oversight

Defense Budget: Improved Reviews Needed to Ensure Better Management of Obligated Funds

Published by the Government Accountability Office on 2003-01-30.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

               United States General Accounting Office

GAO            Report to the Secretary of Defense




January 2003
               DEFENSE BUDGET

               Improved Reviews
               Needed to Ensure
               Better Management of
               Obligated Funds




GAO-03-275
                                               January 2003


                                               DEFENSE BUDGET

                                               Improved Reviews Needed to Ensure
Highlights of GAO-03-275, a report to the      Better Management of Obligated Funds
Secretary of Defense




As of September 30, 2001, the                  We estimated that $929 million of the $1.4 billion in unliquidated operating
Navy’s operating appropriations                obligations valued at $50,000 or more for fiscal years 1997-99 was not
had $2.1 billion in unliquidated—or            properly accounted for (see table). Specifically, the Navy failed to
unpaid—funds that were obligated               deobligate $452 million of unliquidated operating obligations that was no
during fiscal years 1997-99.                   longer needed and potentially available for other permissible purposes, such
Unliquidated obligations that are
no longer needed to pay for goods
                                               as contract modifications. In addition, $147 million of unliquidated
and services tie up funds that could           operating obligations was inaccurately recorded because of problem
be used for other permissible                  disbursements—payments not properly matched to the correct obligation. A
purposes. In addition, inaccurate              further $330 million was inaccurately recorded due to unresolved errors,
obligation data result in                      such as bills that were not processed properly. The remaining $489 million
misstatement of budgetary                      in unliquidated operating obligations was properly accounted for and still
information.                                   needed for the original purpose.

Because of the large dollar value,             An estimated two-thirds of the unliquidated operating obligations over
we examined the Navy’s                         $50,000 were not properly accounted for as a result of the Navy’s failure to
management of unliquidated                     review such obligations three times each year as required by DOD
obligations. Specifically, we
reviewed a statistically
                                               regulations. In addition, the Navy did not fully adhere to the regulation that
representative sample of the Navy’s            unliquidated operating obligations of any value be reviewed at least once
$1.4 billion in unliquidated                   each year. Consequently, the Navy did not know how much money was tied
operating obligations valued at                up in unliquidated operating obligations that could potentially be used for
$50,000 or more for fiscal years               other appropriate needs, and its budgetary reports to Congress and financial
1997-99 to determine whether these             statements were inaccurate. Navy fund managers chose to selectively
obligations were (1) properly                  review their operating obligations, citing obstacles such as difficulties in
accounted for and (2) reviewed in              obtaining accurate payment and billing data and the extensive length of time
accordance with DOD regulations.               needed to review large numbers of obligations. Further, the Navy did not
                                               apply existing internal control activities to ensure that fund managers
                                               performed obligation reviews in accordance with DOD regulations, nor did it
                                               hold fund managers accountable for the accuracy and completeness of the
We are recommending that the
Navy adhere to obligation review               reviews.
regulations and better apply
existing internal controls to ensure
fund managers adhere to these                  Estimate of Navy’s Unliquidated Operating Obligations Valued at $50,000 or More for Fiscal
regulations and are accountable for            Years 1997-99, as of September 30, 2001
accuracy and completeness. The
Navy partially concurred, but                  Dollars in millions
stated that it prioritizes obligation          Category                                               Estimated total    Percentage of total
reviews to enable it to also pursue            Still needed for original purpose                                $489                     35
other efforts to improve financial             Not properly accounted for:
reporting. We note that DOD
regulations require review of all               No longer needed for original purpose                             452                    32
unliquidated obligations and do not             Problem disbursements                                             147                    10
allow for prioritization.                       Unresolved errors                                                 330                    23
www.gao.gov/cgi-bin/getrpt?GAO-03-275.         Subtotal not properly accounted for:                               929                    65
                                                                                                                     a
                                               Total                                                          $1,419                    100
To view the full report, including the scope
                                               Source: DOD.
and methodology, click on the link above.      Note: GAO analysis of DOD data.
For more information, contact Sharon Pickup    a
                                                 Amounts do not add to total due to rounding.
at (202) 512-9619 or pickups@gao.gov.
Contents


Letter                                                                                   1
               Results in Brief                                                          2
               Background                                                                4
               Navy Did Not Properly Account for Large Portion of Unliquidated
                 Operating Obligations                                                   6
               Navy Did Not Fully Adhere to DOD Review Regulations                       9
               Conclusions                                                              11
               Recommendations for Executive Action                                     12
               Agency Comments and Our Evaluation                                       12

Appendix I     Scope and Methodology                                                    16



Appendix II    Agency Comments                                                          19



Appendix III   GAO Contacts and Staff Acknowledgments                                   21



Tables
               Table 1: Estimate of Navy’s Unliquidated Operating Obligations for
                        Fiscal Years 1997-99, as of September 30, 2001                   7
               Table 2: Dollar Value Distribution of Fiscal Year 1997-99
                        Obligations Reviewed in the GAO Sample, as of
                        September 30, 2001                                              17




               Abbreviations

               DOD      Department of Defense
               FMR      Financial Management Regulations




               Page i                                            GAO-03-275 Defense Budget
United States General Accounting Office
Washington, DC 20548




                                   January 30, 2003

                                   The Honorable Donald H. Rumsfeld
                                   Secretary of Defense

                                   Dear Mr. Secretary:

                                   The Department of Defense (DOD) confronts pervasive and complex
                                   financial management problems that can seriously diminish the efficiency
                                   of the military services’ support operations. Recent audits of DOD’s
                                   financial statements highlight ongoing financial management challenges
                                   that affect the development of accurate and complete financial
                                   information. Among the challenges facing DOD is the lack of accurate
                                   obligation data needed for effective budget management and reliable
                                   financial reporting.

                                   To ensure accuracy, it is important for the services to liquidate obligations
                                   if funds are no longer needed as originally planned and adjust their
                                   financial records accordingly. Unliquidated obligations are those that have
                                   not yet been paid. The unliquidated obligations that are no longer needed
                                   to pay for goods and services tie up funds that could be used for other
                                   permissible purposes. Inaccurate obligation data result in misstatement of
                                   budgetary information on federal financial statements and in the
                                   President’s budget and contribute to the failure to provide basic financial
                                   accountability.1

                                   DOD has recognized the need for the services to identify and reduce the
                                   number and amount of unliquidated obligations by requiring that fund
                                   managers review these obligations. In 1996, the DOD Office of the Under
                                   Secretary of Defense (Comptroller) issued a memorandum directing DOD
                                   components to review three times each year the accuracy of unliquidated
                                   operating obligations valued at $50,000 or more. DOD also directed
                                   agencies to review all other unliquidated operating obligations at least
                                   once a year. In reviewing service obligation data, we noted that the Navy
                                   has significantly large amounts of unliquidated obligations. As of



                                   1
                                    “Providing basic financial accountability” has been identified by GAO as a
                                   governmentwide high-risk area in need of attention. See U.S. General Accounting Office,
                                   High-Risk Series: An Update, GAO-01-263 (Washington, D.C.: Jan. 2001).



                                   Page 1                                                       GAO-03-275 Defense Budget
                   September 30, 2001, the Navy’s operating appropriations2 had $2.1 billion
                   in unliquidated funds that were obligated during fiscal years 1997-99, of
                   which $1.4 billion (67 percent) represented unliquidated operating
                   obligations of $50,000 or more.3 Also, in 1999 and 2000, Navy auditors
                   reported inaccuracies in the Navy’s obligation data and found that fund
                   managers were not fully complying with DOD review regulations.

                   Because of the large dollar value of unliquidated obligations and Navy
                   audit findings, we reviewed the Navy’s management of its unliquidated
                   operating obligations. More specifically, we determined whether these
                   unliquidated operating obligations were (1) properly accounted for and
                   (2) periodically reviewed in accordance with DOD regulations. We
                   reviewed a statistically representative sample of the Navy’s unliquidated
                   operating obligations of $50,000 or more for fiscal years 1997-99. We also
                   analyzed documentation related to DOD’s obligation review regulations
                   and the Navy’s guidance to adhere to the regulations, and interviewed
                   Navy officials. A more detailed description of our scope and methodology
                   is included in appendix I.


                   On the basis of our sample, we estimated that $929 million of the
Results in Brief   $1.4 billion in unliquidated operating obligations valued at $50,000 or more
                   for fiscal years 1997-99 was not properly accounted for. Specifically, the
                   Navy failed to deobligate $452 million of unliquidated operating
                   obligations that was no longer needed and potentially available for other
                   permissible purposes, such as contract cost overruns or contract
                   modifications. In addition, $477 million of unliquidated operating
                   obligations was not properly accounted for due to billing and recording
                   errors. For example, payments were made and recorded on behalf of the
                   wrong obligation, or payments were not made because bills were not
                   processed properly. In addition to tying up funds unnecessarily, these
                   obligation errors resulted in inaccurate reporting in the Navy’s budgetary
                   reports and in its financial statements. The remaining $489 million in
                   unliquidated operating obligations was properly accounted for and still
                   needed for the original purpose.



                   2
                     “Operating” appropriations include the Operation and Maintenance (O&M), Defense-wide,
                   and Defense Health Program appropriations.
                   3
                    The Navy obligated a total of $25.6 billion in operating funds during fiscal years 1997-99,
                   as reported in its Standard Accounting and Reporting System, which maintains
                   approximately 90 percent of all operating appropriation obligations.




                   Page 2                                                         GAO-03-275 Defense Budget
An estimated two-thirds of the unliquidated operating obligations over
$50,000 were not properly accounted for as a result of the Navy’s failure to
review such obligations three times each year as required by DOD
regulations. In addition, the Navy did not fully adhere to the regulation
that unliquidated operating obligations of any value be reviewed at least
once each year. Consequently, the Navy did not know how much money
was tied up in unliquidated operating obligations that could potentially be
used for other permissible needs, and its budgetary reports to Congress
and financial statements were inaccurate. Navy fund managers chose to
selectively review their operating obligations, citing obstacles such as
difficulties in obtaining accurate payment and billing data and the
extensive length of time needed to review large numbers of obligations.
Further, the Navy did not apply existing internal control activities to
ensure that fund managers performed obligation reviews in accordance
with DOD regulations, nor did it hold fund managers accountable for the
accuracy and completeness of the reviews.

Accordingly, we are recommending that the Navy adhere to its obligation
review regulations and apply existing internal controls to ensure fund
manager adherence to these regulations. The Navy partially concurred
with our recommendations, acknowledging that more thorough efforts
dedicated to the review of obligations would increase the accuracy and
reliability of financial reports. The Navy, however, noted that because
numerous factors contribute to problems in financial reports, it has to
prioritize its remedial efforts and therefore focus on reviewing
unliquidated obligations in available appropriations, correcting systemic
problems, and pursuing broad improvements in financial management.
When appropriate requirements have arisen, the Navy commented that
encumbrances for unliquidated obligations have not been an impediment
to obtaining necessary funds. While we agree focusing on systemic issues
offers opportunities to improve the Navy’s financial information, we note
DOD’s obligation review regulations are in fact designed to minimize
systemic problems and do not allow for prioritization. Furthermore, the
ability of the Navy to gain access to funds when needs arise does not
relieve it of the responsibility to adhere to existing laws and regulations
governing sound financial management. We therefore are making no
changes to the recommendations in our report.




Page 3                                             GAO-03-275 Defense Budget
             Obligations are recorded when an authorized agent of the federal
Background   government enters into a legally binding agreement to purchase specific
             goods or services.4 As bills are received and payments are made, the
             recorded obligation is reduced by the amount of the payments made.
             When all services or goods have been received and paid for, the obligation
             is considered “liquidated,” and any remaining amount of the unliquidated
             (unpaid) obligation should be deobligated and reduced to zero.5 Operating
             funds must be obligated in the fiscal year for which they are appropriated.
             However, obligated funds may be spent over a period of 5 additional years,
             as bills for goods and services are received and paid.6 If the goods and
             services are received and paid for in the first year of the obligation, the
             remaining unliquidated obligation can be reused for other needs consistent
             with the source appropriation. If the goods and services are received and
             paid for in the subsequent 5 years, the remaining unliquidated obligation
             can still be used, if permissible, to modify contracts or to increase existing
             obligations that might need more funds.

             Accurate obligation information is essential for reliable budgeting reports
             to Congress, agency financial statements, performance measurements, and
             funds control. Inaccurate obligation data misstates the amount of funds
             available from the appropriation, contributes to inaccuracies in the Navy’s
             budget and financial reports, and subsequently leads to inaccuracies in
             federal financial statements. For example, the Navy’s unliquidated
             obligations are reported in the Navy Statement of Budgetary Resources,
             which are in turn incorporated in other DOD and federal budget reports
             and financial statements.

             We have documented weaknesses in DOD’s accounting practices and Navy
             auditors have documented inaccuracies in the Navy’s obligations data. In
             our 2001 Performance and Accountability Series report, we stated that
             because of weaknesses in DOD’s budget execution accounting, the
             department does not know with certainty the amount of funding it has




             4
              31 U.S.C. 1501; DOD Financial Management Regulation (FMR) volume 3, chapter 8,
             section 080301.
             5
              DOD FMR volume 3, chapter 8, section 080405 A, requires all deobligations, adjustments
             or corrections to be documented and processed within 10 working days of their
             identification.
             6
                 31 U.S.C. 1552.




             Page 4                                                      GAO-03-275 Defense Budget
available.7 Naval Audit Service reports published in February 19998 and
January 20009 reported that Navy fund managers were not complying with
obligation review regulations and documented inaccuracies in the Navy’s
obligation data. In July 2000 we reported that such inaccuracies in
obligation data not only hamper DOD’s ability to produce timely and
accurate financial information, but also significantly impair efforts to
improve the economy and efficiency of its operations.10

To ensure that obligation data are tracked and accurately reported, the
DOD Financial Management Regulations (FMR) require that the services,
including the Navy, review their unliquidated operating obligations valued
$50,000 or more three times a year to ensure that they are accurate and
that the funds are still needed.11 All unliquidated operating obligations,
regardless of dollar value, must be reviewed at least once a year.12 Also,
Congress specifically established in chapter 15 of title 31, United States
Code, a framework for reviewing, adjusting, certifying to, and reporting
on, among other items, the status and amounts of unliquidated
obligations.13 In addition, for many interagency obligations entered under
specific statutory authority, such as the Economy Act,14 the authorizing




7
 U.S. General Accounting Office, High Risk Series: An Update, GAO-01-263 (Washington,
D.C.: Jan. 1, 2001).
8
  Naval Audit Service, Obligations Associated Primarily with Indefinite Delivery
Contracts and Basic Ordering Agreements (Falls Church, Va.: February 18, 1999).
9
 Naval Audit Service, Validation of Selected Work Request Obligations in the Standard
Accounting and Reporting System (Washington, D.C.: Jan. 28, 2000).
10
 U.S. General Accounting Office, Department of Defense: Implications of Financial
Management Issues, GAO/T-AIMD/NSIAD-00-264 (Washington, D.C.: July 20, 2000).
11
   DOD FMR volume 3, chapter 8, section 080403 B. DOD first implemented this
requirement in May 1996 via a memorandum issued by the Office of the Under Secretary of
Defense to all military services, including the Navy. DOD formally added the requirement to
volume 3, chapter 8 of the FMR in November 2000.
12
     DOD FMR volume 3, chapter 8, section 080403 E.
13
  31 U.S.C., chapter 15, subchapter IV. 31 U.S.C. § 1554(b) specifically directs heads of
agencies to report to the President and the Secretary of the Treasury, and to certify to
those reports, regarding unliquidated obligations and other balances and adjustments.
Section 1554(c) directs agencies to establish controls to assure that an adequate review of
obligated balances is performed.
14
     31 U.S.C. § 1535.




Page 5                                                        GAO-03-275 Defense Budget
                        statute may mandate the deobligation of appropriations at specific times
                        or when certain conditions arise.15

                        The DOD regulation also directs the services to implement effective
                        internal controls to ensure that the required reviews are completed and
                        that identified corrective actions are completed in a timely manner.16
                        Further, the Federal Managers’ Financial Integrity Act of 198217 requires
                        that agencies’ controls reasonably ensure that (1) obligations and costs
                        comply with applicable law and (2) revenues and expenditures applicable
                        to agency operations are properly recorded and accounted for so that
                        agency accounts and reliable financial and statistical reports may be
                        prepared and the accountability of assets may be maintained.18


                        An estimated two-thirds of the Navy’s unliquidated operating obligations
Navy Did Not            valued at $50,000 or more from the fiscal years 1997-99 operating
Properly Account for    appropriations was not properly accounted for. Specifically, we estimated
                        that $929 million of the $1.4 billion in unliquidated operating obligations
Large Portion of        was not properly accounted for. As shown in table 1, $452 million of the
Unliquidated            unliquidated operating obligations was no longer needed for its original
                        purpose. These funds could have been used for other permissible purposes
Operating Obligations   of the same appropriation and fiscal year, such as contract modifications.
                        In addition, $477 million was not properly accounted for due to billing and
                        recording errors, including $147 million in problem disbursements and
                        $330 million in unresolved accounting and recording errors. Finally,
                        $489 million in unliquidated operating obligations was properly accounted
                        for and still needed for the original purpose.




                        15
                          Section 1535(d) of the Economy Act, for example, requires deobligation of funds at the
                        end of their period of availability if the performing agency has not performed or otherwise
                        made authorized contracts.
                        16
                             DOD FMR volume 3, chapter 8, section 080404.
                        17
                          P.L. 97-255, § 2, 96 Stat. 814, September 8, 1982 (codified at 31 U.S.C. § 3512(b) and (c)),
                        and is commonly called the Federal Managers’ Financial Integrity Act of 1982.
                        18
                             31 U.S.C. § 3512(c)(1).




                        Page 6                                                           GAO-03-275 Defense Budget
Table 1: Estimate of Navy’s Unliquidated Operating Obligations for Fiscal Years
1997-99, as of September 30, 2001

    Dollars in millions
    Category                                       Estimated total   Percentage of total
    Still needed for original purpose                        $489                    35
    Not properly accounted for:
     No longer needed for original purpose                     452                   32
     Problem disbursements                                     147                   10
     Unresolved errors                                         330                   23
    Subtotal not properly accounted for:                       929                   65
    Total                                                  $1,419a                  100
Source: DOD.
Note: GAO analysis of DOD data.
a
    Amounts do not add to total due to rounding.


The Navy failed to deobligate an estimated $452 million that was no longer
needed for the original obligated purpose. According to DOD regulations,
these unliquidated funds should have been deobligated once services had
been performed, final payment issued, and the funds made available for
other purposes consistent with the appropriation. In many of our sample
cases, the entire amount of an obligation was not required to meet billing
needs and resulted in funds remaining over. For example, in one of the
cases we reviewed, $4.7 million had been disbursed from a 1997
obligation, valued at $6 million, to support the San Diego Harbor Tug
Charter; however, the last disbursement was made in October 1999. We
discovered that the remaining unliquidated funds were no longer needed
and the Navy subsequently deobligated the unliquidated $1.3 million.
Similarly, we reviewed a 1996 (fiscal year 1997) obligation to fund systems
development at the Bureau of Naval Personnel. When the responsible
Navy fund manager reviewed the unliquidated obligation at our request, he
determined that the outstanding balance of $1.4 million attached to this
obligation was no longer required and deobligated it. In both of these
cases, if Navy personnel had reviewed these obligations in accordance
with DOD regulations, they would have detected the error and deobligated
the funds years ago, thereby possibly allowing Navy to use the funds for
other permissible purposes, including contract modifications, or other
obligation needs of the same appropriation and fiscal year.

The Navy had also not properly accounted for an estimated $147 million in
unliquidated operating obligations due to expenditures that were not
properly matched to a specific obligation recorded in the Navy’s records—
problem disbursements. We previously reported that the Navy’s financial


Page 7                                                       GAO-03-275 Defense Budget
control policy and procedures do not ensure that the Navy can match
payments to corresponding obligations before or at the time a payment is
made.19 Consequently, if the Navy cannot resolve these problem
disbursements by matching the disbursement to the original obligation, it
must record a new obligation to cover the disbursement after a payment is
made. For example, one of our sample items had an unliquidated
obligation balance of $1,362,790 on September 30, 2001. The fund manager
of this 1998 obligation stated that all of the funds had been disbursed;
however, the Navy’s Standard Accounting and Reporting System indicated
that no disbursements had been made. We discovered that in fact all of the
funds had been disbursed for this obligation, but the disbursements had
been posted to the wrong obligation in the accounting system. Funds that
remain unliquidated due to a problem disbursement may not be
deobligated and used for other purposes because the funds are still needed
to reimburse the obligation that was erroneously charged for the
disbursement.

The Navy had not properly accounted for an estimated $330 million due to
unresolved accounting and recording errors. These obligations remained
unliquidated for several reasons. Most unresolved errors in our sample
occurred because fund managers were unable to identify whether the
providers of goods or services had been paid in full for services rendered.
The fund managers claimed that providers were often slow to bill or had
not sent a final bill. For example, we reviewed a 1997 obligation for
aircraft maintenance that had an unliquidated balance of $14.4 million. The
fund managers said that they had not received a bill from the Air Force,
which provided the maintenance service. In this case, the $14.4 million
remained on the books as unresolved, because the fund managers still
expected to receive a bill for the services. An example of a recording error
is illustrated in a $12 million obligation to support alterations on the USS
LaSalle. A disbursement was input twice and then reversed twice instead
of once. The second reversal of the disbursement left an unliquidated
balance on the obligation that should have been disbursed. Funds that
remain unliquidated due to unresolved accounting and recording errors
cannot be deobligated and used for other purposes, because the Navy
needs to have funds available to pay providers after the errors have been
resolved.



19
  U.S. General Accounting Office, Financial Management: Problems in Accounting for
Navy Transactions Impair Funds Control and Financial Reporting, GAO/AIMD-99-19
(Washington, D.C.: Jan. 19, 1999).




Page 8                                                   GAO-03-275 Defense Budget
                     The Navy did not fully adhere to DOD regulations to review all
Navy Did Not Fully   unliquidated operating obligations, including those obligations valued at
Adhere to DOD        $50,000 or more three times per year and those obligations valued at less
                     than $50,000 once every year. Furthermore, the Navy did not utilize
Review Regulations   internal controls to determine the accuracy of the review process or the
                     outcomes of the reviews. As a result, the Navy did not know how much
                     money was tied up in unliquidated operating obligations that could
                     potentially be used for other permissible needs.

                     According to DOD regulations, obligation reviews are to be conducted by
                     fund managers within 14 days following the end of January, May, and
                     September. DOD regulations also require the services to implement
                     effective internal controls to ensure that the reviews are completed and
                     corrective actions are implemented in a timely manner. The purpose of
                     these reviews is to ensure that the unliquidated balances are accurate and
                     still needed. The Navy issued implementing guidance that (1) restates the
                     three deadlines provided in the DOD regulations, (2) requires that internal
                     controls be implemented by each entity as described in DOD regulations,
                     and (3) requires each fund manager to complete a checklist of the review
                     steps performed. For example, one required step is to follow up and
                     ensure the obligation is still needed. The guidance also requires the
                     comptroller of each major command to consolidate the review results
                     from the fund managers and include a list of all fund managers who did
                     not fully adhere to DOD regulations and the reason why. The major
                     command confirmation statement is to be forwarded to the Assistant
                     Secretary of the Navy (Financial Management and Comptroller), Office of
                     Budget.

                     Although DOD regulations require Navy fund managers to review all
                     operating obligations once annually and those $50,000 and above three
                     times each year, fund managers have not fully adhered. Fund managers
                     stated that they selectively reviewed some unliquidated operating
                     obligations, but were unable to make all the required reviews or complete
                     all the steps on some of the cases they reviewed. For example, fund
                     managers first prioritize for review the high-value unliquidated operating
                     obligations in the current fiscal year to accommodate immediate funding
                     requirements. That frees the funds for reobligation during the same fiscal
                     year. Unliquidated operating obligations that are approximately 5 years old
                     and, based on appropriations that will cancel at the end of the fiscal year,
                     are also a high priority for review in order to pay outstanding bills while
                     funds are available. As a result of prioritized and selective obligations
                     review, some operating obligations are not reviewed three times a year as
                     required by DOD regulations and some are not reviewed at all.


                     Page 9                                             GAO-03-275 Defense Budget
Navy fund managers provided several reasons why they selectively
reviewed obligations and did not review all of them. They stated that the
process of reviewing an obligation can be time-consuming due to a lack of
automated tools and, often, a lack of accurate billing information needed
to assess the validity of an obligation, especially for older obligations.
Officials acknowledged that the Navy’s Standard Accounting and
Reporting System provides users with the capability to conduct ad hoc
queries of the obligation database, but they claim these tools are not user-
friendly because users must be familiar with the system’s database-
programming code to take full advantage of its capabilities. Few of the
staff assigned to perform obligation reviews had the required computer
training or knowledge to write queries. Some of the fund managers also
told us that they were reluctant to review the large volume of low dollar
unliquidated operating obligations because they felt the expected rate of
return was not cost beneficial given the magnitude of resources required
to conduct the review. To illustrate the large volume, Atlantic Fleet
officials reported that they had 579,904 unliquidated operating obligations
valued $50,000 or less,20 and officials at the Pacific Fleet reported 724,266
such unliquidated operating obligations.21 Further, some fund managers
stated that it was impossible for them to comply with the requirement to
review all such unliquidated operating obligations even once a year,
because they did not have enough staff to review the large number of such
obligations.

Officials in the Navy Comptroller Office acknowledged that fund managers
have reported difficulties performing obligation reviews. Navy officials
also acknowledged that inaccurate obligation data compromises the
reliability of their financial statements, and therefore it is reasonable that
they review their obligations according to the regulations. Consequently,
the Navy has not sought relief from DOD obligation review regulations.

The Navy did not utilize internal control activities necessary to ensure that
fund managers performed thorough obligation reviews in accordance with
DOD regulations. Although some major commands had developed written
standard operating procedures or checklists to track whether fund
managers had reviewed their unliquidated operating obligations, they did
not hold managers accountable for the accuracy and completeness of the
reviews. Fund managers submitted obligation-review confirmation


20
     As of Mar. 10, 2002.
21
     As of June 14, 2002.




Page 10                                             GAO-03-275 Defense Budget
              statements to their major commands, but often the commands could not
              determine specific details about the obligations, including the number of
              unliquidated operating obligations reviewed, the amount of the obligations
              reviewed, and the resolution of any problems identified during the review.
              For example, one major command has a process to review whether fund
              managers submit the required obligation review paperwork. However, the
              command does not spot-check obligations to determine if they are valid as
              claimed by the fund managers and accepts the fund managers obligations
              review paperwork as is.

              Officials in the Navy Comptroller Office stated that fund managers should
              place more emphasis on reviewing obligations in accordance with DOD
              regulations. However, they did not think it would be productive to
              discipline fund managers for failure to adhere to the regulations. Rather,
              they believe that the Navy should rely on financial system upgrades to
              improve the accuracy of obligation data.


              As highlighted in our 2001 Performance and Accountability Series reports,
Conclusions   financial management is one of the major management challenges facing
              DOD.22 The large dollar value of unliquidated Navy obligations that were
              not properly accounted for contributes to inaccuracies in the Navy’s
              budget and financial reports, and subsequently leads to inaccuracies in
              federal financial statements and the President’s budget. Moreover, the
              Navy will not be able to pass the test of an independent financial audit
              until it corrects inaccurate obligation data.

              DOD regulations and Navy guidance provide for unliquidated obligations
              to be reviewed by fund managers on a regular basis. The fund managers’
              ability to deobligate or resolve the errors on many of our sample items
              demonstrates that the review process could be effective. But the fund
              managers have chosen to only selectively follow the requirements for
              review because they said they were constrained by too little time to review
              the large number of transactions, inaccurate billing information, and the
              lack of automated tools. Although the Navy recognized the potential
              benefits of timely identification of funds that are no longer needed or in
              error, its internal controls have not ensured that required reviews were
              made and corrective action taken. We note that fund managers were able



              22
                U.S. General Accounting Office, High Risk Series: An Update, GAO-01-263 (Washington,
              D.C.: Jan. 1, 2001).




              Page 11                                                   GAO-03-275 Defense Budget
                         to successfully resolve nearly all of the unliquidated operating obligations
                         in our sample even though the resolution of some of the obligations
                         required an extensive amount of time and effort. Therefore, it is likely that
                         many of the unliquidated obligations in our sample that were not properly
                         accounted for could have been identified and accounting errors could
                         have been corrected prior to our review had fund managers performed
                         obligation reviews in accordance with the DOD regulations.


                         We recommend that the Secretary of Defense direct the Secretary of Navy
Recommendations for      to:
Executive Action
                     •   adhere to DOD unliquidated operating obligation review regulations; and
                     •   better apply existing internal control activities to ensure adherence to
                         these regulations, and to hold fund managers accountable for the accuracy
                         and completeness of their reviews.

                         As you know, 31 U.S.C. requires the head of a federal agency to submit a
                         written statement of the actions taken on our recommendations to the
                         Senate Committee on Government Affairs and the House Committee on
                         Government Reform not later than 60 days after the dare of this report. A
                         written statement must also be sent to the House and Senate Committees
                         on Appropriations with the agency’s first request for appropriations made
                         more than 60 days after the date of this report.


                         The Director, Office of the Budget, Department of the Navy provided
Agency Comments          DOD’s written comments on a draft of this report, which are provided in
and Our Evaluation       their entirety in appendix II. The Navy partially concurred with our
                         recommendations and noted that more thorough efforts dedicated to the
                         review of obligations would increase the accuracy and reliability of
                         financial reports. It also plans to make the review process a part of its
                         management structure and stress the importance of accurate financial
                         statements. The Navy, however, commented that because numerous
                         factors contribute to problems in financial reports, it has to prioritize its
                         remedial efforts. Specifically, the Navy places a premium on reviewing
                         unliquidated obligations in available appropriations, correcting systemic
                         problems, and pursuing broad improvements in financial management. For
                         example, the Navy stated it made significant improvements in correcting
                         systemic issues—such as problem disbursements—and is working to
                         provide automated tools and correct systemic issues that would positively
                         impact the fund managers’ ability to conduct obligation reviews. While it
                         noted validating unliquidated obligations is desirable and important, the


                         Page 12                                             GAO-03-275 Defense Budget
Navy emphasized that systemic improvement of its financial information
offers the better opportunity for success.

The Navy did not agree that the difficulty the fund managers have had in
reviewing unliquidated obligations precluded the use of funds for other
appropriate needs. It noted that Congress has intentionally and
progressively limited the availability of funds from prior year
appropriations, clearly establishing that the appropriateness of use
outweighs the efficiency of use. When appropriate requirements for the
application of available funds from prior year appropriations have arisen,
the Navy commented that encumbrances for unliquidated obligations have
not been an impediment to obtaining necessary funds.

While we understand numerous factors, including systemic issues, affect
the accuracy of Navy financial reports, DOD regulations require that fund
managers annually review all unliquidated obligations and, as currently
written, do not provide for prioritization of such reviews. We recognize the
Navy has taken steps to significantly reduce the amount of outstanding
problem disbursements; however, as our report points out, problem
disbursements are only part of the reason for the significant amount of
unliquidated obligations. For example, about $782 million of the $929
million in unliquidated obligations in our sample were improperly
accounted for due to reasons unrelated to problem disbursements.
Specifically, the aggregate of these transactions involved funds that were
no longer needed for their original purpose or involved unresolved
accounting and recording errors. While we agree that focusing on systemic
issues offers opportunities to improve the Navy’s financial information, we
also note that the internal control procedures reflected in DOD’s
obligation review regulations are in fact designed to minimize systemic
problems such as problem disbursements. To the extent that the Navy’s
efforts to make systemic improvements include automated tools designed
to assist the fund managers in complying with obligation review
requirements, we believe these efforts represent a positive step.

We disagree with the Navy’s views regarding the impact of failing to
review all unliquidated obligations as required under current DOD
regulations. Regardless of whether the Navy is able to gain the funds
necessary from unliquidated obligations to satisfy appropriate
requirements as they arise, inaccurate obligation data in the Navy’s
financial system has broader implications, such as inaccurate financial
reports and misstatements of budgetary information on federal financial
statements and in the President’s budget. While we agree Congress has
placed statutory limitations on the availability of appropriated funds, DOD,


Page 13                                            GAO-03-275 Defense Budget
like all agencies, is responsible for effectively and efficiently implementing
its activities within the limitations applicable to the appropriations it
receives. Indeed, Congress specifically established in chapter 15 of title 31,
United States Code, a framework for reviewing, adjusting, certifying to,
and reporting on, among other items, the status and amounts of
unliquidated obligations.23 In addition, the Federal Managers’ Financial
Integrity Act of 198224 requires that agencies have controls to reasonably
ensure that revenues and expenditures applicable to agency operations are
recorded and accounted for properly so that accounts and reliable
financial and statistical reports may be prepared and accountability of
assets may be maintained.25 Finally, for many interagency obligations
entered under a specific statutory authority—such as the Economy Act26—
the authorizing statute may mandate the deobligation of appropriations at
specific times or when certain conditions arise.27 In this context, the ability
of the Navy to access funds encumbered by unliquidated obligations does
not relieve it of the responsibility to adhere to existing laws and
regulations governing sound financial management. We therefore are
making no changes to the recommendations in our report.


We are sending copies of this report to congressional committees with
jurisdiction over DOD’s budget and the Secretary of the Navy. We will also
make copies available to others upon request. In addition, the report will
be available at no charge on the GAO Web site at http://www.gao.gov.




23
  31 U.S.C., chapter 15, subchapter IV. 31 U.S.C. § 1554(b) specifically directs heads of
agencies to report to the President and the Secretary of the Treasury, and to certify to
those reports regarding unliquidated obligations and other balances and adjustments.
Section 1554(c) directs agencies to establish controls to assure that an adequate review of
obligated balances is performed.
24
  P.L. 97-255, § 2, 96 Stat. 814, September 8, 1982 (codified at 31 U.S.C. § 3512(b) and (c)),
and is commonly called the Federal Managers’ Financial Integrity Act of 1982.
25
     31 U.S.C. § 3512(c)(1).
26
     31 U.S.C. § 1535.
27
  Section 1535(d) of the Economy Act, for example, requires deobligation of funds at the
end of their period of availability if the performing agency has not performed or otherwise
made authorized contracts.




Page 14                                                          GAO-03-275 Defense Budget
If you or your staff have any questions about this report, please call me at
(202) 512-9619. Key contributors to this report are listed in appendix III.




Sharon Pickup
Director, Defense Capabilities and Management




Page 15                                             GAO-03-275 Defense Budget
             Appendix I: Scope and Methodology
Appendix I: Scope and Methodology


             Our objective was to determine whether the Navy’s unliquidated operating
             obligations were (1) properly accounted for and (2) periodically reviewed
             in accordance with DOD regulations.

             To determine whether Navy’s unliquidated operating obligations were
             properly accounted for, we requested that the Defense Finance
             Accounting Office provide us with a database that identified all
             unliquidated operating obligations outstanding on September 30, 2001. We
             relied on the completeness and accuracy of that database based on the
             office’s representations and did not independently test or reconcile the
             validity of their database. For our review, we selected unliquidated
             operating obligations for fiscal years 1997-99. Older obligations are more
             likely to be in error and thus provided a better test of the Navy’s obligation
             management practices. We then divided the individual unliquidated
             operating obligations into two groups—those valued at less than $50,000
             and those valued at $50,000 or more. Those valued at $50,000 or more
             represented $1.4 billion, or 67 percent of the value of all outstanding
             operating obligations for fiscal years 1997-99.

             From the population of obligations valued at $50,000 or more, we drew a
             stratified random sample of 205 unliquidated operating obligations to
             review. For each transaction, we obtained the following documentation:
             (1) documentary support describing each obligation, including
             amendments and modifications for each sample transaction; (2) responses
             from Navy officials regarding whether each unliquidated operating
             obligation in our sample was still needed for its original purpose according
             to the criteria in the DOD Financial Management Regulation1 (FMR); and
             (3) support for how to classify each unliquidated operating obligation in
             our sample as still needed, no-longer-needed, problem disbursement, or an
             unresolved accounting and recording error.

             The sample was selected from three strata defined by the dollar value of
             the obligations, as shown in table 3.




             1
                 DOD FMR volume 3, chapter 8, section 080303 A.




             Page 16                                              GAO-03-275 Defense Budget
Appendix I: Scope and Methodology




Table 2: Dollar Value Distribution of Fiscal Year 1997-99 Obligations Reviewed in
the GAO Sample, as of September 30, 2001

Strata                                       Number of items           Total value
Over $10,000,000                                            5      $240,382,914.38
$500,000 to $10,000,000                                   100       113,190,918.46
$50,000 to $499,999                                       100        14,571,125.75
Total                                                     205      $368,144,958.59
Source: DOD.
Note: GAO analysis of DOD data.


To determine whether the amount of each unliquidated operating
obligation was properly accounted for, we reviewed support provided by
the Navy, discussed the status of the unliquidated obligation with the
primary Navy official responsible for the individual transaction, and used
the criteria set forth in DOD’s regulations. We classified unliquidated
operating obligation transactions as “still needed” and properly accounted
for when the Navy provided documentation to support that the contracted
goods or services were still needed; thus, the transaction passed a bona
fide needs test. Items not properly accounted for fell into three categories.
We classified the transaction “no longer needed for original purposes”
when the Navy could not provide support that a bona fide need existed.
We classified transactions as “problem disbursements” when specific
disbursements were not properly matched to corresponding obligations
recorded in the department’s records. We classified the remaining
unliquidated operating obligation transactions as “unresolved accounting
and recording errors” when they did not clearly meet the criteria for
needed, no-longer-needed, or problem disbursements.

To determine if the Navy’s unliquidated operating obligations were
periodically reviewed in accordance with DOD regulations, we requested
that the Navy provide documentation and guidance on the Navy’s
implementation of the regulations. We also interviewed officials at
12 locations to discuss (1) their procedures for performing obligation
reviews, (2) the magnitude of transactions involved to perform the review
as set forth in the DOD obligation review regulations, and (3) whether the
officials had difficulty meeting the obligation review requirements,
including the reasons why. We visited the Commander in Chief of the
Atlantic Fleet in Norfolk, Va.; the Commander, Navy Mid-Atlantic Region
in Norfolk, Va.; the Commander, Naval Sea Systems Command in
Washington, D.C.; the Naval Facilities Engineering Command in
Washington, D.C.; the Director of Strategic Systems Programs in
Washington, D.C.; the Commander in Chief of the Pacific Fleet in Pearl



Page 17                                                  GAO-03-275 Defense Budget
Appendix I: Scope and Methodology




Harbor, Hawaii; the Commander, Naval Region in Pearl Harbor, Hawaii;
the Commander, Naval Air Force Command of the Pacific Fleet in San
Diego, Calif.; the Commander, Naval Surface Force Command of the
Pacific Fleet in San Diego, Calif.; the Space and Naval Warfare Systems
Command in San Diego, Calif.; the Commander, Naval Air Systems
Command in Patuxent River, Md.; and the Bureau of Medicine and Surgery
in Washington, D.C.

We conducted our review from October 2001 through October 2002 in
accordance with generally accepted government auditing standards.




Page 18                                         GAO-03-275 Defense Budget
             Appendix II: Agency Comments
Appendix II: Agency Comments




             Page 19                        GAO-03-275 Defense Budget
Appendix II: Agency Comments




Page 20                        GAO-03-275 Defense Budget
                  Appendix III: GAO Contacts and Staff
Appendix III: GAO Contacts and Staff
                  Acknowledgments



Acknowledgments

                  Sharon Pickup (202) 512-9619
GAO Contacts      Gary L. Billen (214) 777-5703


                  In addition to the individuals named above, Lori Adams, Linda Garrison,
Staff             Gregory Kutz, Steve L. Pruitt, Rhonda P. Rose, and R.K. Wild made key
Acknowledgments   contributions to this report.




(350126)
                               Page 21                                         GAO-03-275 Defense Bud
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