oversight

Navy Working Capital Fund: Backlog of Funded Work at the Space and Naval Warfare Systems Command Was Consistently Understated

Published by the Government Accountability Office on 2003-07-01.

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

             United States General Accounting Office

GAO          Report to the Chairman, Subcommittee
             on Defense, Committee on
             Appropriations, House of
             Representatives

July 2003
             NAVY WORKING
             CAPITAL FUND
             Backlog of Funded
             Work at the Space and
             Naval Warfare
             Systems Command
             Was Consistently
             Understated




GAO-03-668
             a
                                               July 2003


                                               NAVY WORKING CAPITAL FUND

                                               Backlog of Funded Work at the Space
Highlights of GAO-03-668, a report to the
Chairman, Subcommittee on Defense,
                                               and Naval Warfare Systems Command
Committee on Appropriations, House of
Representatives
                                               Was Consistently Understated



The Space and Naval Warfare                    The budgeted and reported actual amounts of SPAWAR gross carryover
Systems Command (SPAWAR) has                   were consistently understated, resulting in the Congress and DOD decision
hundreds of millions of dollars of             makers not having reliable information to decide on funding levels for
funded work that its working                   working capital fund customers. First, GAO found that SPAWAR centers’
capital fund activities did not                budgeted gross carryover for fiscal years 1998 through 2002 was significantly
complete before the end of the
fiscal year. Reducing the amount
                                               less than the reported actual year-end gross carryover.
of workload carryover at fiscal
year-end is a key factor in the                SPAWAR Systems Centers’ Budgeted and Reported Actual Gross Workload Carryover
effective management of                         Dollars in millions
Department of Defense (DOD)                                                                   Budgeted       Actual            Actual exceeds
resources and in minimizing the                 Fiscal year                                   carryover   carryover         budgeted carryover
“banking” of funds for work to be               1998                                              $377         $530                         $153
performed in subsequent years.                  1999                                               332          563                          231
GAO was asked to analyze                        2000                                               358          613                          255
SPAWAR’s carryover balances.                    2001                                               567          875                          308
GAO assessed the accuracy of the                2002                                               610          896                          286
budgeted amounts, the accuracy of
                                               Sources: Navy budget and accounting reports.
the reported actual carryover
balance, and the reliability of                Note: Gross carryover is the dollar value of work that has been ordered and funded (obligated) by
underlying financial data on which             customers but not completed by working capital fund activities at the end of the fiscal year.
reported actual carryover is based.            Budgeted gross carryover was understated primarily due to problems with
                                               estimating the underlying customer order data. For example, for fiscal year
                                               2002, SPAWAR’s budgeted amount for customer orders was 88 percent less
GAO is making several                          than the reported actual orders received.
recommendations aimed at
improving the accuracy and                     Second, SPAWAR’s reported actual carryover balances were also unreliable
reliability of SPAWAR’s and other              and adjusted downward by hundreds of millions of dollars. These
working capital fund activities’               adjustments understated carryover and resulted in Navy reports to the
budgeted and reported actual year-             Congress showing that SPAWAR carryover balances for fiscal years 1998
end carryover amounts. GAO is                  through 2002 did not exceed DOD’s 3-month carryover standard. SPAWAR
also making recommendations to                 was able to report reduced carryover balances for the following reasons.
improve SPAWAR’s tri-annual                    •   As GAO previously reported, the DOD guidance for calculating the
review process so that these                       number of months of carryover allowed carryover to be adjusted and
reviews can serve to verify the
                                                   understated. DOD agreed with GAO’s previous recommendation and in
reliability of underlying financial
data. DOD concurred with 12 of                     December 2002 changed its carryover guidance.
the 14 recommendations and                     •   SPAWAR centers used accounting entries to manipulate the amount of
partially concurred with 2. For                    customer orders for the sole purpose of reducing reported carryover
these 2 recommendations, DOD                       below the 3-month standard. For example, the centers did this for at
agreed with GAO’s intent to ensure                 least $50 million at the end of fiscal year 2001. SPAWAR officials issued
that obligated and unobligated                     guidance in September 2002 discontinuing this practice.
balances are reviewed regularly to
ensure effective use of funds.                 Finally, SPAWAR had not taken key steps to verify the underlying financial
                                               data on which reported actual carryover is based. The SPAWAR centers had
www.gao.gov/cgi-bin/getrpt?GAO-03-668.
                                               only recently begun conducting the required tri-annual reviews of such data,
To view the full report, including the scope   which DOD has required since 1996. However, the reviews were ineffective,
and methodology, click on the link above.      including the exclusion of slightly less than half of their reported actual
For more information, contact Gregory D.
Kutz at (202) 512-9505 or kutzg@gao.gov.       carryover from the review process.
Contents



Letter                                                                                                                  1
                             Results in Brief                                                                           2
                             Background                                                                                 6
                             Gross Carryover Budget Estimates Were Consistently and
                               Substantially Understated                                                                8
                             Reported Actual Carryover Balances Were Consistently Understated
                                                                                                                    12
                             Reported Actual Carryover Is Based on Unreliable Underlying
                               Financial Data                                                                       18
                             Conclusions                                                                            29
                             Recommendations for Executive Action                                                   29
                             Agency Comments and Our Evaluation                                                     31


Appendixes
              Appendix I:    Scope and Methodology                                                                  35
             Appendix II:    Comments from the Department of Defense                                                37
                             GAO Comments                                                                           42
             Appendix III:   GAO Contact and Staff Acknowledgments                                                  43


Tables                       Table 1: SPAWAR Systems Centers’ Budgeted and Reported Actual
                                      Gross Carryover from Fiscal Year 1998 through Fiscal Year
                                      2002                                                                              9
                             Table 2: SPAWAR Systems Centers’ Budgeted and Reported Actual
                                      Orders Received from Customers for Fiscal Year 1998
                                      through Fiscal Year 2002                                                      10
                             Table 3: SPAWAR Systems Centers’ Reported Actual Gross
                                      Carryover before and after Adjustments for Fiscal Years
                                      1998 through 2002                                                             15


Figure                       Figure 1: DOD Carryover Computation Based on the Fiscal Year
                                       2002 Budget                                                                  14




                              This is a work of the U.S. government and is not subject to copyright protection in the
                              United States. It may be reproduced and distributed in its entirety without further
                              permission from GAO. However, because this work may contain copyrighted images or
                              other material, permission from the copyright holder may be necessary if you wish to
                              reproduce this material separately.




                             Page i                                             GAO-03-668 Navy Working Capital Fund
A
United States General Accounting Office
Washington, D.C. 20548



                                    July 1, 2003                                                                                  Lert




                                    The Honorable Jerry Lewis
                                    Chairman, Subcommittee on Defense
                                    Committee on Appropriations
                                    House of Representatives

                                    Dear Mr. Chairman:

                                    This is the third in a planned series of reports that discusses the Defense
                                    Working Capital Fund fiscal year-end workload funding issue, generally
                                    referred to as “carryover.” Section 1051 of the Floyd D. Spence National
                                    Defense Authorization Act For Fiscal Year 20011 required that we review
                                    various aspects of the Department of Defense (DOD) policy that allowed
                                    Defense Working Capital Fund activities to carry over a 3-month level of
                                    work2 to ensure continuity of operations from one fiscal year to the next.
                                    Excessive amounts of carryover3 financed with customer appropriations
                                    may indicate excessive or unneeded funds and are subject to reductions by
                                    DOD and the congressional defense committees during the budget review
                                    process. To the extent that carryover is high, the Congress may redirect the
                                    funds gained from such reductions to other priority initiatives.

                                    In May 2001, we reported4 that (1) DOD did not have a sound analytical
                                    basis for its 3-month carryover standard, (2) military services used
                                    different methods to calculate the number of months of carryover, and
                                    (3) some activity groups underestimated their budgeted carryover year
                                    after year, thereby providing decision makers with misleading year-end
                                    carryover information resulting in more funding being provided than was




                                    1
                                      Floyd D. Spence National Defense Authorization Act For Fiscal Year 2001, Pub. L. No. 106-
                                    398, Section 1051, 114 Stat. 1654, 1654A-264 (2000).
                                    2
                                      DOD changed this policy in December 2002 by revising its methodology for calculating the
                                    allowable amount of carryover. Under the revised method, DOD eliminated the 3-month
                                    standard, and the allowable amount of carryover is to be based on the overall disbursement
                                    rate of the customers’ appropriations financing the work.
                                    3
                                      The carryover amount includes work for which customers have recorded obligations but
                                    the work has not yet started and the cost to complete work that has been started.
                                    4
                                      U.S. General Accounting Office, Defense Working Capital Fund: Improvements Needed
                                    for Managing the Backlog of Funded Work, GAO-01-559 (Washington, D.C.: May 30, 2001).




                                    Page 1                                             GAO-03-668 Navy Working Capital Fund
                   intended. In June 2002, we reported5 on our review of the contract portion
                   of the Air Force depot maintenance activity group. We found that the Air
                   Force reported carryover balances were not reliable due to (1) faulty
                   assumptions used in calculating work-in-process and (2) records not
                   accurately reflecting work that was actually completed by fiscal year-end.

                   As requested and agreed to with your office, this report assesses carryover
                   related to the Navy’s Space and Naval Warfare Systems Command
                   (SPAWAR) systems centers located at Charleston, South Carolina and San
                   Diego, California. The SPAWAR systems centers have hundreds of millions
                   of dollars of carryover and the carryover balance has been steadily
                   increasing over the last 5 years. Our objectives were to determine if
                   (1) differences existed between the budgeted and reported actual gross6
                   carryover and, if so, the reasons for the variances, (2) the reported actual
                   carryover balances accurately reflected the amount of work that remained
                   to be accomplished, and (3) the SPAWAR systems centers had reliable
                   underlying financial information to serve as the basis for reported actual
                   carryover. Our review was performed from July 2002 through June 2003 in
                   accordance with U.S. generally accepted government auditing standards.
                   However, we did not fully validate the accuracy of the accounting and
                   budgeting data referred to in this report, all of which were provided by the
                   Navy. Further details on our scope and methodology can be found in
                   appendix I. We requested comments on a draft of this report from the
                   Secretary of Defense or his designee. Written comments from the Under
                   Secretary of Defense (Comptroller) are reprinted in appendix II.



Results in Brief   We found that the budgeted and reported actual amounts of gross
                   carryover were consistently understated, resulting in the Congress and
                   DOD decision makers not having carryover information they need to make
                   decisions regarding the level of funding to be provided to working capital
                   fund customers. For fiscal years 1998 through 2002, SPAWAR systems
                   centers reported that actual gross year-end carryover was substantially
                   greater than their budgeted gross carryover. For example, for fiscal year

                   5
                     U.S. General Accounting Office, Air Force Depot Maintenance: Management
                   Improvements Needed for Backlog of Funded Contract Maintenance Work, GAO-02-623
                   (Washington, D.C.: June 20, 2002).
                   6
                     Gross carryover is the dollar value of work that has been ordered and funded (obligated)
                   by customers but not completed by working capital fund activities at the end of the fiscal
                   year.




                   Page 2                                              GAO-03-668 Navy Working Capital Fund
2002, the Navy budget request estimated that the SPAWAR systems centers
would have about $610 million in gross carryover, but the Navy
subsequently reported that the centers actually had about $896 million—a
difference of $286 million, or 47 percent.

The budget requests substantially underestimated gross carryover because
the Navy also underestimated the dollar value of orders that the SPAWAR
systems centers would receive from customers by hundreds of millions of
dollars from fiscal years 1998 through 2002. For example, for fiscal year
2002, in formulating its budget request the Navy expected the SPAWAR
systems centers to receive about $1.3 billion in customer orders, but the
Navy reported that the centers actually received about $2.4 billion in
customer orders—a difference of $1.1 billion, or 88 percent. The Navy
underestimated customer orders from fiscal years 1998 through 2002 for
the following reasons.

• The customers had consistently underestimated the amount of orders
  being placed with the SPAWAR systems centers.

• Orders received from certain Navy customers, called third-party
  customers, were not included in SPAWAR’s budget.

• The Naval Computers and Telecommunications Command merged with
  SPAWAR systems centers, resulting in about $125 million of additional
  orders being received in fiscal year 2001 than were reflected in the
  systems centers’ fiscal year 2001 budget request.

• The Navy changed its policy on performing work on certain types of
  orders placed with the San Diego Systems Center, resulting in more
  work being performed in the working capital fund than envisioned in the
  original budget estimates for fiscal years 2001 and 2002.

• The SPAWAR systems centers received about $167 million in orders
  financed with a supplemental appropriation in fiscal year 2002 that was
  not reflected in the budget.

In addition, we found that the systems centers’ reported actual carryover
balances were unreliable and adjusted downward by hundreds of millions
of dollars because (1) DOD’s guidance for calculating the number of
months of carryover allowed these adjustments and (2) the systems centers
manipulated customer work orders at year-end to reduce reported
carryover.



Page 3                                   GAO-03-668 Navy Working Capital Fund
• In May 2001, we reported7 that DOD’s guidance was not clear regarding
  the treatment of contractual obligations in calculating carryover. The
  number of months of carryover is a ratio of the dollar value of
  unfinished orders (numerator) at year-end to revenue earned for that
  fiscal year (denominator). Since DOD’s guidance was unclear, the Navy
  reduced the dollar value of unfinished orders in the numerator related to
  contractual obligations but did not reduce revenue in the denominator
  by the amount of revenue earned from customers for contractual
  services. As a result of this practice and another discussed below, from
  fiscal years 1998 through 2002, the Navy was able to reduce SPAWAR’s
  carryover balances below the 3-month standard. In May 2001, we also
  reported that the months of carryover reported by Navy activity groups,
  which include the SPAWAR systems centers, would more accurately
  reflect the actual backlog of in-house work if adjustments for contract
  obligations affected both contract carryover and contract revenue. The
  Office of the Under Secretary of Defense (Comptroller) agreed with our
  May 2001 report. DOD revised its carryover policy in December 2002,
  and the policy became effective with the fiscal year 2004 budget
  submission. Under the revised method, DOD eliminated the 3-month
  standard, and the allowable amount of carryover is to be based on the
  overall disbursement rate of the customers’ appropriations financing the
  work. This policy, if implemented as designed, would eliminate the
  contractual obligation and related revenue problem discussed above.
  DOD is in the process of developing written procedures for
  implementing the new policy.

• We found that the two systems centers manipulated their reported
  carryover by making accounting entries at fiscal year-end that shifted
  reimbursable work (working capital fund) to direct cite work (direct
  appropriation) for the sole purpose of reducing reported carryover
  below the 3-month standard.8 This practice resulted in the Navy
  providing misleading carryover information to the Congress and DOD.
  For example, the systems centers made these accounting entries at
  fiscal year-end 2000 for at least $38 million and at fiscal year-end 2001
  for at least $50 million. SPAWAR officials told us that this has been a
  long-standing practice to reduce reported carryover below the 3-month

7
    GAO-01-559.
8
  Reimbursable work is work performed for the customer by the systems centers for which
the customer pays the systems centers directly. Direct cite work is work performed for the
customer by a private sector contractor, which bills the customer directly.




Page 4                                             GAO-03-668 Navy Working Capital Fund
   standard. After we discussed this with SPAWAR officials, guidance was
   issued discontinuing this practice beginning in fiscal year 2002.

Furthermore, the actual carryover data that the two SPAWAR systems
centers reported were based on unreliable underlying financial data, in
part, because the two centers had not fully complied with DOD’s May 1996
guidance that requires them, and all other DOD fund holders, to conduct
tri-annual reviews of commitments, obligations, and accrued expenditures
to ensure the accuracy and timeliness of financial transactions.
Specifically, our work showed that the two systems centers (1) did not
begin conducting their reviews until September 2001 and September
2002—at least 5 years after the establishment of the DOD requirement,
(2) excluded about 46 percent of their September 2002 reported actual
carryover from their tri-annual reviews, (3) did not effectively review
dormant obligations (obligations with balances that have not changed for
more than 120 days) and, therefore, returned unneeded funds to customers
after the funds had expired, and (4) were not effectively reviewing accrued
expenditure data (accrued expenditures reduce carryover). We also found
that neither SPAWAR headquarters nor the two systems centers’
commanders had developed effective policies and procedures for ensuring
that tri-annual reviews are conducted in accordance with DOD guidance
and that timely and appropriate corrective action is taken on problems that
are identified during the reviews.

We are making recommendations to the Secretary of Defense to
(1) improve the reliability of reported carryover amounts to decision
makers and (2) issue procedures for DOD’s new carryover policy. We are
also making a recommendation to the Secretary of the Navy to improve the
management and reporting of budgeted and actual carryover by comparing
budgeted orders to actual orders received from customers, and to consider
these trends in developing the budget estimates on orders to be received
from customers. We are also making recommendations to the
Commanders of SPAWAR and one of the systems centers that are aimed at
improving the effectiveness of their tri-annual reviews. In its comments on
a draft of this report, DOD concurred with 12 of our 14 recommendations
and partially concurred with the remaining 2 recommendations. For these
2 recommendations, DOD agreed with our intent to ensure that obligations,
unobligated balances, and commitments are reviewed regularly to ensure
effective use of funds. To that end, DOD said it would review its guidance
to ensure clarity of intent.




Page 5                                    GAO-03-668 Navy Working Capital Fund
Background                   According to the Navy’s fiscal year 2003 budget, the Navy Working Capital
                             Fund will earn about $20.8 billion in revenue during fiscal year 2003. The
                             Navy Working Capital Fund consists of the following six major activity
                             groups: depot maintenance, transportation, base support, information
                             services, supply management, and research and development. The Navy
                             estimates that the research and development activity group will earn about
                             $7.7 billion during fiscal year 2003, the largest activity group in terms of the
                             dollar amount of revenue earned. This activity group includes the
                             following subactivity groups: (1) the Naval Surface Warfare Center, (2) the
                             Naval Air Warfare Center, (3) the Naval Undersea Warfare Center, (4) the
                             Naval Research Laboratory, and (5) the Space and Naval Warfare Systems
                             Centers.

                             The SPAWAR systems centers are the Navy’s full-spectrum research,
                             development, test and evaluation, engineering, and fleet support centers
                             for command, control, and communication systems and ocean surveillance
                             and the integration of those systems. The systems centers (1) support the
                             fleet in mission and capability by providing capable and ready command
                             and control systems for the Navy and (2) provide the innovative scientific
                             and technical expertise and facilities necessary to ensure that the Navy can
                             develop, acquire, and maintain the warfare systems needed to meet
                             requirements. The SPAWAR systems centers’ primary locations are in San
                             Diego, California and Charleston, South Carolina.



Description of the Working   As part of the Navy Working Capital Fund, the SPAWAR systems centers
Capital Fund Process of      rely on sales revenue rather than direct congressional appropriations to
                             finance their operations. DOD policy requires working capital fund activity
Setting Prices and
                             groups to (1) establish prices that allow them to recover their expected
Obligating Customer Funds    costs from their customers and (2) operate on a break-even basis over
                             time—that is, not make a profit nor incur a loss. DOD policy also requires
                             the activity groups to establish their sales prices prior to the start of each
                             fiscal year and to apply these predetermined or “stabilized” prices to most
                             orders received from customers during the year—regardless of when the
                             work is actually accomplished or what costs are actually incurred.

                             Customers use appropriated funds to finance the orders placed with the
                             SPAWAR systems centers. When a systems center accepts the customer
                             order, its own obligational authority is increased and the customer’s
                             appropriation is obligated by the amount of the order. The working capital




                             Page 6                                       GAO-03-668 Navy Working Capital Fund
                            fund activity incurs obligations for costs, such as material and labor, to
                            perform the work.

                            In addition to receiving orders from customers to do work as part of the
                            working capital fund, SPAWAR systems centers also award hundreds of
                            millions of dollars in contracts with the private sector for work to be
                            performed for the centers’ customers. These contracts and related work
                            are not included in the working capital fund from a financial standpoint
                            because the contractors directly bill the customers for work performed and
                            the customers directly pay the contractors. DOD and the Navy refer to this
                            process of awarding contracts for customers as direct cite orders, since the
                            SPAWAR systems centers cite the customers’ appropriation(s) on the
                            contracts. The customers’ funds are obligated when the systems centers
                            award the contracts with contractors.9



What Is Carryover and Why   Carryover is the dollar value of work that has been ordered and funded
Is It Important?            (obligated) by customers but not yet completed by working capital fund
                            activities at the end of the fiscal year.10 Carryover consists of both the
                            unfinished portion of work started but not yet completed, as well as
                            requested work that has not yet commenced. To manage carryover, DOD
                            converted the dollar amount of carryover to equivalent months of work.
                            This was done to put the magnitude of the carryover in proper perspective.
                            For example, if an activity group performs $100 million of work in a year
                            and had $100 million in carryover at year-end, it would have 12 months of
                            carryover. However, if another activity group performs $400 million of
                            work in a year and had $100 million in carryover at year-end, this group
                            would have 3 months of carryover.


                            9
                              The systems centers charge customers a fee for awarding and administering these
                            contracts.
                            10
                               The two basic types of orders customers can place with a working capital fund activity are
                            Project Orders and Economy Act orders, which are issued under the authority of Section 23
                            of Title 41, United States Code, and Section 1535 of Title 31, United States Code,
                            respectively. These two types of orders are distinguished for accounting purposes by the
                            period of time that the related funding is available for use by a working capital fund. For
                            example, an Economy Act order funded by the Navy Operation and Maintenance
                            appropriation that is not used (obligated) by the working capital fund activity by the end of
                            the fiscal year is no longer available for new obligations and must be returned to the
                            customer, absent some specific statutory authorization. However, the same appropriated
                            funds used to finance a Project Order may be used (or “carried over”) by the working capital
                            fund activity to enter into new obligations in the next fiscal year.




                            Page 7                                               GAO-03-668 Navy Working Capital Fund
                        The congressional defense committees and DOD have acknowledged that
                        some carryover is necessary at fiscal year-end if working capital funds are
                        to operate efficiently and effectively. In 1996, DOD established a 3-month
                        carryover standard for all the working capital fund activities except for the
                        contract portion of the Air Force depot maintenance activity group.11 In
                        May 2001, we reported12 that DOD did not have a basis for its carryover
                        standard and recommended that DOD determine the appropriate carryover
                        standard for the depot maintenance, ordnance, and research and
                        development activity groups. Based on our recommendation, in December
                        2002, DOD revised its carryover policy for working capital fund activities.
                        Under the revised method, DOD eliminated the 3-month standard, and the
                        allowable amount of carryover is to be based on the overall disbursement
                        rate of the customers’ appropriations financing the work. Too little
                        carryover could result in some activity groups not having work to perform
                        at the beginning of the fiscal year, resulting in the inefficient use of
                        personnel. On the other hand, too much carryover could result in an
                        activity group receiving funds from customers in one fiscal year but not
                        performing the work until well into the next fiscal year or subsequent
                        years. By minimizing the amount of the carryover, DOD can use its
                        resources most effectively and minimize the “banking” of funds for work
                        and programs to be performed in subsequent years.



Gross Carryover         For fiscal years 1998 through 2002, SPAWAR systems centers’ budgeted
                        gross carryover was significantly less than reported actual gross carryover,
Budget Estimates Were   thereby providing decision makers, including the Office of the Under
Consistently and        Secretary of Defense (Comptroller) and congressional defense committees,
                        misleading carryover information.13 These decision makers use carryover
Substantially           information to determine whether the SPAWAR systems centers have too
Understated             much carryover. If the systems centers have too much carryover, the
                        decision makers may reduce the customers’ budgets and use these
                        resources for other purposes. For example, during its review of the fiscal


                        11
                          The Air Force is the only military service that includes its contract depot maintenance
                        operation in its working capital fund. To reflect this difference, DOD established a 4.5-
                        month carryover standard to account for the additional administrative functions associated
                        with awarding contracts. The Air Force is currently in the process of taking its contract
                        depot maintenance operation out of the working capital fund.
                        12
                             GAO-01-559.
                        13
                             We previously reported on this issue in May 2001 in our report GAO-01-559.




                        Page 8                                                GAO-03-668 Navy Working Capital Fund
                            year 2003 budget, the Office of the Under Secretary of Defense
                            (Comptroller) noted that the Navy research and development activities
                            carryover had been steadily increasing from about $2.2 billion in fiscal year
                            1997 to about $3.4 billion in fiscal year 2003. Since a significant portion of
                            the carryover was related to work that was to be contracted out, the Office
                            of the Under Secretary of Defense (Comptroller) reduced the customer
                            funding by $161.1 million because these efforts could be funded in fiscal
                            year 2004 with no impact on performance.



Customers’ Underestimated   SPAWAR systems centers’ reported actual year-end gross carryover was
Budgeted Orders Caused      substantially greater than their budgeted gross carryover. Table 1 shows
                            that from fiscal year 1998 through fiscal year 2002 reported actual gross
Understated Budgeted
                            carryover exceeded budgeted gross carryover, and the difference has
Gross Carryover             increased from about $153 million to about $286 million.



                            Table 1: SPAWAR Systems Centers’ Budgeted and Reported Actual Gross Carryover
                            from Fiscal Year 1998 through Fiscal Year 2002

                            Dollars in millions
                                                                Budgeted gross        Actual gross            Actual exceeds
                            Fiscal year                             carryovera          carryovera         budgeted carryover
                            1998                                           $377                 $530                        $153
                            1999                                            332                  563                        231
                            2000                                            358                  613                        255
                            2001                                            567                  875                        308
                            2002                                            610                  896                        286
                            Sources: Navy budget and accounting reports.
                            a
                             Gross carryover is the dollar value of work that has been ordered and funded (obligated) by
                            customers but not completed by working capital fund activities at the end of the fiscal year.


                            The Navy’s budget requests consistently underestimated SPAWAR systems
                            centers’ gross carryover, in part, because the Navy consistently
                            underestimated the amount of orders to be received from customers by
                            hundreds of millions of dollars. Table 2 shows that the amount of
                            difference between budgeted and reported actual orders increased from
                            about $352 million (39 percent) in fiscal year 1998 to about $1.1 billion (88
                            percent) in fiscal year 2002. Since orders received from customers are the
                            major source of funds for SPAWAR and one of the key factors in
                            determining the amount of carryover at fiscal year-end, it is critical that the



                            Page 9                                                    GAO-03-668 Navy Working Capital Fund
Navy has accurate budget estimates on the amount of orders to be received
from customers. However, for fiscal years 2000, 2001, and 2002 actual
orders exceeded budgeted orders by at least 68 percent each year.



Table 2: SPAWAR Systems Centers’ Budgeted and Reported Actual Orders Received
from Customers for Fiscal Year 1998 through Fiscal Year 2002

Dollars in millions
                          Fiscal year          Fiscal year   Fiscal year   Fiscal year   Fiscal year
                               1998a                1999a         2000a          2001          2002
Budgeted                         $ 912              $ 913         $ 890        $1,226        $1,259
Actual                            1,263             1,243         1,533         2,055         2,363
Difference                           352              329           644           829         1,104
Percentage
difference                             39              36            72            68            88
Sources: Navy budget and accounting reports.
a
Figures do not add due to rounding.


The data in table 2 indicate that the SPAWAR systems centers’ customers
have not accurately estimated the amount of orders they will place with the
systems centers. Customers determine and justify their anticipated
requirements for goods and services and the levels of performance they
require from the systems centers to fulfill mission objectives. Our analysis
of budget and accounting reports that provide information on customer
orders shows that orders financed with three appropriations made up a
large part of the differences in fiscal years 2000, 2001, and 2002. The
appropriations used by customers to finance 49 percent to 67 percent of the
differences for these 3 fiscal years were the

• Other Procurement, Navy appropriation;

• Research, Development, Test, and Evaluation, Defense appropriation;
  and

• Research, Development, Test, and Evaluation, Navy appropriation.




Page 10                                                        GAO-03-668 Navy Working Capital Fund
Reasons for Variances     Officials from the Charleston and San Diego Systems Centers and SPAWAR
between Budgeted and      headquarters stated, and our work found, that customers have historically
                          understated their budget estimates on customer orders that are received by
Reported Actual Gross     the SPAWAR working capital fund. They stated that the systems centers’
Carryover and Orders      budgets for orders are based on what the customers tell them their
Received from Customers   requirements would be for a particular fiscal year. However, they also told
                          us that customers are hesitant to make a full commitment to the estimated
                          amount of work that will need to be performed.

                          SPAWAR and Navy headquarters budget officials acknowledged that the
                          SPAWAR systems centers’ budgets have consistently understated gross
                          carryover and orders received from customers (claimants). They also
                          stated that the dollar amount of orders that the systems centers receive
                          from customers must match the dollar amount of orders that customers
                          submit in their appropriated fund budgets. Customers only record in their
                          budgets those orders that they will be sending directly to the systems
                          centers. If a customer initially allocates budgeted funds to an activity not
                          related to the working capital fund—which is a third party—and the third
                          party places the order with a SPAWAR systems center, the customer’s
                          budget reflects that these funds went to a third party. This results in the
                          amount of budgeted orders that the systems centers receive from
                          customers being understated. Navy headquarters officials stated that this
                          is not an easy problem to resolve because there are many customers and no
                          one person or office is responsible for fixing the problem and it is hard to
                          pinpoint which customers are not budgeting correctly.

                          Navy headquarters budgeting officials also stated that the fiscal year 2001
                          and 2002 budgets further understated gross carryover and orders for the
                          following three reasons. First, the Naval Computers and
                          Telecommunications Command merged with SPAWAR, which resulted in
                          about $125 million of additional orders being received in fiscal year 2001
                          than was reflected in SPAWAR systems centers’ budget. Second, the Navy
                          changed its policy on work performed on certain types of work orders
                          placed with the San Diego Systems Center. As a result, customers placed
                          more orders for work that was contracted out by the working capital fund
                          than was originally budgeted for in fiscal years 2001 and 2002. Third, the
                          SPAWAR systems centers received $166.7 million in orders financed by the
                          Defense Emergency Response Fund in fiscal year 2002 that was not
                          reflected in the SPAWAR systems centers’ budget. These funds were
                          provided via a supplemental appropriation.




                          Page 11                                    GAO-03-668 Navy Working Capital Fund
                     Navy headquarters officials were aware of this budgeting problem and
                     issued guidance in March 2002 on preparing the fiscal 2004/2005 budget
                     estimates that stressed the importance of customers accurately preparing
                     budget estimates for orders placed with the Navy Working Capital Fund,
                     including the SPAWAR systems centers. The guidance also stated that (1) it
                     was imperative that all funds to be sent to the Navy Working Capital Fund
                     be accurately reflected in the budget and (2) customers have historically
                     underreported the funds to be placed with the Navy Working Capital Fund
                     (particularly with the research and development business area that
                     includes the SPAWAR systems centers) and overreported the use of these
                     funds in other areas.



Reported Actual      In addition to understating budgeted gross carryover, SPAWAR systems
                     centers also consistently understated their reported actual carryover.
Carryover Balances   Inaccurate carryover information results in the Congress and DOD officials
Were Consistently    not having the information they need to perform their oversight
                     responsibilities, including reviewing DOD’s budget. Navy reports show that
Understated          the systems centers’ fiscal year-end carryover balances for fiscal years 1998
                     through 2002 did not exceed DOD’s 3-month carryover standard. However,
                     we found that the systems centers’ reported carryover balances were
                     understated because (1) DOD’s guidance for calculating the number of
                     months of carryover allowed this to happen and (2) the systems centers
                     used accounting entries to manipulate customer work orders at year-end to
                     help reduce reported carryover below the 3-month standard.




                     Page 12                                     GAO-03-668 Navy Working Capital Fund
Defense Carryover Policy   Prior to 1996, if working capital fund activity groups’ budgets projected
                           more than a 3-month level of carryover, their customers’ budgets could be,
                           and sometimes were, reduced by the Office of the Under Secretary of
                           Defense (Comptroller) and/or congressional committees. Because of the
                           military services’ concerns about (1) the methodology used to compute the
                           months of carryover and (2) the reductions that were being made to
                           customer budgets because of excess carryover, Defense performed a joint
                           review14 of carryover in 1996 to determine if the 3-month standard should
                           be revised. Based on the joint review, DOD decided to retain the 3-month
                           carryover standard for all working capital fund activity groups except Air
                           Force contract depot maintenance.15 Furthermore, as a result of the review
                           and concerns expressed by the Navy, DOD also approved several policy
                           changes that had the effect of increasing the carryover standard for all
                           working capital fund activities. Specifically, under the policy implemented
                           after the 1996 review, certain categories of orders, such as those from non-
                           DOD customers, and contractual obligations, such as SPAWAR system
                           centers’ contracts with private sector firms for research and development
                           work, can be excluded from the carryover balance16 that is used to
                           determine whether the carryover standard has been exceeded.

                           These policy changes were documented in an August 2, 1996, DOD decision
                           paper that provided the following formula for calculating the number of
                           months of carryover. (See fig.1.)




                           14
                            This joint study group included representatives from the Office of the Secretary of
                           Defense, the Office of the Joint Chiefs of Staff, and each of the military services.
                           15
                             The Air Force is the only service that contracts out significant amounts of depot
                           maintenance work through the working capital fund. Because of the additional
                           administrative functions associated with awarding contracts, DOD set a 4.5-month
                           carryover standard for Air Force contract depot maintenance. The Air Force is currently in
                           the process of removing the contract portion of its depot maintenance operation from the
                           working capital fund.
                           16
                              Adjusted carryover is the obligated balance of budget authority carried over from one
                           fiscal year to the next and adjusted for contractual obligations and certain categories of
                           orders, such as those from non-DOD customers.




                           Page 13                                              GAO-03-668 Navy Working Capital Fund
                        Figure 1: DOD Carryover Computation Based on the Fiscal Year 2002 Budget




Carryover Calculation   DOD’s 1996 decision to allow certain categories of orders to be excluded
Understated Reported    (adjustments) from reported gross carryover has had a significant impact
                        on SPAWAR systems centers’ reported carryover, particularly the
Carryover
                        adjustment for contractual obligations. As table 3 shows, these
                        adjustments have allowed the systems centers to significantly reduce
                        actual reported gross carryover by hundreds of millions of dollars,
                        resulting in reported carryover below the 3-month standard. As discussed
                        below, we do not agree with how the Navy interpreted DOD’s guidance for
                        using contractual obligations and related revenue in calculating carryover.
                        Our analysis of the systems centers’ adjustments to their carryover



                        Page 14                                     GAO-03-668 Navy Working Capital Fund
amounts shown in table 3 found that contractual obligations accounted for
75 percent to 89 percent of the dollar adjustments made.



Table 3: SPAWAR Systems Centers’ Reported Actual Gross Carryover before and
after Adjustments for Fiscal Years 1998 through 2002

Dollars in millions
                                  Before adjustments                After adjustments
Fiscal year                            Dollars         Months          Dollars          Months
1998                                       $530           5.8            $196               2.1
1999                                           563        5.4             212               2.0
2000                                           613        4.8             243               1.9
2001                                           875        6.0             368               2.5
2002                                           896        4.5             421               2.1
Sources: Navy budget and accounting reports.


In May 2001, we reported17 that the months of carryover reported by Navy
activity groups, which include the SPAWAR systems centers, would more
accurately reflect the actual backlog of in-house work if adjustments for
contract obligations affected both contract carryover and contract
revenue. As shown in figure 1, DOD’s formula for calculating months of
carryover is based on the ratio of adjusted orders carried over to revenue.
The formula specifies that gross carryover should be reduced by the
amount of contract obligations. However, DOD did not provide clear
guidance on whether downward adjustments for the revenue associated
with contract services should also be made. Unless this is done, the
number of months of reported carryover will be understated.

In our May 2001 report we recommended, among other things, that the
revenue used in calculating months of carryover be adjusted (reduced) for
revenue earned for work performed by contractors. However, as discussed
below, until recently DOD had not changed its policy for calculating
carryover. As a result, the Navy did not adjust the revenue amount used in
the denominator of the calculation and, therefore, continued to understate
its reported carryover in its budget submissions to the Congress through
fiscal year 2003. Navy officials informed us that they used total revenue in
their calculation because total revenue represents the full operating

17
     GAO-01-559.




Page 15                                                    GAO-03-668 Navy Working Capital Fund
capability of a given activity group to accomplish a full year’s level of
workload. Further, even though Navy officials acknowledged that the
revenue amount used in the calculation includes revenue earned from
contracts, they stated the reason for not removing contract-related revenue
from the denominator of the calculation was that the numerator of the
calculation includes carryover (funds) related to work for which contracts
would eventually be awarded but which had not yet been awarded at fiscal
year-end. In addition, Navy officials told us that the accounting systems
cannot readily break out what portion of the total revenue amount is
contract-related. They further told us that the revenue information can be
extracted from the system, but doing so involves a lot of work to develop
the program(s) necessary to obtain the information.

When the Navy reduces the dollar amount of carryover (numerator) by the
amount of contractual obligations and does not reduce the revenue amount
(denominator) for revenue associated with contracts, it is not being
consistent with the use of adjustments in the formula to calculate
carryover. Because the Navy cannot readily determine the amount of
contract-related revenue, we asked SPAWAR headquarters to estimate what
the amount would be for the systems centers based on the same criteria
they use to determine the dollar amount of contractual obligations to be
deducted in the carryover calculation. SPAWAR’s estimate shows that 63
percent of the total revenue amount used in calculating the SPAWAR
systems centers’ number of months of actual carryover reported for fiscal
year 2002 is related to revenue associated with contractual services. By not
reducing total revenue used in the calculation for revenue related to work
performed by contractors, the systems centers’ reported months of
carryover for that fiscal year were understated.

In response to our May 2001 report, the Under Secretary of Defense
(Comptroller) agreed that the methodology for calculating carryover
needed to be revised. In December 2002, the Under Secretary of Defense
(Comptroller) issued new guidance on carryover for working capital fund
activities. Under the revised methodology, the formula shown in figure 1
has been eliminated and, therefore, working capital fund activities can no
longer reduce reported carryover by the amount of their contractual
obligations. DOD adopted the revised methodology for the Defense
Working Capital Fund fiscal year 2004 budget estimates, but DOD has not
yet issued written procedures to ensure that the services consistently
implement the new policy. DOD officials informed us that they are
developing the procedures and will update the appropriate regulations in
2004. We did not evaluate DOD’s revised carryover policy.



Page 16                                    GAO-03-668 Navy Working Capital Fund
Customer Orders Were         We also found that the systems centers reduced reported carryover by
Manipulated at Year-end to   simply making accounting entries that took work to be performed by the
                             working capital fund and turned it into work to be performed outside the
Reduce Reported Carryover    working capital fund. Customer work that is performed by the working
                             capital fund is referred to as reimbursable work. Customer work that is not
                             performed by the working capital fund is referred to as direct cite work.
                             Under the direct cite method of performing work, the working capital fund
                             acts as an agent to get the work done through a private sector contractor.
                             Customer funds that finance work done on a direct cite basis are not
                             included in the working capital fund. Instead, the customer uses the direct
                             cite funds to directly pay private sector contractors for the work performed
                             rather than reimbursing or paying the working capital fund. Because the
                             funds for direct cite work are not part of the working capital fund, there is
                             no carryover associated with this work. Therefore, the work is not subject
                             to DOD’s 3-month carryover standard.

                             The two SPAWAR systems centers made some accounting entries at fiscal
                             year-end that moved customer orders out of the working capital fund for
                             the sole purpose of reducing reported carryover below the 3-month
                             standard, which understated the amount of carryover that SPAWAR
                             reported to the Navy and DOD. They then reversed these accounting
                             entries in the beginning of the next fiscal year. Specifically, the systems
                             centers did this at fiscal year-end 2000 for customer orders totaling at least
                             $38 million and at fiscal year-end 2001 for orders totaling at least
                             $50 million. SPAWAR systems centers’ officials acknowledged that these
                             accounting adjustments were made at fiscal year-end to reduce reported
                             carryover. The officials told us that this has been a long-standing practice
                             and was used as a “tool” to manage reported carryover. For example,
                             comptroller officials at one systems center told us that as the fiscal year-
                             end grew near, they had a good idea of how much they needed to move
                             from reimbursable to direct cite in order to get down below the 3-month
                             carryover standard. At year-end, if it was determined that they moved more
                             funds than needed to get below the standard, they would move the excess
                             back to reimbursable before the accounting period was officially closed.

                             We do not view these actions as a tool for managing workload as reflected
                             by the reported carryover but as a misrepresentation of actual carryover
                             balances in order to mislead decision makers, including DOD budget
                             officials and the Congress. After discussing this practice with SPAWAR
                             headquarters officials, they issued guidance in September 2002, prohibiting
                             the use of reimbursable/direct cite accounting adjustments to mask year-
                             end carryover balances. In discussing this with Navy headquarters and


                             Page 17                                     GAO-03-668 Navy Working Capital Fund
                        DOD officials, they told us that they were not aware that the systems
                        centers were doing this and that they did not agree with this practice.



Reported Actual         In addition to understating budgeted and reported actual carryover
                        information, the two SPAWAR systems centers’ actual carryover data that
Carryover Is Based on   were reported to the Congress as part of the President’s budget were based
Unreliable Underlying   on some unreliable underlying financial data. Although many factors could
                        have contributed to this data problem, a primary cause was that the two
Financial Data          centers had not fully complied with DOD guidance that required them and
                        all other DOD fund holders18 to conduct tri-annual reviews of their financial
                        data (outstanding commitments, obligations, and accrued expenditures).
                        In fact, although DOD established its tri-annual review requirement in 1996
                        in order to improve the timeliness and accuracy of its financial data, the
                        Charleston and San Diego Systems Centers did not conduct their first
                        reviews until September 2001 and September 2002, respectively. Further,
                        as of September 2002, the systems centers were fully complying with only a
                        few of the 16 specific tasks that they were required to accomplish during
                        their reviews.

                        As discussed below, three carryover-related problems with the two systems
                        centers’ tri-annual reviews are that the centers (1) excluded about 46
                        percent of their reported actual carryover from their September 2002 tri-
                        annual reviews, (2) were not effectively reviewing dormant obligations19
                        and, therefore, were sometimes returning unneeded funds to customers
                        after the funds had expired, and (3) were not effectively reviewing accrued
                        expenditure data (accrued expenditures reduce carryover). A fourth
                        problem was that neither SPAWAR headquarters nor the systems centers’
                        commanders had developed effective policies and procedures for ensuring
                        that (1) tri-annual reviews are conducted in accordance with DOD
                        guidance and (2) timely and appropriate corrective action is taken on
                        problems that are identified during the reviews.




                        18
                          The fund holder is the organization on whose accounting records a commitment,
                        obligation, and/or accrued expenditure is recorded.
                        19
                         Obligations are considered dormant if their unliquidated balances have not changed for
                        more than 120 days.




                        Page 18                                           GAO-03-668 Navy Working Capital Fund
Effective Tri-Annual         The May 1996 memorandum from the Under Secretary of Defense
Reviews Can Result in More   (Comptroller) that established DOD’s tri-annual review requirement noted
                             that the timely review of commitments and obligations to ensure the
Informed Carryover-Related   accuracy and timeliness of financial transactions is a vital phase of
Budget Decisions and Other   financial management. To illustrate this point, the Under Secretary stated
Benefits                     that the accurate recording of commitments and obligations (1) forms the
                             basis for formal financial reports issued by the department and (2) provides
                             information for management to make informed decisions regarding
                             resource allocation.

                             Carryover-related budget decisions are examples of resource allocation
                             decisions that require reliable obligation data. This is because there is a
                             direct link between the (1) carryover data that working capital fund
                             activities report to the Congress and DOD decision makers and
                             (2) obligation data contained in the accounting records of working capital
                             fund activities and their customers. Specifically,

                             • when working capital fund activities, such as the SPAWAR systems
                               centers, accept customer orders, obligations are created in the
                               customers’ accounting records, and the systems centers become the
                               “fund holders” and

                             • as work is performed and customers are billed, both the unliquidated
                               obligation balances in the customers’ accounting records and the
                               working capital fund activities’ reported carryover balances are
                               reduced.

                             DOD’s implementing guidance for the tri-annual reviews requires fund
                             holders, such as the two SPAWAR systems centers, to certify that they
                             completed 16 specific tasks during their reviews. For example, the
                             guidance requires fund holders to confirm, among other things, that they
                             have (1) traced the obligations and commitments that are recorded in their
                             accounting systems back to source documents and (2) conducted adequate
                             follow-up on all dormant obligations and commitments to determine if they
                             are still valid.20 Additionally, the guidance requires fund holders to


                             20
                               All obligation and commitment balances that have not changed for more than 120 days are
                             required to be reviewed during the 4-month period ending September 30 each fiscal year—
                             but only those balances greater than a certain amount are required to be reviewed during
                             each of the 4-month periods ending January 31 and May 31 of each fiscal year (e.g., for
                             customer order-related obligations and commitments, the amount is $50,000).




                             Page 19                                           GAO-03-668 Navy Working Capital Fund
                           (1) identify the problems that were noted during their reviews, (2) advise
                           their higher headquarters—SPAWAR headquarters for the two systems
                           centers—whether, and to what extent, adjustments or corrections to
                           remedy noted problems have been taken, (3) summarize, by type, the
                           actions or corrections remaining to be taken, (4) indicate when such
                           actions/corrections are expected to be completed, and (5) identify the
                           actions that have been taken to preclude identified problems from
                           recurring in the future. Thus, if properly implemented, tri-annual reviews
                           can provide a systematic process that helps fund holders not only improve
                           the reliability of their financial data but also identify and correct the
                           underlying causes of their data problems.

Tri-Annual Reviews Have    As noted previously, DOD established the tri-annual review requirement in
Received Very Little       May 1996, but the Charleston and San Diego Systems Centers did not
Management Emphasis        conduct their first reviews until September 2001 and September 2002,
                           respectively. Discussions with SPAWAR officials and the centers’ financial
                           managers indicated that a lack of management emphasis is the primary
                           reason for this delayed implementation.

                           For example, SPAWAR headquarters officials pointed out that the Navy’s
                           implementing guidance was not issued until July 2001—more than 5 years
                           after DOD established the requirement, and San Diego Systems Center
                           financial managers stated that they were not aware of the tri-annual review
                           requirement until fiscal year 2001. Further, when Charleston and San Diego
                           financial managers were asked why their centers did not conduct their first
                           tri-annual reviews until the end of fiscal year 2001 and 2002, respectively,
                           they stated that their personnel were busy reconciling data problems that
                           were caused by multiple organizational consolidations and accounting
                           system conversions, and indicated that their personnel did not have time to
                           conduct tri-annual reviews.



DOD Guidance Allows a      The SPAWAR systems centers’ reported actual carryover falls into two
Substantial Amount of      major categories—obligated carryover and unobligated carryover.
                           Obligated carryover refers to the portion of customer orders for which the
Carryover to Be Excluded   systems centers have obligated their own funds. For example, if a
from Tri-Annual Reviews    customer submits a $1,000 order for engineering services, and a contractor
                           will accomplish 10 percent of the work, then the systems center will award
                           a contract for $100—which will obligate the center’s funds—and the $100
                           will, therefore, be referred to as obligated carryover. A customer order’s
                           unobligated carryover balance is calculated by subtracting obligated
                           carryover from the total amount remaining on the order—or $900 for this



                           Page 20                                    GAO-03-668 Navy Working Capital Fund
example. As of September 30, 2002, the two SPAWAR systems centers had
about $896.1 million of reported actual carryover—$379.5 million of
obligated carryover and $516.6 million of unobligated carryover.

The distinction between obligated carryover and unobligated carryover is
important because (1) neither DOD nor Navy guidance explicitly requires
the systems centers to review unobligated carryover during their tri-annual
reviews (unless the work is recorded as a commitment in their accounting
records) and (2) about $414 million of the systems centers’ September 30,
2002, unobligated carryover was not recorded as a commitment in the
centers’ accounting records. In other words, even if the tri-annual reviews
were performed effectively and in a timely manner, they would not cover
about 46 percent of the systems centers’ reported actual carryover.

DOD guidance does require customers, as part of their tri-annual reviews,
to validate the orders they have placed with working capital fund activities
because these orders are recorded as obligations in their accounting
records, regardless of whether they are obligated or unobligated carryover
in the working capital fund activities’ records. However, customers have
limited visibility over whether the unobligated portion of their funded
orders are needed to finance future work, and, therefore, the working
capital fund activities are in a better position than the customers to make
this determination.

If the systems centers were required to review unobligated carryover
balances when performing their tri-annual reviews, they could (1) reduce
the amount of carryover on their records and (2) better identify unneeded
funds and be in a better position to return them to customers before the
funds expired21 so the customers could use them for new obligations. For
example, our review of 34 customer orders that (1) had $7 million of
unobligated carryover balances as of September 30, 2001, and (2) were
financed with funds that had already expired as of that date showed that
most of the orders contained unneeded funds that were eventually returned
to customers. Our analysis showed that (1) 27 of the orders (about 79
percent) had unneeded funds and (2) $2.9 million, or about 41 percent, of
the orders we reviewed represented unneeded funds.

21
  The Congress generally provides budget authority to an agency for use during a specific
period, referred to as the period of availability. During this period of availability, the agency
may incur new obligations, for example, those for goods and services, and charge them
against the appropriation. At the end of the period of availability, the appropriation expires,
meaning that it may not be used to incur new obligations.




Page 21                                                GAO-03-668 Navy Working Capital Fund
                               Although most of the unneeded funds we identified were eventually
                               returned to customers, in some instances the funds were not returned until
                               long after the funds expired. For example, $469,916 of unneeded funds on
                               two Charleston Systems Center orders expired in September 2001, but was
                               not returned to the customer until September 2002—almost 1 year after the
                               funds had expired. Similarly, $71,718 of unneeded funds on a San Diego
                               order expired in September 1998, but was not returned to the customer
                               until December 2002—more than 4 years after the funds had expired.

                               We believe, and a senior DOD accounting official agreed, that the systems
                               centers and other working capital fund activities should be required to
                               validate their unobligated carryover during tri-annual reviews because, as
                               noted previously, they have better visibility over whether unobligated funds
                               will be needed in the future. However, neither center requires its managers
                               to review unobligated carryover during the tri-annual reviews because, as
                               financial managers at one center pointed out, they are concentrating on the
                               requirements explicitly identified in the DOD guidance, and they will add
                               other tasks, such as reviews of unobligated carryover, if and when (1) the
                               guidance is changed or (2) they have the time and resources to do so.



More Effective Reviews of      A key element of the tri-annual reviews is the requirement to follow up on
Dormant Obligations Could      all obligations that have been dormant for more than 120 days to determine
                               if unused funds are still needed. This task is one of the 16 tri-annual review
Result in More Effective Use
                               requirements and is important from the systems centers’ perspective
of Customer Funds              because the identification and return of unneeded funds to the customer
                               will reduce the centers’ reported carryover—thereby reducing the
                               likelihood of customers’ budget cuts. Additionally, the task is important
                               from the customers’ perspective because the funds can be reused for other
                               purposes if they are returned before they expire.

                               However, our analysis of the two centers’ financial data and review of
                               individual customer orders showed that neither center was effectively
                               identifying unneeded funds and returning them to customers in a timely
                               manner. For example, our analysis of the two systems centers’ financial
                               data showed that, as of September 30, 2002, the two centers had thousands
                               of obligated carryover balances, valued at more than $7 million, that had
                               not changed for more than a year. Further, some of these dormant balances
                               were financed with customer funds that had long since expired. For
                               example, 165 of the dormant carryover balances were financed with fiscal
                               year 1996 or earlier appropriations. According to a systems center official,
                               the monumental financial workload involved with the acquisition of



                               Page 22                                     GAO-03-668 Navy Working Capital Fund
                             additional activities and the transition to a consolidated financial
                             accounting system occurring over the past several years greatly hindered
                             their efforts to close all expired funding documents and return the unused
                             funds to customers in a timely manner. For example, the official pointed
                             out that the center had almost 13,000 old funding documents needing to be
                             reconciled and closed at the start of fiscal year 2000 because of these
                             problems and that the center was still working on them.



Large Accrued Expenditure    At the conclusion of their tri-annual reviews, fund holders are required to
Balances Warrant Increased   certify that they have conducted adequate research on all accrued
                             expenditures22 that are more than 120 days old to determine if they are
Management Emphasis
                             valid. This task is important because

                             • large accrued expenditure balances, in general, and large dormant
                               accrued expenditure balances, in particular, can indicate either serious
                               accounting problems or ineffective procedures for developing accrued
                               expenditure schedules and

                             • accrued expenditures reduce reported carryover balances, and overly
                               optimistic accrued expenditure schedules can, therefore, cause
                               reported carryover to understate actual carryover.

                             The task of validating accrued expenditures is especially important for the
                             two SPAWAR systems centers because they had about $673 million of
                             accrued expenditures as of September 30, 2002.

                             However, the San Diego Systems Center, which had the larger accrued
                             expenditure balance—about $423 million as of September 2002—is
                             currently developing a methodology for validating its accrued
                             expenditures. Further, although the Charleston Systems Center had
                             developed a methodology to review its accrued expenditures, the
                             Charleston Comptroller was concerned about the timeliness and adequacy
                             of these reviews and, therefore, was unwilling to certify that the center
                             adequately reviewed its dormant accrued expenditures.



                             22
                               According to DOD’s Financial Management Regulation 7000.14-R, Volume 1, accrued
                             expenditures represent the amount of paid and unpaid expenditures for (1) services
                             performed by employees, contractors, etc., (2) goods and tangible property received, and
                             (3) amounts owed under programs for which no current service or performance is required.




                             Page 23                                           GAO-03-668 Navy Working Capital Fund
Although the tri-annual review’s tasks related to accrued expenditures
focus primarily on accounting problems, reviews of dormant accrued
expenditures are also important from a carryover perspective. Overly
optimistic accrued expenditure schedules—which are the basis for
determining when accrued expenditures will be recorded in the accounting
system—can cause reported carryover to understate actual carryover. For
example, if a contractor is to perform $600 of work, and an accrued
expenditure schedule is based on the assumptions that the work will begin
immediately and will be performed at a uniform rate over a 6-month period,
then (1) $100 of expenditures will be accrued each month and (2) each
accrued expenditure will trigger a $100 customer payment and, in turn, a
$100 reduction in the reported carryover. Thus, after 4 months, the
reported carryover will be $200, regardless of how much work has actually
been accomplished. If the work begins later than expected or if it takes
longer than expected to complete, and accrued expenditures are not
adjusted accordingly, reported carryover would be understated.

Two ways to put the magnitude of the systems centers’ accrued
expenditure balances in perspective are to (1) compare the balances with
other financial indicators and (2) show their impact on reported carryover.
For example, the San Diego Systems Center’s September 2002 accrued
expenditure balance of $423 million is the equivalent of about 32 percent of
the orders the center received during fiscal year 2002 ($1.315 billion) and
about 31 percent of the revenue it received during the year ($1.372 billion).
The accrued expenditures allowed the center to reduce its reported
carryover at the end of fiscal year 2002 by about 3.7 months.

A San Diego Systems Center accounting official acknowledged that the
center’s large accrued expenditure balance is a major area of concern.
Specifically, this official indicated that the center’s large accrued
expenditure balance is caused partly by delays in contractor and interfund
billings, but acknowledged that there are other apparent problems that
warrant attention. For example, the official said that the $405 million
variance between the center’s September 30, 2002, accrued expenditure
and accounts payable balances is an apparent problem that should be
reviewed.

However, the accounting official also pointed out that currently the center
cannot analyze its accrued expenditures because its new accounting
system, which has been tailored to meet its specific needs and is unique
within DOD, cannot provide the data in a format that will allow it to do so.
When asked what the San Diego Systems Center is doing to develop the



Page 24                                     GAO-03-668 Navy Working Capital Fund
                             data needed to effectively analyze its accrued expenditure data, the
                             accounting official indicated that the center is developing a “data
                             warehouse.” However, the official acknowledged that (1) they have just
                             begun identifying the specific requirements for the data warehouse,
                             (2) there will be many competing requirements, (3) due to resource
                             constraints, the data warehouse will not be able to satisfy all of the center’s
                             data analysis needs, and (4) they, therefore, do not know when or, for that
                             matter, if they will ever have the data they need to effectively analyze their
                             accrued expenditures.



Improvements Are Needed      In addition to the major problems identified above, our review of the
in SPAWAR’s Tri-Annual       procedures that SPAWAR headquarters and its two systems centers use to
                             conduct their tri-annual reviews identified several areas that need
Review Procedures            improvements. For example, SPAWAR headquarters has not evaluated the
                             systems centers’ reviews and, as a result, the command (1) does not have a
                             sound basis for assessing the adequacy of the reviews that the centers have
                             conducted on individual obligation, commitment, and accrued expenditure
                             balances and (2) was not aware of the process-related problems discussed
                             below.

San Diego’s Decentralized    The San Diego Systems Center accomplishes its tri-annual reviews on a
Review Process Needs to Be   decentralized basis. During the first step of the process, the Office of the
Refined                      Comptroller, which has overall responsibility for the reviews, develops
                             computer lists that contain information on all of the center’s outstanding
                             obligations and commitments. The Comptroller’s Office then provides
                             these lists to the center’s technical departments, which are then required to
                             conduct the actual reviews. When the technical departments finish their
                             reviews, their department heads certify that the reviews have been
                             completed and then forward this certification to the San Diego Systems
                             Center’s Comptroller. On the basis of the technical departments’
                             certifications, the Comptroller then certifies that the center has completed
                             its review.

                             Although this approach seems reasonable on the surface, we found
                             numerous problems with the process. For example, because the systems
                             center’s draft tri-annual review guidance does not specifically require the
                             technical departments to accomplish many important tasks, the
                             effectiveness and usefulness of the reviews varied significantly from one
                             department to another. For example, two of the center’s technical
                             departments did not (1) summarize or analyze the results of their reviews,
                             (2) establish internal controls to ensure that timely and appropriate



                             Page 25                                      GAO-03-668 Navy Working Capital Fund
corrective action was taken on problems that were identified during the
reviews, or (3) maintain adequate documentation to show who conducted
the reviews, what problems were identified, and/or what additional actions
were required.

Conversely, although it was not required to do so, another department
(1) summarized the results of its reviews in a single Excel spreadsheet to
facilitate analysis of the review results, (2) analyzed the data to determine
if there were any indications of systemic or compliance problems (e.g.,
inadequate reviews by one or more of the department’s divisions or
problems with accrual schedules), and (3) developed internal control
procedures to ensure that timely and appropriate action was taken on
identified problems and/or unresolved research requirements.
Additionally, this department requires its managers to maintain
documentation that (1) shows who conducted the actual reviews (so these
individuals can be held accountable for the adequacy of the reviews),
(2) identifies the additional research or corrective action that is required as
a result of the reviews, and (3) indicates who is responsible for taking the
action.

Managers from this department said that they were initially skeptical about
the benefits of the tri-annual reviews, but indicated that they are now
strong supporters because the reviews have provided a structured way to
address their data problems and have already resulted in significant
improvements in the quality of their data. Additionally, they acknowledged
that documenting what corrective action is required and who is responsible
for taking it requires additional time, at least in the short term. However,
they believe this documentation is essential for (1) holding people
accountable and (2) having effective internal controls to ensure that timely
and appropriate corrective action is taken on the problems that are
identified. Further, they believe that the documentation may save time in
the long term because it will serve as a “memory jogger” for subsequent
reviews.

Additional process-related problems we identified during our assessment
of the San Diego Systems Center’s tri-annual review process include the
following.

• As noted previously, although the center had about $423 million of
  accrued expenditures as of September 2002, it had not yet developed a
  methodology for identifying and reviewing its accrued expenditures.




Page 26                                      GAO-03-668 Navy Working Capital Fund
                                 • Fund holders are required to conduct sufficient follow-up on dormant
                                   obligations and commitments to determine if they are still valid.
                                   However, the computer lists that the San Diego Comptroller provides to
                                   the center’s technical departments do not distinguish between the
                                   obligations and commitments that have been dormant and those that
                                   have not. As a result, the technical departments have no way to focus
                                   their attention on the obligations and commitments that require follow-
                                   up action.

                                 • The certifications that the department heads sign are much more
                                   general than the one that the Comptroller must sign on behalf of the
                                   system center and they, therefore, do not provide an adequate basis for
                                   the Comptroller’s certification. For example, the Comptroller is
                                   required, among other things, to (1) advise SPAWAR headquarters
                                   whether, and to what extent, adjustments or corrections to remedy
                                   noted problems have been taken, (2) summarize, by type, the actions or
                                   corrections remaining to be taken, (3) indicate when such
                                   actions/corrections are expected to be completed, and (4) identify the
                                   actions that have been taken to preclude identified problems from
                                   recurring in the future. However, the Comptroller does not require the
                                   departments to report this information to him and, therefore, cannot
                                   report this information to SPAWAR headquarters.

                                 • Although, as noted previously, the Comptroller has overall responsibility
                                   for the center’s tri-annual reviews, his office has not assessed the
                                   adequacy of the reviews that are being conducted by the technical
                                   departments. As a result, the Comptroller does not have a sound basis
                                   for his certification.

Charleston’s Basic Approach Is   The Charleston Systems Center has developed a basic approach for its tri-
Sound, but Some Improvements     annual reviews that appears sound. Charleston’s approach addressed
Are Needed                       several of the concerns we noted with the San Diego Systems Center’s
                                 approach. First, rather than assigning all review requirements to the
                                 technical departments, Charleston divides the responsibilities between the
                                 Comptroller’s Office and the technical departments. This approach allows
                                 the Comptroller’s Office to concentrate on the tasks it is best qualified to
                                 perform, such as tracing obligations back to source documents, and lets the
                                 technical departments concentrate on those tasks that they are best
                                 qualified to perform, such as verifying that dormant obligations are still
                                 valid. Second, the Charleston Comptroller provides the technical
                                 departments with a list of all dormant commitments, obligations, and
                                 accrued expenditures so they can easily focus on those that they must



                                 Page 27                                    GAO-03-668 Navy Working Capital Fund
follow up on. Finally, Charleston’s tri-annual review guidance requires
those who conduct the reviews to document actions taken during the
reviews and is to (1) include corrective actions remaining to be taken and
when such actions will be completed and (2) identify actions that have
been taken to preclude identified problems from recurring in the future.

However, we did identify several problems with Charleston’s overall
approach. More specifically, we found the following:

• Although the Comptroller must sign a certification statement attesting
  to the results of the center’s tri-annual review, the systems center has
  not conducted all of the required reviews, and the Comptroller has not
  developed internal control procedures to ensure that the reviews that
  were conducted were performed properly and completely.

• Charleston’s technical department heads are responsible for ensuring
  that reviews are properly conducted and documented, but they are not
  required to certify that this has been done. Consequently, the
  Comptroller does not have a sound basis for certifying that the tri-
  annual review tasks the center is required to accomplish have been
  completed. In fact, Charleston’s Comptroller acknowledged that our
  work shows that the technical departments’ reviews are not adequate,
  and he indicated that his concern about the timeliness and adequacy of
  the technical departments’ reviews is the reason why he has limited his
  tri-annual review certification to the 4 tasks that are under his control
  and why he has been unwilling to certify the remaining 12 tasks. The
  Comptroller stated, and we agree, that department heads should be held
  accountable for their respective departments’ portion of the tri-annual
  review process. Specifically, he believes they should be required to
  complete and sign certification statements similar to the one that he
  must complete and sign on behalf of the systems center, and
  accordingly, has developed a proposed certification statement for the
  department heads to sign.

We also found that DOD’s tri-annual review guidance regarding the dollar
thresholds for reviewing outstanding commitments and obligations was
unclear. The guidance states that during the January and May reviews,
commitments and obligations of (1) $200,000 or more for investment
appropriations (e.g., procurement funds and the capital budget of the
working capital funds) should be reviewed and (2) $50,000 or more for
operating appropriations (e.g., operation and maintenance funds and the
operating portion of the working capital funds) should be reviewed.



Page 28                                    GAO-03-668 Navy Working Capital Fund
                      Charleston interpreted the guidance to mean that customer orders—which
                      are the operating portion of the working capital fund—financed with
                      investment funds fell into the $200,000 threshold category for review
                      purposes, rather than the $50,000 category, and conducted its tri-annual
                      reviews accordingly. In discussing this issue with the Office of the Under
                      Secretary of Defense (Comptroller) and Navy headquarters officials, the
                      officials acknowledged that the guidance was unclear and, thus, open to
                      interpretation. They stated that the guidance needed to be examined and
                      clarified.



Conclusions           SPAWAR has consistently understated and provided misleading carryover
                      information to the Congress. Reliable carryover information is essential
                      for the Congress and DOD to perform their oversight responsibilities,
                      including reviewing DOD’s budget. To provide assurance that SPAWAR
                      systems centers report reliable carryover information, managers at
                      SPAWAR headquarters and the systems centers must be held accountable
                      for the accuracy of reported carryover and ensure the timely identification
                      of unneeded customer funds. This includes increased management
                      attention that would provide more assurance that the systems centers are
                      effectively reviewing funded orders as part of their tri-annual review
                      process. Until these problems are resolved, the Congress and DOD
                      decision makers will be forced to make key budget decisions, such as
                      whether or not to enhance or reduce customer budgets, based on
                      unreliable information.



Recommendations for   We recommend that the Secretary of Defense

Executive Action      • direct the Secretary of the Navy to issue guidance to all Navy working
                        capital fund activities, including SPAWAR, that prohibits them from
                        deobligating reimbursable customer orders at fiscal year-end and
                        reobligating them in the next fiscal year for the sole purpose of reducing
                        carryover balances that are ultimately reported to the Congress;

                      • direct the Under Secretary of Defense (Comptroller) to determine the
                        extent to which working capital fund activities throughout DOD may be
                        similarly manipulating customer order data at fiscal year-end to reduce
                        reported carryover and, if necessary, issue DOD-wide guidance
                        prohibiting this practice as needed; and




                      Page 29                                    GAO-03-668 Navy Working Capital Fund
• direct the Under Secretary of Defense (Comptroller) to develop and
  issue written procedures to implement the December 2002 carryover
  policy.

To provide reasonable assurance that the dollar amount of orders to be
received from customers in developing annual budgets are based on more
realistic estimates, we recommend that the Secretary of the Navy direct the
Commander of the Space and Naval Warfare Systems Command to
compare budgeted to actual orders received from customers and consider
these trends in developing the following year’s budget estimates on orders
to be received from customers.

We recommend that the Under Secretary of Defense (Comptroller)

• revise the tri-annual review guidance in the DOD Financial Management
  Regulation so that working capital fund activities are required to expand
  the scope of their tri-annual reviews to include unobligated balances on
  customer orders and

• review and clarify the tri-annual review guidance for the January and
  May reviews in the DOD Financial Management Regulation as it pertains
  to the dollar threshold for reviewing outstanding commitments and
  obligations for the capital budget and operating portion of the working
  capital fund.

We recommend that the Commander of the Space and Naval Warfare
Systems Command establish internal control procedures and
accountability mechanisms that provide assurance that the systems centers
are complying with DOD’s tri-annual review guidance.

We also recommend that the Commander of the Space and Naval Warfare
Systems Command direct the Commanders of the Charleston and San
Diego SPAWAR Systems Centers to

• maintain documentation that shows who conducted the tri-annual
  reviews so that these individuals can be held accountable for the
  reviews;

• maintain documentation that identifies (1) any additional research or
  corrective action that is required as a result of the tri-annual reviews and
  (2) who is responsible for taking the action;




Page 30                                     GAO-03-668 Navy Working Capital Fund
                      • require cognizant managers, such as department heads, to confirm in
                        writing that they have (1) performed the required tri-annual reviews and
                        (2) completed the related follow-up actions by signing a statement, such
                        as the draft certification statement developed by the Charleston
                        Systems Center Comptroller, that describes the specific tasks that were
                        accomplished and provide this statement to the systems centers’
                        comptrollers;

                      • develop and implement internal control procedures to provide
                        assurance that tri-annual reviews of individual commitment, obligation,
                        and accrued expenditure balances are adequate; and

                      • develop policies and procedures to capture the information on tri-
                        annual review results, such as the amount of obligations reviewed,
                        confirmed, and revised, that they are required to report to SPAWAR
                        headquarters and that SPAWAR headquarters, in turn, is required to
                        report to Navy headquarters.

                      We recommend that the Commander, San Diego SPAWAR Systems Center
                      direct the Center Comptroller to

                      • develop and implement a methodology for identifying and analyzing
                        accrued expenditure balances and

                      • identify dormant commitments, obligations, and accrued expenditures
                        in the tri-annual review computer lists that are provided to the technical
                        departments.



Agency Comments and   DOD provided written comments on a draft of this report. In its comments,
                      DOD concurred with 12 of our 14 recommendations and partially
Our Evaluation        concurred with the remaining 2 recommendations. For these 2
                      recommendations, DOD agreed with our intent to ensure that obligations,
                      unobligated balances, and commitments are reviewed regularly to ensure
                      effective use of funds. Our evaluation of DOD’s comments is presented
                      below. DOD’s comments are reprinted in appendix II.

                      For the 12 recommendations with which DOD concurred, it stated that 7 of
                      them were completed based on the issuance of SPAWAR Instruction
                      7301.1A on Tri-Annual Reviews of Commitments and Obligations, dated
                      October 9, 2002. We believe that the guidance provided in the instruction is
                      an important step. SPAWAR and the systems centers now need to develop



                      Page 31                                    GAO-03-668 Navy Working Capital Fund
and issue implementing procedures because, in most cases, the guidance
provided in the instruction that is related to these 7 recommendations is
too general to fully address our recommendations. For example, although
the instruction requires those responsible for conducting the review to
report the results to the systems center’s comptroller, the instruction does
not require, as we recommended, that cognizant managers, such as
department heads, sign a written statement to be provided to the
comptroller to confirm that they have performed the required reviews and
certify the results of those reviews.

Further, in concurring with our recommendation that SPAWAR compare
budgeted to actual orders received from customers and consider these
trends in developing budget estimates on orders to be received from
customers, DOD did not state how the Navy would ensure that SPAWAR’s
budget estimates would accurately reflect orders to be received from
customers. In its comments, DOD stated that the Navy will continue to
refine its budget estimates for customer orders. We believe that the Navy
must take additional actions to develop more reliable budget estimates. As
noted in our report, reported actual customer orders received exceeded
budget estimates from 36 percent to 88 percent during fiscal years 1998
through 2002. For example, for fiscal year 2002, in formulating its budget
request, the Navy expected the SPAWAR systems centers to receive about
$1.3 billion in customer orders, but the Navy reported that the centers
actually received about $2.4 billion in customer orders—a difference of
$1.1 billion, or about 88 percent. Having reliable budget estimates on
customer orders to be received is critical since this information is used in
calculating carryover using DOD’s new carryover policy.

DOD partially concurred with our recommendation that it revise its tri-
annual review guidance in the DOD Financial Management Regulation to
require working capital fund activities to expand their tri-annual reviews to
include unobligated balances on customer orders. In its comments, DOD
stated that reviewing such balances during the tri-annual reviews was the
responsibility of the customer who placed the order with the working
capital fund and that the working capital fund activity should work in
cooperation with the customer to ensure that unobligated balances are
reviewed. We agree that the working capital fund activity should work in
conjunction with customers to review unobligated balances. However, as
stated in our report, working capital fund activities are in the best position
to determine whether unobligated balances are still needed to finance
future work. To ensure that unobligated balances are properly reviewed
during the tri-annual review process, we continue to recommend that the



Page 32                                     GAO-03-668 Navy Working Capital Fund
DOD Financial Management Regulation be revised to specify the working
capital fund activities’ role in reviewing unobligated balances on customer
orders.

DOD also partially concurred with our recommendation for the SPAWAR
systems centers to review all balances related to dormant customer orders
in excess of $50,000 during the January and May tri-annual reviews. In its
comments, DOD indicated that the current guidance is not clear with
regard to whether all such dormant balances over $50,000 are to be
reviewed during the specified months. DOD stated that it will review the
guidance, as it pertains to working capital fund activities, and make
adjustments if appropriate. We agree that DOD’s tri-annual review
guidance regarding the dollar thresholds for reviewing outstanding
commitments and obligations was unclear. We have revised our report
accordingly, including the related recommendation, to reflect that DOD’s
tri-annual review guidance was unclear.

In addition, in the cover letter transmitting its comments on our draft
report, DOD took exception to our discussion in the draft report regarding
the methodology used by Navy to determine the levels of carryover—
reducing the numerator in the carryover formula by the amount of
contractual obligations, but not reducing the formula’s denominator by the
amount of revenue earned from contractual services. Because DOD
revised its methodology for calculating carryover in December 2002, DOD
commented that such a discussion in the report was irrelevant and
confusing to the reader and recommended that it be deleted. We disagree
with DOD’s comment. Although DOD revised its methodology for
calculating carryover, it was not incorporated into Navy’s budget
submissions until fiscal year 2004. When we undertook this review in July
2002, one of our objectives was to determine if reported carryover
accurately reflected the amount of work remaining to be accomplished. As
such, this issue was and still is relevant. As stated in this report, our May
2001 report recommended that the revenue used in calculating carryover
be adjusted (reduced) for revenue earned for work performed by
contractors. Unless this is done, reported carryover will be understated.
The Navy did not adjust the revenue amount and, therefore, continued to
understate its reported carryover in its budget submissions to the
Congress. We continue to believe that this is a reportable issue and have
made a related recommendation for DOD to develop and issue written
procedures to implement the December 2002 carryover policy. Further, we
believe this issue remains of interest to the Congress since the Navy has




Page 33                                     GAO-03-668 Navy Working Capital Fund
understated SPAWAR’s reported carryover from fiscal year 1998 through
fiscal year 2002.


We are sending copies of this report to the Chairmen and Ranking Minority
Members of the Senate Committee on Armed Services; the Subcommittee
on Readiness and Management Support, Senate Committee on Armed
Services; the Subcommittee on Defense, Senate Committee on
Appropriations; the House Committee on Armed Services; the
Subcommittee on Readiness, House Committee on Armed Services; and the
Ranking Minority Member, Subcommittee on Defense, House Committee
on Appropriations. We are also sending copies to the Secretary of Defense,
the Secretary of the Navy, and other interested parties. Copies will be
made available to others upon request. Should you or your staff have any
questions concerning this report, please contact Gregory D. Kutz, Director,
at (202) 512-9505. He can also be reached by E-mail at kutzg@gao.gov.

An additional contact and key contributors to this report are listed in
appendix III.

Sincerely yours,




Gregory D. Kutz
Director, Financial Management and Assurance




William M. Solis
Director, Defense Capabilities and Management



Page 34                                    GAO-03-668 Navy Working Capital Fund
Appendix I

Scope and Methodology                                                                         A
                                                                                              A
                                                                                              ppep
                                                                                                 nen
                                                                                                   d
                                                                                                   xIeis




             To determine if differences existed between the budgeted and reported
             actual gross carryover and, if so, the reasons for the variances, we obtained
             and analyzed budget and accounting documents that provided information
             on budgeted and reported actual gross carryover and orders received from
             customers from fiscal year 1998 through fiscal year 2002. When variances
             occurred between the budgeted and reported actual information, we met
             with accounting and budgeting SPAWAR and Navy headquarters officials to
             ascertain why there were differences. We also discussed with officials
             what actions they were taking to develop more reliable budget information
             on carryover and orders received from customers.

             To determine if the reported actual carryover balances reflected the
             amount of work that remained to be accomplished, we obtained and
             analyzed the Department of Defense’s (DOD) regulations and guidance on
             carryover. We also obtained and analyzed the SPAWAR systems centers’
             calculations for the fiscal year 1998 through fiscal year 2002 actual reported
             year-end carryover balances. We met with officials from SPAWAR and
             Navy headquarters to discuss the methodology they used to calculate
             carryover. We (1) obtained explanations about why the Navy made
             adjustments in calculating the dollar amount of carryover balances as well
             as the number on months of carryover and (2) determined the impact of
             those adjustments on the carryover figure. We also reviewed year-end
             transactions that affected the dollar amount and number of months of
             carryover. For these year-end transactions, we met with officials from
             SPAWAR and the two systems centers to determine why these transactions
             occurred at year-end.

             To determine if the Charleston and San Diego SPAWAR Systems Centers
             have the financial data they need in order to provide reliable data on actual
             carryover levels to DOD and congressional decision makers, we reviewed
             the policies and procedures SPAWAR headquarters and the two systems
             centers have used to implement DOD’s tri-annual review guidance.
             Specifically, we (1) reviewed the DOD, Navy, SPAWAR headquarters, and
             the two SPAWAR systems centers’ tri-annual review guidance and
             discussed it with cognizant individuals, (2) reviewed the tri-annual review
             certifications that the two systems centers have submitted since DOD
             issued its tri-annual review guidance in 1996, and discussed these
             certifications with cognizant individuals, (3) discussed the systems centers’
             tri-annual review procedures with cognizant individuals, including those
             who actually accomplished the reviews, and (4) reviewed documentation
             on the results of the reviews. We also obtained data on the status of
             unfilled orders and carryover at the end of fiscal year 2001. Additionally,



             Page 35                                     GAO-03-668 Navy Working Capital Fund
Appendix I
Scope and Methodology




from these data, we selected and analyzed 34 orders that had outstanding
carryover balances at the end of fiscal year 2001 to determine if the
carryover balances accurately reflected the amount of work that remained
to be performed. We selected orders that (1) were financed with expired
appropriations and (2) were unobligated carryover at year-end since these
orders were more likely to have unneeded funds and because a review of
these orders was, therefore, more likely to identify problems with the
systems centers’ review procedures.

We performed our work at the headquarters offices of the Under Secretary
of Defense (Comptroller) and the Assistant Secretary of the Navy
(Financial Management and Comptroller), Washington, D.C.; Space and
Naval Warfare Systems Command, San Diego, California; the Charleston
Space and Naval Warfare Systems Center, Charleston, South Carolina; and
the San Diego Space and Naval Warfare Systems Center, San Diego,
California. The reported actual year-end carryover information used in this
report was produced from DOD’s systems, which have long been reported
to generate unreliable data. We did not independently verify this
information. The DOD Inspector General has cited deficiencies and
internal control weaknesses as major obstacles to the presentation of
financial statements that would fairly present the Defense Working Capital
Fund’s financial position for fiscal years 1993 through 2002.

Our review was performed from July 2002 through June 2003 in accordance
with U.S. generally accepted government auditing standards. The Navy
provided the budgeting and accounting information referred to in this
report. We requested comments on a draft of this report from the Secretary
of Defense or his designee. DOD provided written comments, and these
comments are presented in the Agency Comments and Our Evaluation
section of this report and are reprinted in appendix II.




Page 36                                   GAO-03-668 Navy Working Capital Fund
Appendix II

Comments from the Department of Defense                               AppenIx
                                                                            di




Note: GAO comments
supplementing those in
the report text appear
at the end of this
appendix.




See comment 1.




                         Page 37   GAO-03-668 Navy Working Capital Fund
                Appendix II
                Comments from the Department of Defense




Now on p. 30.




Now on p. 30.




Now on p. 30.




                Page 38                                   GAO-03-668 Navy Working Capital Fund
                 Appendix II
                 Comments from the Department of Defense




Now on p. 30.




Now on p. 30.

See comment 1.




Now on p. 31.

See comment 1.




Now on p. 31.




                 Page 39                                   GAO-03-668 Navy Working Capital Fund
                Appendix II
                Comments from the Department of Defense




Now on p. 31.




Now on p. 31.




Now on p. 31.




Now on p. 31.




                Page 40                                   GAO-03-668 Navy Working Capital Fund
                 Appendix II
                 Comments from the Department of Defense




See comment 2.


Now on p. 30.

See comment 2.




Now on p. 32.




Now on p. 32.




                 Page 41                                   GAO-03-668 Navy Working Capital Fund
               Appendix II
               Comments from the Department of Defense




               The following are GAO’s comments on the Department of Defense’s (DOD)
               letter dated June 10, 2003.



GAO Comments   1. See the Agency Comments and Our Evaluation section of this report.

               2. As discussed in the Agency Comments and Our Evaluation section of
                  this report, we have modified this recommendation and the related
                  section of the report in response to DOD’s comment.




               Page 42                                   GAO-03-668 Navy Working Capital Fund
Appendix III

GAO Contact and Staff Acknowledgments                                                         Appen
                                                                                                  Ix
                                                                                                   di




GAO Contact       Greg Pugnetti, (703) 695-6922



Acknowledgments   Staff who made key contributions to this report were Francine DelVecchio,
                  Karl Gustafson, William Hill, Christopher Rice, Ron Tobias, and Eddie
                  Uyekawa.




(192067)          Page 43                                  GAO-03-668 Navy Working Capital Fund
GAO’s Mission            The General Accounting Office, the audit, evaluation and investigative arm of
                         Congress, exists to support Congress in meeting its constitutional responsibilities
                         and to help improve the performance and accountability of the federal government
                         for the American people. GAO examines the use of public funds; evaluates federal
                         programs and policies; and provides analyses, recommendations, and other
                         assistance to help Congress make informed oversight, policy, and funding
                         decisions. GAO’s commitment to good government is reflected in its core values of
                         accountability, integrity, and reliability.


Obtaining Copies of      The fastest and easiest way to obtain copies of GAO documents at no cost is
                         through the Internet. GAO’s Web site (www.gao.gov) contains abstracts and full-
GAO Reports and          text files of current reports and testimony and an expanding archive of older
                         products. The Web site features a search engine to help you locate documents
Testimony                using key words and phrases. You can print these documents in their entirety,
                         including charts and other graphics.
                         Each day, GAO issues a list of newly released reports, testimony, and
                         correspondence. GAO posts this list, known as “Today’s Reports,” on its Web site
                         daily. The list contains links to the full-text document files. To have GAO e-mail this
                         list to you every afternoon, go to www.gao.gov and select “Subscribe to
                         e-mail alerts” under the “Order GAO Products” heading.


Order by Mail or Phone   The first copy of each printed report is free. Additional copies are $2 each. A check
                         or money order should be made out to the Superintendent of Documents. GAO
                         also accepts VISA and Mastercard. Orders for 100 or more copies mailed to a single
                         address are discounted 25 percent. Orders should be sent to:
                         U.S. General Accounting Office
                         441 G Street NW, Room LM
                         Washington, D.C. 20548
                         To order by Phone:     Voice: (202) 512-6000
                                                TDD: (202) 512-2537
                                                Fax: (202) 512-6061


To Report Fraud,         Contact:
                         Web site: www.gao.gov/fraudnet/fraudnet.htm
Waste, and Abuse in      E-mail: fraudnet@gao.gov
Federal Programs         Automated answering system: (800) 424-5454 or (202) 512-7470



Public Affairs           Jeff Nelligan, Managing Director, NelliganJ@gao.gov (202) 512-4800
                         U.S. General Accounting Office, 441 G Street NW, Room 7149
                         Washington, D.C. 20548
United States                  Presorted Standard
General Accounting Office      Postage & Fees Paid
Washington, D.C. 20548-0001           GAO
                                 Permit No. GI00
Official Business
Penalty for Private Use $300
Address Service Requested