Department of Defense: Improving the DOD Payment Process, Using Recovery
Auditing and Changing the Prompt Payment Act (Testimony, 06/16/1999,
GAO/T-NSIAD-99-193).
Unless the Pentagon gains control over its payment process, it will
continue to risk erroneously paying contractors hundreds of millions of
dollars and perpetuating other financial management and accounting
control problems. Improving the efficiency of the payment process could
save millions of dollars each year. Although the Defense Department
(DOD) is trying to improve its payment process and controls, it will
likely take many years before DOD gets its payment problems under
control. DOD needs to make better use of technology to improve and
integrate its payment systems and to streamline and simplify its payment
requirements. These actions will require sustained attention from top
management. DOD also needs to concentrate on reducing overpayments and
to adopt best practices to quickly identify and recover them.
Contractors do not have to notify the government when they have been
overpaid. GAO believes that contractors should be required to do so.
Also, it may be time to raise the minimum dollar threshold required by
the Prompt Payment Act. The Defense Finance and Accounting Service now
sends out interest payments whose processing costs total more than the
face value of the checks.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: T-NSIAD-99-193
TITLE: Department of Defense: Improving the DOD Payment Process,
Using Recovery Auditing and Changing the Prompt
Payment Act
DATE: 06/16/1999
SUBJECT: Overpayments
Internal controls
Federal agency accounting systems
Department of Defense contractors
Contract oversight
Defense cost control
Contractor payments
Defense procurement
Financial management
Refunds to government
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United States General Accounting Office GAO
Testimony Before the Subcommittee on National Security,Veterans'
Affairs, and International Relations, Committee on Government
Reform, House of Representatives For Release on Delivery Expected
at 10:00 a.m., DEPARTMENT OF Wednesday,
June 16, 1999 DEFENSE Improving the DOD
Payment Process, Using Recovery Auditing and Changing the Prompt
Payment Act Statement of David Cooper, Associate Director, Defense
Acquisition Issues, National Security and International Affairs
Division GAO/T-NSIAD-99-193 Mr. Chairman and Members of the
Subcommittee: I appreciate the opportunity to discuss the
Department of Defense's (DOD) payment problems and how recovery
auditing is being used to identify and recover overpayments. I
will also make some comments on changes to the Prompt Payment Act.
To put these issues in perspective, in fiscal year 1998, DOD spent
about $115 billion contracting for goods and services. DOD
contract dollars account for about two-thirds of total federal
government contract spending for goods and services. Thus, it is
vital that DOD have sound controls to ensure that contract
payments are proper, accurate, and timely. Results in Brief
The need for DOD to achieve effective control over its payment
process remains an imperative. If DOD does not, it will continue
to risk erroneously paying contractors hundreds of millions of
dollars and perpetuating other financial management and accounting
control problems. Further, improving the efficiency of the
payment process could save millions of dollars annually in reduced
processing costs. While DOD is taking steps to improve its payment
process and controls, it will likely take many years before DOD
gets its payment problems under control. The focus of DOD's
actions needs to be on making better use of technology to improve
and integrate its payment systems and to streamline and simplify
its payment requirements. These actions will, however, require
sustained top-management efforts. DOD needs to also concentrate on
reducing overpayments and, recognizing that some overpayments are
inevitable, adopt best practices to quickly identify and recover
them. We believe that recovery auditing offers a low-risk
opportunity to achieve both these goals, and we are supportive of
the recently introduced legislation to require federal agencies to
use recovery auditing. Currently, contractors are not required to
inform the government when they have been overpaid. Contractors
should be required to notify the government of overpayments when
they become aware of them. This requirement should not impose a
significant burden on the contractor. Once notified, government
contracting personnel should immediately ask contractors to refund
the overpayment. Letter Page 1
GAO/T-NSIAD-99-193 It may be time to raise the minimum dollar
threshold required by the Prompt Payment Act. Currently, the
Defense Finance and Accounting Service (DFAS) pays interest
amounts that are less than it costs them to process the checks.
However, raising the threshold should be part of an overall
assessment of the efficiency of the payment process. Erroneous DOD
In recent years, our reports have identified hundreds of millions
of dollars Payments Are a in erroneous government
payments, and interest expense on late payments, and other
financial management problems. For example, in March 1994, Long-
standing Issue we reported that during a 6-month period in
fiscal year 1993, DFAS in Columbus, Ohio-a principal DOD contract
paying activity-processed $751 million in payments returned by
defense contractors.1 Our examination of about one-half of these
checks disclosed that about 78 percent represented overpayments by
the government. We also found that while some contractors
returned overpayments, others did not. In one case, an
overpayment of $7.5 million was outstanding for 8 years. We
estimate that the government lost interest on the overpayment
amounting to nearly $5 million. We concluded that neither DOD nor
some contractors appeared to be aggressively pursuing resolution
of payment discrepancies. DOD continues to make substantial
erroneous payments to its contractors. For example, in the 5 years
between fiscal year 1994 and 1998, defense contractors returned
about $4.6 billion to DFAS Columbus-in fiscal year 1998, they
returned $746 million. However, some contractors were still
retaining overpayments. For example, 4 of the 13 contractors we
visited during a recent review were retaining overpayments
totaling about $1.1 million. At each location contractor
personnel told us that they had a practice of retaining
overpayments until the government issued a demand letter
requesting the overpayments be returned.2 There is no requirement
for contractors who have been overpaid to notify the government of
overpayments or to return overpayments prior to the government
issuing a demand letter for a refund. The magnitude of
overpayments defense contractors are retaining is not known. 1DOD
Procurement: Millions in Overpayments Returned by DOD Contractors
(GAO/NSIAD-94-106, Mar. 14, 1994). 2A demand letter is a formal
notification to the contractor that it owes the government money.
Letter Page 2
GAO/T-NSIAD-99-193 We have also found problems that contribute to
improper and fraudulent payments. For example, in September 1998,
we reported on internal control and system weaknesses that
contributed to two cases of Air Force vendor payment fraud-one
resulting in the embezzlement of over $500,000 and the other
resulting in embezzlement of $435,000 and attempted theft of over
$500,000.3 We found that the lack of segregation of duties and
other control weaknesses created an environment where employees
were given broad authority and the capability, without
compensating controls, to perform functions that should have been
performed by separate individuals under proper supervision. We
also found that over 1,800 DFAS and Air Force employees had access
to the vendor payment system that allowed them to submit all the
information necessary to create fraudulent and improper payments.
In testimony before the Congress earlier this year, the DOD
Inspector General commented on the vulnerability of DOD finance
operations, particularly to fraud in the vendor pay area.
According to the Inspector General, the Defense Criminal
Investigative Service (DCIS), an arm of the DOD Inspector General,
is working with the DFAS to decrease that vulnerability through
such measures as increased fraud awareness training. She said at
the time that DCIS has about 80 open criminal investigations
related to finance operations. Factors Contributing to In an
April 1997 report,4 we concluded that DOD's erroneous payments are
Erroneous Payments due, in part, to (1) nonintegrated
computer systems that often require data to be entered manually,
and with data that are often erroneous or incomplete and (2)
payments that are required to be allocated among numerous
accounting classifications. In addition, these factors increase
the cost of paying contract invoices. The need for DOD to
effectively control its payment process remains imperative. If
DOD does not, it will continue to risk erroneously paying
contractors hundreds of millions of dollars and perpetuating other
financial management and accounting control problems. Further,
improving the efficiency of the payment process would save
additional millions of dollars 3Financial Management: Improvements
Needed in Air Force Vendor Payment Systems and Controls (GAO/AIMD-
98-274, Sept. 28, 1998). 4Contract Management: Fixing DOD's
Payment Problems Is Imperative (GAO/NSIAD-97-37, Apr. 10, 1997).
Page 3
GAO/T-NSIAD-99-193 annually in reduced processing costs. Two key
areas where DOD needs to focus its efforts are (1) better using
available technology by developing seamless, fully integrated
payment systems and (2) streamlining and simplifying, to the
extent practical, its payment processes. Detailed Accounting
Let me give a few examples of the detailed accounting requirements
that Requirements Are a Burden on DFAS payment
personnel are faced with when paying a bill. These Payment
Process examples clearly suggest the need
for simplification. DOD uses what is called a "long line of
accounting" to accumulate appropriation, budget, and management
information for contract payments. For all contracts, the buying
activity assigns a two-character code called an accounting
classification reference number (ACRN) to each accounting line
containing unique information. Figure 1 is an example of an
accounting line-the type and quantity of information varies among
the services. Figure 1: Example of DOD's Long Line of Accounting
Source: DOD. Page 4
GAO/T-NSIAD-99-193 Contracts can be assigned anywhere from 1 to
over 1,000 ACRNs. A contract with numerous ACRNs may involve
extensive data entry, increasing the chance for errors and manual
payment processing. Manual payment processing costs an average of
$15 per ACRN, according to a consulting firm's study. Payment
allocations to numerous ACRNs can be time consuming and may not
provide useful or reliable management information. For example,
in one case we reviewed, a single payment on a contract with many
ACRNs took 6 to 8 hours to process. The contractor, required to
bill by ACRN, took 487 pages to assign $2.1 million in costs and
fees to 267 ACRNs. Ten of the ACRNs cited by the contractor had
insufficient obligation balances to cover the payment, according
to DFAS records. The remaining 257 ACRNs corresponded to 8 annual
appropriations covering from 1 to 5 fiscal years and included
Army, Air Force, and general defense funds. Of the 257
transactions processed, 38 were for less than $10, and some
involved debits or credits for pennies. Unresolved discrepancies,
such as insufficient funds on some ACRNs, have persisted for about
3 years. Even for a simple purchase, assigning numerous ACRNs can
cause extensive and costly rework and provide information of
questionable management value. For example, a $1,209-Navy
contract for children's toys, candy, and holiday decorations for a
child care center was written with most line items (e.g., bubble
gum, tootsie rolls, and balloons) assigned a separate ACRN. A
separate requisition number was generated for each item ordered,
and a separate ACRN was assigned for each number. In total, the
contract was assigned 46 ACRNs to account for contract obligations
against the same appropriation. To record this payment against
the 1 appropriation, DFAS had to manually allocate the payment to
all 46 ACRNs. Figure 2 is an actual portion of this contract
showing the ACRNs assigned to each item. Page 5
GAO/T-NSIAD-99-193 Figure 2: Contract Excerpt Source: DOD. The
contract was modified three times-twice to correct funding data
and once to delete funding for out-of-stock items. The
modification deleting funding did not list all of the affected
ACRNs. DFAS personnel made errors in both entering and allocating
payment data, compounding errors made in the modification.
Consequently, DFAS allocated payment for the toy jewelry line item
to fruit chew, jump rope, and jack set ACRNs-all of which should
have been deleted by the modification. Contract delivery was
completed in March 1995, but payment was delayed until October
1995. DFAS officials acknowledged that this payment consumed an
excessive amount of time and effort when compared to the time to
process a payment charged to only one ACRN. The contract could
have been assigned a single ACRN, according to a Navy official,
thus making it easier to pay without losing useful information. A
single ACRN would also have significantly reduced the amount of
data entered into the system and the opportunities for errors.
User requirements for detailed accounting place unreasonable or
unachievable demands on the payment system. Moreover, DOD's
current pricing structure does not reflect the time it takes DFAS
to meet user Page 6
GAO/T-NSIAD-99-193 requirements. Thus, the user has little
incentive to critically evaluate the level of detail being
required and its associated costs. DOD Is Taking Actions to
DOD is taking steps to address its payment problems. Its
initiatives include Address Payment Problems testing and adopting
some best practices. In the long term, it is developing
procurement and payment systems that will be linked by sharing
common data. This linkage is expected to allow one-time entry of
contract data critical to making correct payments. In the
meantime, DOD is enhancing its current technologies to further
automate the payment process. It is also testing streamlined
payment practices and making efforts to reduce the number of
contract fund citations. But, as we point out in our January 1999
recent high-risk report,5 it will be many years before DOD gets
its payment problems under control. Additional Steps Could Be
Recognizing DOD's actions and the fact that DOD continues to
overpay its Taken contractors, one
question is: are there additional steps that DOD might take to
improve the process for both identifying and collecting
overpayments? The answer is yes. First, we believe that defense
contractors should be required to promptly notify the government
of overpayments when they become aware of them. This seems simple
enough, but currently a contractor is not required to return an
overpayment until the government becomes aware of the overpayment
and issues a demand letter for repayment. And, as pointed out
earlier, the true magnitude of contractor retention of
overpayments is not known. In this regard, we will shortly begin
a review to assess the extent to which defense contractors are
retaining and not promptly returning overpayments to the
government. Second, we believe that DOD should take advantage of
best practices that commercial companies use to identify and
recover overpayments. One such practice is the use of recovery
auditing procedures. For both private industry and government
agencies, some payments are processed incorrectly for a variety of
reasons. For instance, vendors make pricing errors on their
invoices, forget to include discounts that have been publicized to
the general public, neglect to offer allowances and rebates, or
miscalculate freight charges. Government payment activities may
also 5Major Management Challenges and Program Risks, Department of
Defense (GAO/OCG-99-4, Jan. 1999). Page 7
GAO/T-NSIAD-99-193 neglect to take discounts to which they are
entitled. These mistakes, when not caught, result in
overpayments. Identifying and recovering overpayments is referred
to as recovery auditing. Recovery Auditing Recovery
auditing started about 30 years ago, and it is used in several
Offers Potential to industries, including the
automobile, retail store, and food service industries. Within
DOD, the Army and the Air Force Exchange Service, and Identify
Overpayments the Navy Exchange Service use recovery auditing. An
external audit recovery group may be the only group used by an
organization or it may be used in combination with an internal
group that examines invoices for overpayments prior to an external
group's review. Recognizing its potential value to the government,
the Fiscal Year 1996 National Defense Authorization Act required
the Secretary of Defense to conduct a demonstration program to
evaluate the feasibility of using recovery auditing to identify
overpayments made to vendors by DOD. Authority to expand the
program was provided in the Fiscal Year 1998 National Defense
Authorization Act. The DOD demonstration program began in
September 1996, when the Defense Supply Center, Philadelphia
(DSCP), competitively contracted with Profit Recovery Group
International (PRGI). The contract covers purchases made during
fiscal years 1993-95 and requires PRGI to identify and document
overpayments and to make recommendations to reduce future
overpayments. PRGI receives a fee of 20 percent of net collected
funds. In our review of the demonstration program, we concluded
that recovery auditing offers potential to identify overpayments
but implementation problems hindered DOD from fully realizing the
benefits of the program.6 As of August 1998, PRGI had identified
$19.1 million in overpayments. However, recoveries of overpayments
amounted to only $1.9 million, in large part, because vendors took
issue with some of the overpayments. This caused the recovery
process to virtually stop for 8 months while DSCP reviewed the
merits of the vendors' issues. DSCP has concluded that the claims
of overpayment are valid. However, according to the contracting
officer, his letter of final decision regarding vendors'
indebtedness has not 6Contract Management: Recovery Auditing
Offers Potential to Identify Overpayments (GAO/NSIAD-99-12, Dec.
3, 1998). Page 8
GAO/T-NSIAD-99-193 been issued. PRGI continues to identify
overpayments. As of June 1999, according to PRGI, it had
identified $29.3 million in overpayments, and collections by DOD
amount to $2.6 million. PRGI has also made recommendations to DFAS
and DSCP to reduce future overpayments, but, at the time of our
review, DOD had not implemented them. In addition, PRGI
identified about $1.8 million in overpayments that were outside
the scope of its contract, either because they were not within the
contractual review period or because they involved other
government agencies. Neither DFAS nor DSCP chose to pursue
payment recovery or inform the other government agencies of the
overpayments so that they could pursue recovery and take steps to
avoid future overpayments. DOD Is Slow to Use DOD has been
slow to embrace recovery auditing. For example, in House Recovery
Auditing Report 105-532, which related to a bill providing
for fiscal year 1999 DOD Techniques authorizations,
DOD was directed to use recovery auditing by selecting at least
two commercial functions within its working capital fund and
issuing a competitive request for proposal by December 31, 1998.
We found, however, that DOD had not done either.7 While DOD issued
an August 1998 memorandum encouraging the use of recovery
auditing, and some activities have expressed interest, no
contracts had been awarded at the time we completed our work in
March 1999. In June 1999, we checked with the recipients of the
August 1998 memorandum and, with the exception of the U.S.
Transportation Command, which told us it just entered into a
contract for recovery auditing services, no other contracts have
been let. The Defense Commissary Agency said it has completed a
statement of work, and plans to have a contract by July 30, 1999.
The Defense Logistics Agency told us it issued a solicitation on
May 28, 1999, to expand the use of recovery auditing from the
demonstration program in place at DSCP to its other four supply
centers. The Defense Logistics Agency said it plans to have a
contract by August 31, 1999. Each of the services and the Defense
Information Services Agency also expressed an interest in recovery
auditing and they are evaluating whether to use it. 7Contract
Management: DOD Is Examining Opportunities to Further Use Recovery
Auditing (GAO/NSIAD-99-78, Mar. 17, 1999). Page 9
GAO/T-NSIAD-99-193 Issues Related to Using While we believe
that recovery auditing could be beneficial to DOD and Recovery
Auditing other federal agencies, there are some
important implementation issues that need to be considered as
federal agencies evaluate using recovery auditing to identify and
recover overpayments. First, it is not clear how DOD agencies
should organize to perform recovery auditing. Should it be
contracted out? Should it be performed with in-house personnel?
Should some combination of the two be used? We believe that
agencies need to carefully consider the extent to which recovery
auditing is applicable to their operations and, if applicable, if
it would be cost-effective to undertake moderate internal recovery
auditing efforts to pick the "low hanging fruit" before turning
audit recovery efforts over to an external group. Second, it is
important that there be (1) periodic reporting by those performing
recovery auditing on the factors causing overpayments and on
recommendations to reduce overpayments and (2) a process to
evaluate these recommendations and implement those that make
sense. One of the criticisms we made of the demonstration program
was that DOD did not implement the contractor's recommendations to
reduce overpayments. These issues have been addressed in the
"Government Waste Corrections Act of 1999" (H.R. 1827), introduced
on May 17, 1999, by Congressmen Burton, Armey, and Ose. We
believe the bill is a positive step in the government's effort to
reduce overpayments and to obtain timely identification and
recovery of overpayments when they occur. Prompt Payment Act
Mr. Chairman, you also asked us for our views on how the Prompt
Payment Issues Act could be improved to
support DOD's efforts to reduce the risk of overpayments. The
Prompt Payment Act of 1982, as amended, provides governmentwide
guidelines for establishing due dates on commercial invoices and
paying interest on invoices paid late. Except where otherwise
specified within contracts, the act provides that agencies should
pay within 30 days after the designated office receives the vendor
invoice or the government accepts the items ordered as
satisfactory, whichever is later. The act also states that if a
payment is late, a business concern shall be entitled to any
interest penalty of $1 or more from the government (interest
penalties of less than $1 are not required to be paid). Page 10
GAO/T-NSIAD-99-193 In a report we issued in May 1997,8 we stated
that small interest payments made by the DFAS Columbus Contract
Entitlement Directorate comprised a large portion of the number of
payments made but accounted for a very small portion of the total
interest dollars paid. For example, of the 47,773 interest
payments in fiscal year 1996, 10,789, about one quarter of all
interest payments, were for $5 or less, and totaled $28,701-less
than one quarter of 1 percent of total interest payment dollars.
Interest payments up to $25 comprised over 50 percent of all
interest payments but less than 2 percent of total interest
dollars paid. DOD officials said that the current minimum payment
of $1 might need to be increased because the benefits from such
small interest payments may not justify the costs of making the
payments. According to DOD, it takes an average of 45 minutes to
process each interest payment at DFAS, Columbus, and that the time
spent processing such payments could be better spent on other high
priority tasks. We recently obtained updated information on the
interest payments made by the DFAS Columbus Contract Entitlement
Directorate under the act. This information shows that in fiscal
year 1998, the directorate issued 23,355 checks totaling $15
million in interest payments to defense contractors. Thirty-eight
percent were for payments of $25 or less. According to the
Contract Entitlement Directorate, its cost to process an interest
payment check in fiscal year 1998 was at least $24. DFAS issues a
separate check for interest payments. Through the first half of
fiscal year 1999, the DFAS Columbus Contract Entitlement
Directorate issued 30,781 checks totaling $16.6 million in
interest for late payments. About 41 percent of these checks
representing less than 1 percent of the dollars were for $25 or
less. According to directorate personnel, the increase in
interest payments is due to a priority initiative to reduce the
backlog of late payments. Given the cost of processing an interest
payment check, it might be cost-effective to increase the minimum
dollar requirement for paying interest under the act.
Alternatively, the late payment interest could be included in the
same check with the principal payment, which would significantly
reduce the costs of processing interest payments. We believe
8Financial Management: The Prompt Payment Act and DOD Problem
Disbursements (GAO/AIMD-97-71, May 23, 1997). Letter Page 11
GAO/T-NSIAD-99-193 that any initiative to change the minimum
interest payment should consider the efficiency of agency payment
processes. Conclusions In closing, Mr. Chairman, DOD
needs to achieve more effective control over its payment process.
If DOD does not, it will continue to risk erroneously paying
contractors hundreds of millions of dollars and perpetuating other
financial management and accounting control problems. Recovery
auditing, which has a long-standing track record in the private
sector, offers a low-risk opportunity to identify overpayments and
to recover them and we are supportive of the recently introduced
legislation to require federal agencies to use recovery auditing.
Currently, contractors are not required to inform the government
when they have been overpaid. Contractors should be required to
notify the government of overpayments when they become aware of
them. Once notified, government contracting personnel should
immediately ask contractors to refund the overpayment. Finally, it
may be time to raise the minimum dollar threshold required by the
Prompt Payment Act. However, raising the threshold should be part
of an overall assessment of the efficiency of the payment process.
Mr. Chairman, this concludes my statement. I will be glad to
answer any questions you or the other Members of the Subcommittee
may have at this time. Major contributors to this testimony were
Daniel J. Hauser and Charles W. Thompson. (707429) Letter
Page 12 GAO/T-
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