally not expected to be attributable to timing.

At least some of the decrease in the total differences can be attributed to
the practice of some DFAS center staff to routinely adjust their records
each month to match those at Treasury without first identifying whether the
adjustment is proper. This practice results in fewer differences on the
reports but does not necessarily mean that the reconciliation process has
actually improved or that the causes of the differences have been addressed
and resolved. For example, one Army disbursing station recorded $608 million
in differences to a suspense account. These differences were ultimately
charged to Operations and Maintenance at year-end to avoid showing this
amount on the Statement of Differences.

Finally, DOD records show that an estimated $1.6 billion of transactions
held in suspense accounts at the end of fiscal year 1999 have not been
properly reported to Treasury and may also affect the fund balance with
Treasury amount. DOD reported $823 million in suspense accounts at the end
of fiscal year 1998. Until suspense account transactions are posted to the
proper appropriation account, the department will have little assurance that
it has a right to the collections, that adjustments are valid, and that the
disbursements do not exceed appropriated amounts. Moreover, the reported
amounts in suspense accounts represent the offsetting (netting) of
collections and adjustments against disbursements, thus understating the
magnitude of the unrecorded amounts in suspense accounts.

Computer Security Weaknesses Continue to Undermine Financial Management and
Other Operations

While not unmindful of the computer security weaknesses of its financial
management and other critical computer system operations, until recently,
the department has necessarily focused its efforts on preparing its computer
infrastructure for the Year 2000. However, with that challenge successfully
addressed, DOD can now turn even greater attention to countering cyber
threats and protecting its information systems in support of both
warfighting and its financial management and other business missions.

In some areas, the Year 2000 effort has laid a foundation for long-term
improvement in the way federal agencies view, manage, and protect computer
systems supporting critical missions. Among the lessons learned were the
importance of understanding the significance of computer-supported
operations and the extensive dependence agencies have on computers. This
dependence has heightened DOD's exposure and vulnerability to a rapidly
growing number of sophisticated internal and external cyber threats. As
such, DOD reports that it is firmly embarked on improving its overall
information assurance posture. For example, we recently reported to the
Special Committee on the Year 2000 Technology Problem that DOD expects
funding for computer-network defense to increase significantly for fiscal
years 2001 through 2005. DOD reports that this funding is in support of its
efforts to improve computer security capabilities and to manage and
strengthen its information assurance posture.

As laid out in our 1998 Executive Guide on information security management,
establishing and effectively implementing a computer security program should
establish a process and assign responsibilities for systematically (1)
assessing risk, (2) developing and implementing effective security policies
and controls, (3) promoting security awareness, (4) monitoring the
appropriateness and effectiveness of these policies and related controls,
and (5) providing feedback to managers who may then make needed adjustments.
In February 1997, we included information security in our list of government
program areas at high risk for waste, fraud, abuse, and mismanagement, a
designation that continued in last year's update.

Although many factors contribute to these weaknesses, audits by GAO and
Inspectors General have found that an underlying cause of weak information
security is poor management of security programs. In August 1999, we
reported that serious weaknesses in DOD's information security-at both the
department and component levels-continued to provide hackers and hundreds of
thousands of authorized users the opportunity to modify, steal,
inappropriately disclose, and destroy sensitive data. Moreover, they
endanger other important DOD-wide functions, such as weapons and
supercomputer research, logistics, procurement, personnel management, and
military health. In fact, attackers have stolen, modified, and destroyed
both data and software at DOD. They have installed "back doors" that
circumvented normal system protection and allowed attackers unauthorized
future access. They have also shut down and crashed entire systems and
networks.

In particular, we found that DOD lacked adequate (1) controls over access to
sensitive systems and data, (2) controls over software development and
changes, (3) segregation of duties, (4) system software controls, and
(5) continuity of service plans. For example, we found that users were
granted access to computer resources that exceeded what they required to
carry out their job responsibilities, including sensitive system privileges
for which they had no need. In addition, we found that personnel were still
being assigned both systems programming and security administration duties.
This dual assignment would enable users for example, to modify payroll
records or shipping records to generate unauthorized payments or misdirect
inventory shipments and to suppress the related system audit data to avoid
detection.

At the time of our 1999 review, in response to our recommendations, DOD was
developing but had not yet implemented a departmentwide security
program-known as the Defense-wide Information Assurance Program (DIAP). DIAP
planning documents, which incorporate at a high level most of the best
practices associated with information security management, indicate that DOD
recognizes and is attempting to establish the departmentwide structure
needed to manage the complex information security risks associated with its
heavy reliance on computer systems. Also, in December 1998, a newly created
Joint Task Force for Computer Network Defense began coordinating and
directing the defense of DOD computer systems and networks against strategic
attack. Its functions include (1) situation monitoring and assessment, (2)
directing DOD actions to stop attacks, contain damage, restore
functionality, and provide feedback to users, (3) coordinating DOD defensive
actions with other government agencies and private organizations, as
appropriate,
(4) participating in joint training exercises, and (5) developing
contingency plans and techniques. We currently have a review under way to
determine how well these improvements are being implemented and whether they
are being effectively coordinated.

We also made recommendations in our earlier reports aimed at ensuring that
information security programs of the military departments and Defense
agencies were consistent with the departmentwide security program. This
recommendation came partly as a result of persistent general control
weaknesses at many military installations, including unauthorized access to
sensitive information and weak controls over key automated data processing
operations used to support accounting and operational systems. Our recently
completed general and application control review of one DOD component's key
financial management system identified similar weaknesses.

Preliminary results of this review identified serious weaknesses in access
controls and systems software. For example, we gained access to sensitive
information through a file that was publicly available over the Internet.
Without valid user authentication, we gained access to employees' social
security numbers, addresses, and pay information, as well as budget,
expenditure, and procurement information on projects. This component is
taking corrective actions consistent with DOD's overall information
assurance initiatives.

Integrated Financial Management System Using Year 2000 Approach

Integrated Financial Management System Needed

Establishing an integrated system is central to the framework for financial
reforms set out by the Congress in the Chief Financial Officers (CFO) Act of
1990 and the Federal Financial Management Improvement Act (FFMIA) of 1996.
Specifically, among the requirements of the CFO Act is that each agency CFO
develop an integrated agency accounting and financial management system.
Further, FFMIA provided a legislative mandate to implement and maintain
financial management systems that substantially comply with federal
financial management systems requirements, including the requirement that
federal agencies establish and maintain a single, integrated financial
management system.

The department faces a significant challenge in integrating its financial
management systems because of its size and complexity and the condition of
its current financial management operations. DOD is not only responsible for
an estimated $1 trillion in assets and liabilities, but also for providing
financial management support to personnel on an estimated 500 bases in 137
countries and territories throughout the world. DOD has also estimated that
it makes $24 billion in monthly disbursements, and that in any given fiscal
year, the department may have as many as 500 or more active appropriations.
Each service operates unique, nonstandard financial processes and systems.
In describing the scope of its challenge in this area, DOD recognized that
it will not be possible to reverse decades-old problems overnight.

DOD submitted its first Financial Management Improvement Plan to the
Congress on October 26, 1998. We reported that DOD's plan represented a
great deal of effort and provided a first-ever vision of the department's
future financial management environment. In developing this overall concept
of its envisioned financial management environment, DOD took an important
first step in improving its financial management operations. DOD's 1999
update to its Financial Management Improvement Plan set out an integrated
financial management system as the long-term solution for establishing
effective financial management. As part of its 1999 plan, DOD reported that
it relies on an inventory of 168 systems to carry out its financial
management responsibilities. This financial management systems inventory
includes 98 finance and accounting systems and 70 critical feeder
systems-systems owned and operated by functional communities throughout DOD,
such as personnel, acquisition, property management, and inventory
management. The inclusion of feeder systems in the department's inventory of
financial management systems is a significant landmark because of the
importance of the programmatic functions to the department's ability to
carry out not only its financial reporting but also its asset accountability
responsibilities. The department has reported that an estimated 80 percent
of the data needed for sound financial management comes from these feeder
systems. However, DOD has also acknowledged that overall, its financial
management systems do not comply with the FFMIA federal financial management
systems requirements.

DOD presently lacks the integrated, transaction-driven, double entry
accounting systems that are necessary to properly control assets and
accumulate costs. As a result, millions of transactions must be keyed and
rekeyed into the vast number of systems involved in a given business
process. To illustrate the degree of difficulty that DOD faces in managing
these complex systems, the following figure shows for one business
area-contract and vendor payments-the number of systems involved and their
relationship to one another.

Source: Department of Defense.

In addition to the 22 financial systems involved in the contract payment
process that are shown in figure 1, DFAS has identified many other critical
acquisition systems used in the contract payment process that are not shown
on this diagram. To further complicate the processing of these transactions,
each transaction must be recorded using a nonstandard, complex line of
accounting that accumulates appropriation, budget, and management
information for contract payments. Moreover, the line of accounting code
structure differs by service and fund type. For example, the following line
of accounting is used for the Army's Operations and Maintenance
appropriation.

2162020573106325796.BD26FBQSUPCA200GRE12340109003AB22WORNAAS34030

Because DOD's payment and accounting processes are complex, and generally
involve separate functions carried out by separate offices using different
systems, the line of accounting must be manually entered multiple times,
which compounds the likelihood of errors. An error in any one character in
such a line of code can delay payment processing or affect the reliability
of data used to support management and budget decisions. In either case,
time-consuming research must then be conducted by DOD staff or by contractor
personnel to identify and correct the error. Over a period of 3 years, one
DOD payment center spent
$28.6 million for a contractor to research such errors.

The combination of nonintegrated systems, extremely complex coding of
transactions, and poor business processes have resulted in billions of
dollars of adjustments to correct transactions processed for functions such
as inventory and contract payments. As stated previously, during fiscal year
1999, almost one of every three dollars in contract payment transactions was
made to adjust a previously recorded transaction. In addition, the DOD IG
found that $7.6 trillion of adjustments to DOD's accounting transactions
were required last year to prepare DOD's financial statements.

DOD Adopts Year 2000 Approach

To successfully adapt this structured, disciplined process to DOD's current
financial management improvement initiatives, DOD must ensure that the
lessons learned in addressing the Year 2000 effort and from our financial
management best practices survey are effectively applied. In this regard,
two important lessons should be drawn from the Year 2000 experience-the
importance of (1) focusing on process improvement instead of systems
compliance and (2) strong leadership at the highest levels of the department
to ensure the reform effort becomes an entitywide priority.

End-to-End Business Process Focus

Establishing the right goal is essential for success. Initially, DOD's Year
2000 focus was on information technology and systems compliance. This
process was geared toward ensuring compliance system by system and did not
appropriately consider the interrelationship of all systems within a given
business process. However, DOD eventually shifted to a core mission and
function approach and greatly reduced its Year 2000 risk through a series of
risk mitigation measures including 123 major process end-to-end evaluations.
Through the Year 2000 experience, DOD has learned that the goal of systems
improvement initiatives should be improving end-to-end business processes,
not systems compliance.

This concept is also consistent with provisions of the Clinger-Cohen Act of
1996 and related system and software engineering best practices, which
provide federal agencies with a framework for effectively managing large,
complex system modernization efforts. This framework is designed to help
agencies establish the information technology management capability and
controls necessary to effectively build modernized systems. For example, the
act requires agency chief information officers to develop and maintain an
integrated system architecture. Such an architecture can guide and constrain
information system investments, providing a systematic means to preclude
inconsistent system design and development decisions and the resulting
suboptimal performance and added cost associated with incompatible systems.
The act also requires agencies to establish effective information technology
investment management processes whereby
(1) alternative solutions are identified, (2) reliable estimates of project
costs and benefits are developed, and (3) major projects are structured into
a series of smaller increments to ensure that each constitutes a wise
investment.

The financial management concept of operations included in DOD's Financial
Management Improvement Plan should fit into the overall system architecture
for the department developed under the provisions of the Clinger-Cohen Act.
In addition, the goal of DOD's Financial Management Improvement Plan should
be to improve DOD's business processes in order to provide better
information to decisionmakers and ensure greater control and accountability
over the department's assets. However, we reported last year, the vision and
goals the department established in its Financial Management Improvement
Plan fell short of achieving basic financial management accountability and
control and did not position DOD to adopt financial management best
practices in the future.

Although the 1999 improvement plan includes more detailed information on the
department's hundreds of improvement initiatives, the fundamental challenges
we highlighted last year remain. Specifically, a significant effort will be
needed to ensure that future plans address (1) how financial management
operations will effectively support not only financial reporting but also
asset accountability and control, (2) how financial management ties to
budget formulation, (3) how the planned and ongoing improvement initiatives
will result in the target financial management environment, and (4) how
feeder systems' data integrity will be improved-an acknowledged major
deficiency in the current environment.

For example, to effectively support accountability and control, DOD's plan
needs to define each of its business processes and discuss the
interrelationships among the functional areas and related systems. To
illustrate, the plan should address the entire business process for property
from acquisition to disposal and the interrelationships among the functional
areas of acquisition, property management, and property accounting.

The department recently announced its intent to develop a "Y2K like"
approach for tracking and reporting the CFO compliance of its financial
management systems, including critical feeder systems. However, the
department currently has hundreds of individual initiatives aimed at
improving financial management, many of which were begun prior to the
decision that a Year 2000 approach would be used for financial management
reform. These decentralized, individual efforts must now be brought under
the disciplined structure envisioned by the Clinger-Cohen Act and used
previously during the department's Year 2000 effort. Doing so will ensure
that further investments in these initiatives will be consistent with
Clinger-Cohen Act investment criteria and that the department's financial
management reform efforts focus on entire business processes and needed
process improvements.

Because of the extraordinarily short time frames involved for the Year 2000
effort, the department rarely had the opportunity to evaluate alternatives
such as eliminating systems and reengineering related processes. DOD has
established a goal of September 30, 2003, for completing its financial
management systems improvement effort. This time frame provides a greater
opportunity to consider all available alternatives, including reengineering
business processes in conjunction with the implementation of new technology,
which was envisioned by the Clinger-Cohen Act.

Strong Department-Level Leadership

Lessons learned from the Year 2000 effort and from our survey of leading
financial management organizations also stressed the importance of strong
leadership from top leaders. Both these efforts pointed to the critical role
of strong leadership in making any goal-such as financial management and
systems improvements-an entitywide priority. As we have testified many times
before, strong, sustained executive leadership is critical to changing the
culture and successfully reforming financial management at DOD. Although it
is the responsibility of the DOD Comptroller, under the CFO Act, to
establish the mission and vision for the future of DOD financial management,
the department has learned through its Year 2000 effort that major
initiatives that cut across DOD components must have the leadership of the
Secretary and Deputy Secretary of Defense to succeed. In addition, our best
practices work has shown that chief executives similarly need to
periodically assess investments in major projects in order to prioritize
projects and make sound funding decisions.

Improving DOD financial management is a managerial, as well as technical,
challenge. The personal involvement of the Deputy Secretary played an
important role in building entitywide support for Year 2000 initiatives by
linking these improvements to the warfighting mission. To energize DOD, the
Secretary of Defense directed the DOD leadership to treat Year 2000 as a
readiness issue. This turning point ensured that all DOD components
understood the need for cooperation to achieve success in preparing for Year
2000 and it galvanized preparedness efforts.

Similarly, to gain DOD-wide support for financial management systems
initiatives, DOD's top leadership must link the improvement of financial
management to DOD's mission. For example, DOD stated in its Defense Reform
Initiative that improved business practices will eventually provide a major
source of funding for weapon system modernization. This can occur through
reductions in the cost of performing these activities as well as through
efficiencies gained through better information. To ensure that this mission
objective is realized will require top leadership involvement to reinforce
the relationship between good financial management and improved mission
performance. To build this support across the organization, many leading
organizations have developed education programs that provide financial
managers a better understanding of the business problems and nonfinancial
managers an appreciation of the value of financial information to improved
decision-making. As discussed below, DOD is taking these first steps in
providing training to its financial personnel, and DOD officials have
recently stated that their next annual financial management improvement plan
will begin to address the need for financial management training for
nonfinancial managers.

Strategic Human Capital Investment Integral to Reform

An integral part of financial and information management is building,
maintaining, and marshaling the human capital needed to achieve results.
While DOD has several initiatives underway directed at improving the
competencies and professionalism of its financial management workforce, it
has not yet embraced a strategic approach to improving its financial
management human capital. Our recently issued guide on the results of our
survey of the best practices of recognized world-class financial management
organizations shows that a strategic approach to human capital is essential
to reaching and maintaining maximum performance.

DOD's 1999 Financial Management Improvement Plan recognized the key role of
financial management training in ensuring that the department has a
qualified and competent workforce. The DOD Comptroller recently issued a
memorandum to the department's financial management community emphasizing
the importance of professional training and certification in helping to
ensure that its financial managers are well-qualified professionals.
Consistent with this recent emphasis, the department has begun several
initiatives aimed at improving the professionalism of its financial
management workforce. For example, DFAS contracted to have government
financial manager training developed by the Association of Government
Accountants provided to several thousand of its employees over the next 5
years. This training is aimed at enhancing participants' knowledge of
financial management and can then be used to prepare for a standardized exam
to obtain a professional certification, such as the Certified Government
Financial Manager (CGFM)-a designation being encouraged by DOD management.

In another initiative, undertaken in conjunction with the American Society
of Military Comptrollers, the department reports that it expects to have its
own examination-based certification program for a defense financial manager
in place in the near future. The department has contracted with the USDA
Graduate School-a continuing education institution-to provide financial
management training to an estimated 2,000 DOD financial personnel in fiscal
year 2000 and thousands more over the next 5 years. The department reports
that this training will be directed at helping participants to develop
sufficient knowledge so that they can demonstrate competencies in
governmentwide accounting and financial management systems requirements as
they are applied in the DOD financial management environment.

The department is faced with a considerable challenge if it is to improve
its financial management human capital to the performance-based level of
financial management personnel operating as partners in the management of
world-class organizations. While DOD's financial personnel are now
struggling to effectively carry out day-to-day transaction processing,
personnel in world-class financial management organizations are providing
analysis and insight about the financial implications of program decisions
and the impact of those decisions on agency performance goals and
objectives. To help agencies better implement performance-based management,
we have identified common principles that underlie the human capital
strategies and practices of leading private sector organizations. Further,
we have issued a human capital self-assessment checklist for agency leaders
to use in taking practical steps to improve their human capital practices.

Mr. Chairman, this concludes my statement. We will be glad to answer any
questions you or the other Members of the Subcommittee may have at this
time.

(919504)

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