oversight

DOD Contract Payments: Management Action Needed to Reduce Billions in Adjustments to Contract Payment Records

Published by the Government Accountability Office on 2003-08-08.

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

              United States General Accounting Office

GAO           Report to the Chairman, Committee on
              the Budget, House of Representatives



August 2003
              DOD CONTRACT
              PAYMENTS
              Management Action
              Needed to Reduce
              Billions in
              Adjustments to
              Contract Payment
              Records




GAO-03-727
              a
                                               August 2003


                                               DOD CONTRACT PAYMENTS

                                               Management Action Needed to Reduce
Highlights of GAO-03-727, a report to the      Billions in Adjustments to Contract
Chairman, Committee on the Budget,
House of Representatives                       Payment Records



GAO has reported that the                      For fiscal year 2002, DFAS Columbus data showed that about $1 of every $4
Department of Defense’s (DOD)                  in contract payment transactions in the MOCAS system was for adjustments
inability to accurately account for            to previously recorded payments—$49 billion of adjustments out of
and report on disbursements is a               $198 billion in transactions. To research payment allocation problems,
long-term, major problem. GAO                  DFAS Columbus reported that it incurred costs of about $34 million in fiscal
was requested to determine (1) the
magnitude of the adjustments and
                                               year 2002. This represents about 35 percent of the total $97 million that
related costs in fiscal year 2002,             DFAS Columbus spent on contract pay services. DFAS Columbus bills DOD
(2) why contracts, including                   activities for contract pay services based on the number of accounting lines
payment terms, are so complex,                 on an invoice. Consequently, all DOD activities pay the same line rate,
(3) the key factors that caused                regardless of whether substantial work is needed to reconcile problem
Defense Finance and Accounting                 contracts and adjust payment records.
Service (DFAS) Columbus to make
payment adjustments, and (4) what              GAO’s analysis of two contracts showed that the contracts were complex
steps DOD is taking to address the             because of the (1) legal and DOD requirements to track and report on the
payment allocation problems.                   funds used to finance the contracts, (2) substantial number of modifications
                                               made on the contracts to procure goods and/or services, and (3) different
                                               pricing provisions on the contracts. GAO’s review of $160 million of
GAO recommends that DOD
(1) develop options for presenting             adjustments showed that the adjustments were made for four reasons:
standard payment instructions in
contracts and (2) automate those               •   The Army made an error in accounting for obligations, resulting in about
instructions in the Mechanization                  $127 million in payment allocation adjustments.
of Contract Administration
Services (MOCAS) system. GAO                   •   DFAS Columbus did not follow its internal procedures for allocating
also recommends that DOD’s                         payments to accounts on an Army contract containing multiple pricing
contracting community and DFAS                     provisions, resulting in about $5 million in adjustments.
follow existing regulations and
procedures concerning contract                 •   DFAS made over $2 million in adjustments to correct recording errors on
payment instructions. In its                       an Army contract due to complex and changing payment instructions.
comments, DOD concurred with
two recommendations and partially
concurred with two others related              •   The Air Force frequently changed payment instructions after payments
to developing and automating the                   were made on an Air Force contract, resulting in about $26 million in
standard payment instructions.                     adjustments.
DOD stated that although the
working group would analyze their              DOD has initiated a major long-term effort to improve its business
feasibility, until the coordination            operations, including its acquisition and disbursement activities. If
and review process was completed,              implemented successfully, this initiative may help correct many of the
it could not commit to these                   contract payment allocation problems. In the interim, DOD has initiatives
actions. We continue to believe                under way to address payment allocation problems, including (1) billing
that decisive steps towards a                  DOD contracting offices for contract reconciliation services, (2) providing
lasting solution are needed to
                                               DOD activities information on the correct method for presenting payment
address DOD’s long-standing
contract payment problems.                     instructions, and (3) establishing a working group to develop options for
                                               presenting standard contract payment instructions. While the DOD working
www.gao.gov/cgi-bin/getrpt?GAO-03-727.         group initiative may reduce payment allocation errors associated with
To view the full report, including the scope   misinterpreting contract payment instructions, DOD needs to automate the
and methodology, click on the link above.      standard payment instructions to eliminate payment allocation errors
For more information, contact Gregory D.       associated with manually allocated payments.
Kutz at (202) 512-9505 or kutzg@gao.gov.
Contents



Letter                                                                                                 1
                             Results in Brief                                                          2
                             Background                                                                5
                             DFAS Columbus Made $49 Billion of Adjustments at a Cost of about
                               $34 Million in Fiscal Year 2002                                        12
                             Contracts Were Complex Due to Legal and DOD Requirements,
                               Contract Modifications, and Pricing Provisions                         12
                             Reasons for DFAS Columbus Making
                               $160 Million of Adjustments to Correct Prior Payment
                               Allocations                                                            17
                             DOD Initiatives to Address Payment Allocation Problems                   23
                             Conclusions                                                              27
                             Recommendations for Executive Action                                     28
                             Agency Comments and Our Evaluation                                       29


Appendixes
              Appendix I:    Scope and Methodology                                                    32
             Appendix II:    Comments from the Department of Defense                                  34
             Appendix III:   GAO Contact and Staff Acknowledgments                                    37
                             GAO Contact                                                              37
                             Acknowledgments                                                          37


Related GAO Products                                                                                  38


Table                        Table 1: Reasons for $160 Million in Contract Payment Adjustments
                                      for Two Contracts                                               17


Figures                      Figure 1: Sample Line of Accounting on the Air Force Contract             6
                             Figure 2: Payment Process Information Flow for the Air Force
                                       Contract                                                        7
                             Figure 3: Army Tactical Missile Launched from Multiple Launch
                                       Rocket System                                                  10
                             Figure 4: Army Data Link System Transferring Information
                                       Collected by Aircraft, Satellites, and Ground Stations         11
                             Figure 5: Contract Funding Structure for Three Contract Line
                                       Items on the Air Force Contract                                22




                             Page i                                      GAO-03-727 DOD Contract Payments
Contents




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Page ii                                               GAO-03-727 DOD Contract Payments
A
United States General Accounting Office
Washington, D.C. 20548



                                    August 8, 2003                                                                        Leter




                                    The Honorable Jim Nussle
                                    Chairman
                                    Committee on the Budget
                                    House of Representatives

                                    Dear Mr. Chairman:

                                    The reliability of contract disbursing data is critical to the Department of
                                    Defense (DOD) for (1) properly accounting for and accurately making
                                    contract payments, (2) effectively accounting for and controlling billions of
                                    dollars in budget authority, and (3) preparing reliable financial information
                                    on the results of operations to support management and congressional
                                    decision making on programs, operations, and budget requests. We have
                                    previously reported1 on DOD’s inability to accurately account for and
                                    report on disbursements, which is a long-term problem that is pervasive
                                    and complex in nature. For example, Defense Finance and Accounting
                                    Service (DFAS) Columbus fiscal year 1999 data showed that almost $1 of
                                    every $3 in contract payment transactions in the Mechanization of Contract
                                    Administration Services (MOCAS) system was for adjustments to
                                    previously recorded payments—$51 billion of adjustments out of
                                    $157 billion in transactions.

                                    You asked that we determine (1) the magnitude of adjustments that
                                    affected previously recorded payments and DFAS Columbus’s reported
                                    cost to make these adjustments during fiscal year 2002, (2) why contracts,
                                    including payment instructions, were so complex, (3) the key factors that
                                    caused DFAS Columbus to make payment adjustments for the two
                                    contracts that we reviewed in detail, and (4) what steps DOD has taken or
                                    planned to address the adjustment problem. As agreed with your office, we
                                    analyzed two contracts to determine how complex contracts and related
                                    payment instructions contributed to DOD’s payments not being properly
                                    allocated to the correct obligations. In selecting these two contracts, we
                                    worked with DFAS Columbus to identify complex contracts for which they
                                    had encountered problems with correctly allocating payments to
                                    obligations. Thus, the two contracts—a $565 million Army missile contract
                                    and a $49 million Air Force communications contract—are not



                                    1
                                     See Related GAO Products at the end of this report.




                                    Page 1                                                 GAO-03-727 DOD Contract Payments
                   representative of all DOD contracts but, based on our experience, have
                   characteristics similar to other complex contracts.

                   Our review was performed from August 2002 through July 2003 in
                   accordance with U.S. generally accepted government auditing standards.
                   We did not audit the DFAS Columbus data on disbursements, collections,
                   and adjustments or the costs incurred by DFAS Columbus to reconcile
                   contracts. 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 Director,
                   Defense Procurement and Acquisition Policy, Under Secretary of Defense
                   (Acquisition, Technology, and Logistics), are reprinted in appendix II.



Results in Brief   For fiscal year 2002, DFAS Columbus data showed that about $1 of every $4
                   in contract payment transactions in MOCAS was for adjustments to
                   previously recorded payments—$49 billion of adjustments out of $198
                   billion in disbursement, collection, and adjustment transactions. This is an
                   improvement over fiscal year 1999 when reported adjustments represented
                   $1 of every $3 in contract payment transactions. To research the payment
                   allocation problems and make adjustments to correct the disbursing and
                   accounting records, DFAS Columbus reported that it incurred costs of
                   about $34 million in fiscal year 2002 primarily for hundreds of DOD and
                   contractor staff. This represents about 35 percent of the total $97 million in
                   reported costs related to the DFAS Columbus contract pay service
                   operations. DFAS Columbus currently bills DOD activities (for example,
                   the Army) for contract pay services based solely on the number of lines of
                   accounting on an invoice. Consequently, all DOD activities pay the same
                   line rate, regardless of whether substantial work is needed to reconcile
                   problem contracts and adjust the payment records. As a result, the
                   contracting offices that contributed to payment allocation problems had
                   insufficient incentives to reduce payment errors and associated costs.

                   Our analysis of the two contracts we reviewed in detail showed that the
                   contracts and payment instructions were complex because of a
                   combination of factors including the following:




                   Page 2                                         GAO-03-727 DOD Contract Payments
• Legal and DOD requirements to track and report on the funds used to
  finance the contract. For example, on the $565 million Army missile
  contract, (1) 74 different accounting classification reference numbers
  (ACRN)2 were funded by eight different appropriation accounts and
  sales to three foreign countries, (2) 24 of the 74 ACRNs were created to
  comply with legal requirements to report on the appropriations used to
  finance the contract as well as the types of obligations, such as
  personnel, supplies, and acquisition of assets, and (3) the remaining 50
  ACRNs were created to comply with DOD requirements.

• Substantial number of contract modifications over the years that added
  goods and/or services, or added or changed payment instructions. For
  example, the $49 million Air Force communications contract was
  modified 82 times over a 3-year period, including 73 modifications that
  changed the payment instructions.

• Different pricing provisions for goods and services on the contract. For
  example, the Army contract contained 25 separate contract line
  items3—15 were to be paid for under fixed price provisions and 10 were
  to be paid for under cost reimbursable provisions.

Our analysis of $160 million of adjustments for the two contracts we
reviewed showed that 1,458 adjustment transactions were made to
reallocate payments to the correct ACRNs for four reasons: (1) the Army
made an error in accounting for obligations, resulting in about $127 million
in payment allocation adjustments, (2) DFAS Columbus did not follow its
internal procedures for allocating payments to ACRNs on an Army contract
containing multiple pricing provisions when the Army failed to provide
payment instructions, resulting in about $5 million in adjustments,
(3) DFAS Columbus made over $2 million in adjustments to correct
recording errors on the Army contract due to complex and changing
payment instructions, and (4) the Air Force frequently changed payment



2
 For all contracts, the contracting office assigns a two-digit ACRN to each line of accounting
containing unique accounting information in accordance with the requirements contained in
the Defense Federal Acquisition Regulation Supplement (DFARS). Obligations are
established at the ACRN level to ensure that funds are available to cover disbursements.
DFAS Columbus allocates the payments to the ACRNs in an attempt to match contractor
payments to the corresponding obligations.
3
 According to DFARS 204.7103-1, contracts shall identify the items or services to be
acquired as separate contract line items.




Page 3                                                  GAO-03-727 DOD Contract Payments
instructions after payments were made on the Air Force contract, resulting
in about $26 million in adjustments.

Since 1995, DOD had been attempting to develop a new system—called the
Defense Procurement Payment System (DPPS)—to resolve DOD’s long-
standing disbursement problems. However, DOD terminated DPPS in
December 2002, after 7 years in development at a reported cost of over
$126 million, because of poor program performance and increasing life
cycle costs. DOD has now initiated a major long-term effort—referred to
as an enterprise architecture—to improve its business operations,
including its acquisition and disbursement activities. If implemented
successfully, this initiative may help correct many of the contract payment
allocation problems.

In the interim, DOD officials informed us they have several efforts under
way to address these types of payment allocation problems that would help
reduce adjustments made to previously recorded payments. First,
beginning in fiscal year 2004, DFAS Columbus plans to realign its billing
structure and bill contracting offices for reconciliation services to provide
them with an incentive to reduce payment errors and related reconciliation
costs. Second, DFAS Columbus, in partnership with the Defense Contract
Management Agency, visited major procuring activities throughout DOD
and provided information on the correct methods for presenting payment
instructions on contracts. Finally, in September 2002, DOD established a
working group4 to develop payment allocation options for presenting
standard payment instructions on complex contracts that, if implemented,
would be used throughout the DOD contracting community. Our analysis
showed that this initiative should help reduce some of the payment
allocation errors that are the result of misinterpreted payment instructions
but would not completely eliminate payment allocation errors made by
DFAS Columbus when it manually allocates payments to contract ACRNs.
In order to eliminate payment allocation errors, DOD would need to take
the next step in the process and automate the standard payment
instructions so that DFAS Columbus can electronically process the
payments with minimal manual intervention. The working group has not
completed its work and has not yet established a completion date. Further,
DOD has not yet made a final decision to implement the payment allocation


4
  The working group consists of representatives from the Offices of the Under Secretary of
Defense (Comptroller) and the Under Secretary of Defense (Acquisition, Technology, and
Logistics), DFAS Columbus, and the Defense Contract Management Agency.




Page 4                                                 GAO-03-727 DOD Contract Payments
             options for presenting standard payment instructions throughout the DOD
             contracting community.

             We are making recommendations to the Secretary of Defense to improve
             the process of properly allocating payments to correct ACRNs, including
             (1) developing payment allocation options for presenting standard payment
             instructions contained in contracts and (2) automating the standardized
             payment instructions. We are also making recommendations to the Under
             Secretaries of Defense (Acquisition, Technology, and Logistics) and
             (Comptroller) to follow existing regulations and procedures concerning
             contract payment instructions. In its comments on a draft of this report,
             DOD concurred with two of the four recommendations and partially
             concurred with the two recommendations related to developing and
             automating the standard payment instructions. DOD stated that although
             the working group would analyze their feasibility, until the coordination
             and review process was completed, it could not commit to these actions.
             DOD did not indicate any time frame for completing the coordination and
             review process referred to in its response. We continue to believe that
             decisive steps towards a lasting solution in these two areas are essential to
             address DOD’s long-standing contract payment problems.



Background   DFAS Columbus uses MOCAS to make contract payments for the Army,
             Navy, Air Force, and other DOD organizations. In fiscal year 2002, DFAS
             Columbus reported that it made about $87 billion of contract payments.
             DOD, including DFAS Columbus, uses a line of accounting to accumulate
             appropriation, budget, and management information for contract
             payments. Figure 1 shows a line of accounting on the Air Force contract
             that we reviewed.




             Page 5                                        GAO-03-727 DOD Contract Payments
                            Figure 1: Sample Line of Accounting on the Air Force Contract


                                                 Fiscal year                                             Commitment
                                                                                                         document number
                                                                                    Commitment issuing
                                      Appropriation limit                                office code
                                     Appropriation                  Element of resource
                                          account                    code (object class)




                                     BK 97 0 0400 4500 0 5D 5D07 71001000000 255Y 9HZZZZ MIPROLRAB9H756 09H690 S28043




                               ACRN                   Operating                                     Job order number
                                                        agency
                             Department                          Allotment                                 Fiscal accounting
                                   code                        serial number                                  station number
                                             Fiscal                            Army management
                                             year                              structure code


                            Source: DOD.



                            A line of accounting provides various information, such as (1) department
                            code (for example, those for the military services) and (2) fiscal year and
                            appropriation account financing the contract. For all contracts, the
                            contracting office assigns an ACRN to each line containing unique
                            accounting information in accordance with the requirements contained in
                            the Defense Federal Acquisition Regulation Supplement (DFARS).
                            Obligations5 are established at the ACRN level to ensure that funds are
                            available to cover disbursements. DFAS Columbus allocates payment
                            amounts to ACRNs to match contractor payments to the corresponding
                            obligations.



Organizations Involved in   DOD payment and accounting processes are complex, generally involving
the Contract Payment        separate functions carried out by separate offices in different locations
                            using different procurement, accounting, and payment systems. The
Process
                            processes are not always integrated and require data to be entered and



                            5
                              Obligations are the amounts of orders placed, contracts awarded, services received, and
                            similar transactions during an accounting period that will require payment during the same,
                            or a future, period.




                            Page 6                                                        GAO-03-727 DOD Contract Payments
                                                    sometimes reentered manually. Figure 2 shows the payment process
                                                    information flow for the Air Force contract that we reviewed.



Figure 2: Payment Process Information Flow for the Air Force Contract




                                                         Contract and                           Goods and
                                                         modifications                           services




                                                                             Communications                                     DOD
                                                                               contractor                                     activities
                                  Purchase
                                  requests




                                                 Air Force                   Invoices/
        DOD funding                                                                        Payments
                                             contracting office              vouchers
         activities



                                                          Contract and
                                                          modifications



                                                                                                          Receiving reports

                                                                                                                                 Defense Contract
                                                                                                                                Management Agency
                                                                                                          Voucher approval
                                                                             DFAS Columbus
                                                                              (paying office)


                                                                  Disbursement
                                                                                            Adjustments
                                                                          data




                                                                                                                                  Defense Contract
                                                                                                                                   Audit Agency



                                                                             DFAS accounting
                                                                                stations

 Source: GAO and Art Explosion.




                                                    Page 7                                                         GAO-03-727 DOD Contract Payments
                              As illustrated above, the payment process information flow for the Air
                              Force contract began when DOD funding activities requested that the Air
                              Force contracting office procure engineering and technical services as well
                              as spare parts. The Air Force contracting office awarded the contract and
                              modified it to procure additional items. The Air Force contracting office
                              forwarded the contract and modifications to several organizations, such as
                              the communications contractor and DFAS Columbus paying office. Upon
                              receipt of the contract and modifications, the communications contractor
                              performed work for the DOD activities and submitted invoices to DFAS
                              Columbus for payment. For goods procured under the contract, the
                              Defense Contract Management Agency, which is located at the contractor’s
                              site, accepted the goods on behalf of the DOD activities and provided
                              receiving report information to DFAS Columbus. The communications
                              contractor then forwarded the goods to the DOD activities. For services
                              provided by the contractor, the contractor submitted vouchers for services
                              directly to DFAS Columbus for payment. The vouchers were subject to
                              later audit by the Defense Contract Audit Agency.

                              Before making payments to the contractor, DFAS Columbus matched the
                              documents—through automated and manual processes—provided by the
                              Air Force contracting office, the communications contractor, and Defense
                              Contract Management Agency to ensure that (1) items ordered were
                              received and (2) funds were obligated and available to make the payments.
                              Finally, DFAS Columbus paid the contractor, recorded the payment data in
                              DFAS Columbus records, and forwarded these data to the DFAS
                              accounting stations responsible for recording the data in the various DOD
                              organizations’ accounting systems. When errors occurred in allocating
                              payments to the correct ACRNs, the DFAS Columbus contract
                              reconciliation branch made adjustments to correct the payment allocations
                              in DFAS Columbus and the applicable DFAS accounting station records.



Description of the Army and   In order to identify some of the problems DFAS Columbus has experienced
Air Force Contracts           in properly allocating payments to the ACRNs on contracts, we selected an
                              Army and an Air Force contract for a detailed review. These contracts
Reviewed                      support two programs—the Army Tactical Missile System and the Army
                              Data Link System. A description of each of these programs is presented
                              below.

                              • We reviewed an Army contract (contract number DAAH01-98-C-0093)
                                with Lockheed Martin Vought Systems Corporation concerning the
                                Army Tactical Missile System. This missile system is one of a family of



                              Page 8                                       GAO-03-727 DOD Contract Payments
   complementary weapons initially developed by the Army and Air Force
   for engaging enemy forces deep behind the front battle lines. The
   missile system was designed to attack those forces that are in a position
   to have an immediate or directly supporting impact on the close-in
   battle, but are beyond the range of cannon and rocket artillery systems.
   It is intended to delay, disrupt, neutralize, or destroy targets, such as
   second echelon maneuver units, missile sites, and forward command
   posts.

   The Army Tactical Missile System consists of a surface-to-surface
   ballistic missile that can be launched from and controlled by the Army’s
   Multiple Launch Rocket System. The missile system was initially fielded
   with an “antipersonnel/antimaterial warhead” for attacking stationary
   targets. Since the weapon system was first fielded, the missile system
   has been modified to increase its range, improve its guidance systems,
   and reduce collateral damage. This missile system was used in the
   recent war in Iraq. Figure 3 is a photograph of the missile system.




Page 9                                       GAO-03-727 DOD Contract Payments
Figure 3: Army Tactical Missile Launched from Multiple Launch Rocket System




Source: U.S. Army Aviation and Missile Command, Public Affairs Office.


• We reviewed an Air Force contract (contract number F09604-00-C-0090)
  with L-3 Communications to maintain the Army portion of the Army
  Data Link System.6 The Army and Air Force developed the Army Data
  Link System to transfer near-real-time targeting information collected by
  aircraft, satellites, and ground stations and provides this information to
  aircraft and tactical commanders on the ground in-theater. The system
  consists of three major components—the Army Interoperable Data Link,
  the Direct Air to Satellite Relay, and the Reach Back Relay. The Army


6
 In prior years, the Army portion of the Army Data Link System was part of another contract
that supported both the Army and Air Force. According to Air Force contracting officials,
the Air Force separated its portion from the Army portion of the contract because the
contract became difficult to administer due to its size. The Air Force contracting office
retained responsibility for administering both the Army and Air Force portions of the data
link systems.




Page 10                                                                  GAO-03-727 DOD Contract Payments
                                                             Interoperable Data Link provides two-way secure direct
                                                             communications between aircraft and aircraft-to-ground stations. The
                                                             Direct Air to Satellite Relay communicates data gathered by aircraft
                                                             through a secure satellite link to an in-theater ground processing facility.
                                                             The Reach Back Relay communicates data gathered through a secure
                                                             satellite link to ground processing facilities in the continental United
                                                             States. The Data Link System was also used in the recent war in Iraq.
                                                             Figure 4 shows how the communications system transfers data.



Figure 4: Army Data Link System Transferring Information Collected by Aircraft, Satellites, and Ground Stations




     ARL                                           DASR




                                                                     ETRAC                         TMET




                                                                                                                          Remote
                                                                                                                          Repeater
                                      Guardrail




Source: Air Force contractor L-3 Communications.




                                                          Page 11                                         GAO-03-727 DOD Contract Payments
DFAS Columbus Made        For fiscal year 2002, our analysis of DFAS Columbus data showed that
                          about $1 of every $4 in contract payment transactions in MOCAS was for
$49 Billion of            adjustments to previously recorded payments—$49 billion of adjustments
Adjustments at a Cost     out of $198 billion in disbursement, collection, and adjustment
                          transactions. This is an improvement over fiscal year 1999 when DFAS
of about $34 Million in   Columbus data showed that about $1 of every $3 in contract payment
Fiscal Year 2002          transactions (transactions for disbursements, collections, and
                          adjustments) in MOCAS was for adjustments to previously recorded
                          payments—$51 billion of adjustments out of $157 billion in transactions.
                          While DOD has been working on resolving these problems for years, it has
                          yet to correct them.

                          To research the payment allocation problems and make adjustments to
                          correct the disbursing and accounting records, DFAS Columbus reported
                          that it incurred costs of about $34 million in fiscal year 2002, primarily for
                          hundreds of DOD and contractor staff. This represented about 35 percent
                          of the $97.4 million that DFAS Columbus spent on contract pay service
                          operations. Our review showed that the specific contracting offices that
                          contributed to payment allocation problems resulting in adjustments did
                          not pay for all of the work DFAS Columbus performed to make the
                          adjustments. This occurred because DFAS Columbus currently bills DOD
                          activities (for example, the Army) for contract pay services based solely on
                          the number of lines of accounting on an invoice. Consequently, all DOD
                          activities pay the same line rate, regardless of whether substantial work is
                          needed to reconcile problem contracts and adjust the payment records. As
                          a result, the contracting offices that contributed to payment allocation
                          problems had insufficient incentives to reduce payment errors and
                          associated costs. As discussed later in this report, DOD is taking action to
                          change its billing structure for DOD activities.



Contracts Were            Our analysis of an Army and an Air Force contract showed that the
                          contracts and related payment instructions were complex because of a
Complex Due to Legal      combination of factors, including the (1) legal and DOD requirements to
and DOD                   track and report on the funds used to finance the contract, (2) number of
                          modifications made to the contract over the years that added goods and/or
Requirements,             services, or added or changed payment instructions for these goods and/or
Contract                  services, and (3) different pricing provisions to pay for goods and services
Modifications, and        on the contract. While we identified these three factors as unique areas,
                          the factors are interrelated and contributed to the contracts containing
Pricing Provisions        complex payment instructions and the difficulty DFAS Columbus had in



                          Page 12                                        GAO-03-727 DOD Contract Payments
                             properly allocating payment amounts to the correct ACRNs, ultimately
                             contributing to a high rate of adjustments.



Legal and DOD                In order to maintain administrative control over appropriated funds, DOD
Requirements Contribute to   has established a system of controls to help ensure that funds obligated and
                             then expended for the procurement of goods and services were used as
Complex Contracts            intended and in accordance with applicable laws and regulations. A system
                             of controls should be designed to help ensure that agencies do not obligate
                             or expend more funds than available. However, DOD’s system contributes
                             to the complexity of the contracts.

                             To report on the status of its appropriated funds—including amounts
                             obligated and expended—DOD uses a line of accounting to accumulate
                             appropriation, budget, and management information. For all contracts, the
                             contracting office assigns a two-digit ACRN to each line containing unique
                             accounting information in accordance with the requirements contained in
                             DFARS 204.7107 (c). DFAS Columbus allocates payments to the ACRNs to
                             match contract payments to the corresponding obligations.

                             For the two contracts that we reviewed, the Army contract that was valued
                             at $565 million contained 74 separate ACRNs funded by 8 different
                             appropriation accounts and sales to three foreign countries, and the Air
                             Force contract that was valued at $49 million contained 89 ACRNs funded
                             by 23 different appropriation accounts. Each ACRN was established to
                             comply with the DFARS requirement for a separate ACRN for each unique
                             line of accounting. The information on the line of accounting (1) is needed
                             to track the obligations and disbursements back to the DOD activity
                             authorizing the work and (2) provides information on the obligations and
                             disbursement data, such as the organizations providing the funding. While
                             DOD created all of these ACRNs to comply with its requirements, our
                             analysis of the lines of accounting showed that DOD used ACRNs to
                             provide the information needed to comply with legal requirements to




                             Page 13                                      GAO-03-727 DOD Contract Payments
                              account for obligations by appropriation account7 and by object class.8 On
                              the Army contract that contained 74 ACRNs, 24 of these ACRNs—about
                              one-third—were used by DOD to provide the information needed to satisfy
                              the legal requirements. Likewise, on the Air Force contract that contained
                              89 ACRNs, 48 of these ACRNs—or more than half—were used by DOD to
                              provide the information needed to satisfy the legal requirements. DOD
                              accounts for each of these ACRNs separately—in effect treating them as
                              separate bank accounts—even though they all fund the same contract.
                              Each additional ACRN increases the risk of incorrectly allocating payments
                              to the wrong ACRN.



Frequent Contract             While accounting requirements and related ACRNs contributed to complex
Modifications Contribute to   contracts, frequent contract modifications to procure additional goods and
                              services are another factor that contributed to complex contracts. When
Complex Contracts
                              DOD orders more goods and/or services than provided on the original
                              contract, DOD modifies the contract and pays the contractor for the
                              additional goods and/or services. Many times different appropriation
                              accounts are used to pay for these additional goods and/or services
                              resulting in DOD creating more ACRNs to account for the funds. Our
                              analysis of two DOD contracts showed that they were modified many times
                              over the years to procure additional goods and/or services, as well as to
                              add or change payment instructions. Our review found that modifications
                              that changed payment instructions resulted in DFAS Columbus making
                              adjustments to correct prior payment allocations to ACRNs.

                              • In 1997, the Army contracted with Lockheed Martin Vought Systems
                                Corporation to produce an updated version of the Army Tactical Missile
                                System. The basic contract was for the procurement of 100 guided


                              7
                               Several statutes and implementing regulatory requirements established by the Secretary of
                              the Treasury (Treasury) and the Office of Management and Budget (OMB) require the
                              reporting of contractual obligations, properly recorded as prescribed by 31 U.S.C. Section
                              1501, and related disbursements. Principal among these are the content requirements for
                              agencies’ annual budget submission and budget execution reports, 31 U.S.C. Sections 1108c
                              and 1554, respectively, and the Treasury and OMB accounting system and financial reporting
                              requirements that implement 31 U.S.C. Sections 1511 to 1514.
                              8
                                Object classes present information on obligations by the items or services purchased by the
                              federal government. Object classes include personnel compensation and benefits,
                              contractual services and supplies, and acquisition of assets. The President’s budget is
                              required by 31 U.S.C. Section 1104(b) to present obligations by object class for each
                              account, and OMB requires agencies to report on these object classes.




                              Page 14                                                 GAO-03-727 DOD Contract Payments
   missiles and launching assemblies for the Army missile program. The
   Army program office initially obligated $14.2 million in 1997 for this
   effort. As of September 30, 2002, the estimated contract value increased
   to almost $565 million. Our analysis of this contract showed that it was
   modified 122 times over a 5-year period to (1) increase the number and
   type of missile systems ordered for the Army and three foreign countries
   from 100 to 833, (2) procure over 270,000 engineering service hours to
   support the production of the missile systems, and (3) make other
   changes necessary to administer the contract. The Army contracting
   office also issued six modifications to provide detailed payment
   instructions to DFAS Columbus. According to the Administrative
   Contracting Officer, the payment instructions were issued to resolve
   payment allocation errors made by DFAS Columbus and to ensure that
   the payments were applied to the correct ACRNs on the contract.

• Like the Army contract, the Air Force contract was also modified a
  number of times to procure additional goods and services and to
  administer the contract. In October 1999, the Air Force contracted with
  L-3 Communications to maintain the Army portion of the Army Data
  Link System. The basic contract contained a description of the
  engineering and technical services and spare parts necessary to
  maintain the communications system worldwide. The contract also
  stated that funding for the engineering and technical services as well as
  miscellaneous spare parts would be included on individual funding
  modifications on this contract. As of September 30, 2002, the estimated
  contract value was about $49 million. Our analysis of this contract
  showed that it was modified 82 times over a 3-year period by five
  different procurement contracting officers to (1) provide funding for
  and/or increase/decrease the requirements for engineering and technical
  services and miscellaneous spare parts to maintain the Army assets for
  the Army Data Link System and (2) make other changes necessary to
  administer the contract. Furthermore, 73 of the 82 modifications
  revised the payment instructions.




Page 15                                      GAO-03-727 DOD Contract Payments
Contract Pricing Provisions   Our analysis of two DOD contracts showed that contract-pricing provisions
Contribute to Complex         were a third factor that contributed to the complexity of these contracts.
                              As stated previously, the Army and Air Force contracting offices issued
Contracts                     many contract modifications to procure goods and services on behalf of the
                              military services. These modifications included several contract line items
                              that contained numerous goods or services with different pricing
                              provisions. Contract pricing provisions can be placed into two broad
                              categories—fixed price or cost reimbursable. For example, the Army
                              contract contained firm-fixed-price provisions9 for procuring 833 missiles,
                              and cost-plus-fixed-fee10 and cost-plus-award-fee11 provisions for procuring
                              270,000 engineering service hours to support the missile production.

                              Our review found that contracts containing different pricing provisions are
                              more complex, and thus it is more difficult to properly allocate payments to
                              the correct ACRNs because DFAS Columbus voucher examiners must
                              allocate payment amounts manually, resulting in a greater opportunity for
                              error. When DFAS Columbus voucher examiners manually allocate
                              payment amounts to contract ACRNs, the voucher examiners must ensure
                              that the payment amounts associated with fixed price and cost
                              reimbursable provisions are allocated to those ACRNs funding those
                              payment provisions only. However, in some cases it is difficult for the
                              voucher examiner to readily identify these ACRNs without performing a
                              labor-intensive review of the contract. As a result, sometimes the voucher
                              examiner incorrectly applies the payment amounts to ACRNs funding fixed
                              price provisions instead of ACRNs funding cost reimbursable provisions.
                              Our review of the Army contract found that it contained 25 separate
                              contract line items—15 were to be paid for under fixed price provisions

                              9
                               A firm-fixed-price contract provides for a price that is not subject to any adjustment on the
                              basis of the contractor’s cost experience in performing the contract. This contract type
                              places the maximum risk and full responsibility for all costs and resulting profit or loss on
                              the contractor.
                              10
                               A cost-plus-fixed-fee contract is a cost reimbursement contract that provides for payment
                              to the contractor of (1) allowable incurred cost, to the extent prescribed in the contract, and
                              (2) a negotiated fee that is fixed at the inception of the contract. The fee does not vary with
                              actual cost, but may be adjusted as a result of changes in the work to be performed under
                              the contract.
                              11
                                A cost-plus-award-fee contract is a cost reimbursement contract that provides for a fee
                              consisting of (1) allowable incurred cost, to the extent prescribed in the contract, (2) a base
                              amount fixed at inception of the contract, and (3) an award amount, based on the
                              judgmental evaluation by the government, sufficient to provide motivation for excellence in
                              contract performance.




                              Page 16                                                  GAO-03-727 DOD Contract Payments
                         and 10 were to be paid for under cost reimbursable provisions. Similarly,
                         the Air Force contract contained 66 separate contract line items—16 were
                         to be paid for under fixed price provisions and 50 were to be paid for under
                         cost reimbursable provisions.



Reasons for DFAS         As stated previously, the Army and Air Force contracts that we reviewed
                         were complex due to a number of factors, including legal and DOD
Columbus Making          requirements, contract modifications, and pricing provisions. These
$160 Million of          factors contributed to the difficulty DFAS Columbus had in properly
                         allocating payment amounts to the correct ACRNs. As a result, payment
Adjustments to Correct   amounts on these contracts were not allocated to the correct ACRNs, and
Prior Payment            DFAS Columbus made substantial adjustments to correct the payment
Allocations              allocations. Our evaluation of $160 million of adjustments showed that
                         DFAS Columbus made these adjustments to reallocate payments to the
                         correct ACRNs. Table 1 summarizes the reasons for the adjustments and
                         provides the number and dollar amount of adjustment transactions made to
                         reallocate payments to the correct ACRNs.



                         Table 1: Reasons for $160 Million in Contract Payment Adjustments for Two
                         Contracts

                                                                                                  Dollar value of
                                                                                    Number of      adjustments
                                                                                   adjustment         (dollars in
                         Reasons for the adjustments                             transactions           millions)
                         Army contract writing system error in accounting for
                         contract obligations.                                             92             $127.2
                         Procedures and regulations for an Army contract
                         containing multiple pricing provisions were not
                         followed.                                                         88                4.7
                         Complex and changing payment instructions for the
                         Army contract.                                                    16                2.4
                         Frequent contract modifications to change payment
                         instructions for the Air Force contract.                       1,262               26.1
                         Total                                                          1,458             $160.4
                         Source: GAO.




                         Page 17                                                GAO-03-727 DOD Contract Payments
An Army Contract Writing      From 1998 through 2001, DFAS Columbus paid 43 invoices totaling
System Error in Accounting    $63.5 million for the procurement of several missile systems. DFAS
                              allocated these payment amounts to two ACRNs according to the payment
for Contract Obligations      instructions in effect at the time of the payment. Subsequently, the
                              contractor submitted price reductions to the Army for certain contract
                              items that DFAS Columbus had previously paid. In response to the price
                              reductions, the Army issued a contract modification to account for the
                              reductions. When the Army processed this modification, the Army contract
                              writing system incorrectly deobligated the amount for the missiles on the
                              two ACRNs in error and established two new ACRNs on the contract
                              containing the reduced amount. As a result, in January 2002, DFAS
                              Columbus processed 92 adjustment transactions totaling about
                              $127.2 million to move payment amounts to the new ACRNs. In discussing
                              this problem with Army officials, they informed us that they did not know
                              that the system error resulted in DFAS Columbus having to do additional
                              work to make these adjustments. According to these officials, the system
                              problem that resulted in the creation of the new ACRNs was corrected in
                              2001.



Procedures and Regulations    From June 1999 through April 2001, DFAS Columbus paid 38 invoices
for an Army Contract          totaling about $16 million for engineering services on the Army contract.
                              When DFAS Columbus paid the contractor, the contract did not contain
Containing Multiple Pricing
                              specific payment instructions on how to allocate payment amounts to
Provisions Were Not           ACRNs as required by DFARS 204.7107 (e)(3)(i). According to this
Followed                      regulation, when a contract line item is funded by multiple ACRNs, the
                              contracting officer shall provide adequate instructions in the contract to
                              permit the paying office (DFAS Columbus in this case) to accurately charge
                              the ACRNs assigned to that contract line item. Without these payment
                              instructions, DFAS Columbus voucher examiners should follow DFAS
                              Columbus internal procedures.12 These procedures require voucher
                              examiners to prorate payment amounts across all available ACRNs under
                              cost reimbursable provisions when the contract or contractor’s invoice
                              does not provide specific payment instructions on which ACRNs should be
                              charged. However, instead of charging ACRNs funding cost reimbursable
                              provisions only (engineering services), DFAS Columbus voucher
                              examiners manually allocated the payment amounts to ACRNs that funded
                              both engineering services (cost reimbursable provisions) and missiles


                              12
                                   DFAS Columbus Contract Entitlement, Desk Procedure 401, June 1996.




                              Page 18                                               GAO-03-727 DOD Contract Payments
                           (fixed price provisions). As a result, some payment amounts for
                           engineering services were incorrectly allocated to ACRNs funding the
                           procurement of missiles.

                           According to Army contracting officials, in April 2001—almost 2 years after
                           DFAS Columbus paid the first invoice—the Army issued a modification
                           containing detailed payment instructions once it became aware that DFAS
                           was having difficulty in allocating payment amounts to the correct ACRNs.
                           These instructions were different from the payment allocation procedures
                           followed by DFAS Columbus. However, by that time, DFAS Columbus had
                           made 38 payments to the contractor for engineering services and allocated
                           these payments to several ACRNs. To correct payment allocation problems
                           associated with 7 of the previous 38 payments, DFAS Columbus processed
                           88 adjustment transactions totaling about $4.7 million to reallocate
                           previously recorded payments according to the new instructions.



Complex and Changing       DFAS Columbus also processed 16 transactions totaling about $2.4 million
Payment Instructions for   in adjustments to correct payment errors made by DFAS Columbus
                           voucher examiners when they manually applied payment amounts to
the Army Contract          ACRNs on the Army contract. In April 2001, the Army issued a contract
                           modification that provided specific payment instructions to ensure that
                           funds were used prior to cancellation. DFAS Columbus officials told us
                           that these payment instructions were complex and changed several times
                           after the modification was first issued. For example, the following
                           instructions were included in contract modifications to provide payment
                           instructions for contract line item number (CLIN)13 0030.

                           • Contract modification 74 dated April 2001 stated that, “Subclins under
                             CLIN 0030 – prorate across ACRNs BR, BS, and BT.”

                           • Seven months later, in November 2001, contract modification 89 added
                             additional payment terms for CLIN 0030 by incorporating instructions
                             for CLIN 0031 and instructions for contract award fees under these two
                             CLINs. The modification stated, “Subclins under CLIN 0030/0031 –
                             prorate across ACRNs BR, BS, BT, BX, BY, and CD, unless voucher
                             identifies award fee then prorate across ACRNs CE, CF, CG, and CH.”



                           13
                            According to DFARS 204.7103-1, contracts shall identify the items or services to be
                           acquired as separate contract line items.




                           Page 19                                                GAO-03-727 DOD Contract Payments
• Seven months later, in June 2002, contract modification 109 provided
  more payment instructions for CLIN 0030/0031. The modification noted
  that, “Subclins under CLIN 0030/0031 – prorate across ACRNs BR, BS,
  BT, BX, CD, CN, CT, CU, CW and DA, unless voucher identifies award
  fee then prorate across ACRNs CE, CF, CG, CH and CV, or if voucher
  identifies technical publications then prorate across ACRNs BY, CR, and
  DA.”

Our analysis of the payment instructions showed that the instructions were
complex, changed several times, and were difficult to administer properly.
We found that $2.4 million of adjustment transactions were the result of
errors made by voucher examiners. These errors occurred because the
examiners did not follow the complex, frequently changed, and
nonstandard payment instructions correctly. In order for DFAS Columbus
to properly allocate payments on CLIN 0030, our work showed that the
voucher examiner must (1) identify the current modification in effect at the
time of payment to ensure payments are allocated in accordance with the
payment instructions, (2) determine the type of invoice to ensure the
allocations are made against the correct ACRNs, for example, technical
publications or award fee, (3) identify the current available balance
associated with ACRNs funding the services, and (4) calculate a prorated
balance to be distributed to each ACRN funding the services. For example,
for one invoice totaling $350,635 on the Army contract, DFAS Columbus
paid two contract line items and allocated the payment amounts to 23
ACRNs in an attempt to comply with the payment instructions on the
contract that were in effect on the payment date. This condition resulted in
errors in the contract records when voucher examiners incorrectly
allocated payment amounts to the wrong ACRNs.

In discussing this problem with DFAS Columbus officials, they confirmed
our analysis that the payment instructions were complex and difficult to
administer properly. The officials stated that when a contract contains
payment instructions similar to the instructions presented above, DFAS
Columbus voucher examiners must manually allocate the payment
amounts to contract ACRNs. The officials also stated that the instructions
on this contract were very complicated and could easily be misinterpreted
if voucher examiners do not carefully review the payment instructions
prior to allocating the payment amount to ACRNs on the contract.




Page 20                                      GAO-03-727 DOD Contract Payments
Frequent Contract              In March 2001, DFAS Columbus processed 1,262 transactions totaling over
Modifications to Change        $26 million to adjust previously recorded payment allocations on the Air
                               Force contract. At the time these adjustments were made, the Air Force
Payment Instructions for Air   had already issued 42 modifications, which changed the payment
Force Contract                 percentages that DFAS Columbus was required to follow to make correct
                               payment allocations. Because the number and frequency of the payment
                               percentages changed, DFAS Columbus did not allocate payment amounts
                               to the correct ACRNs in many cases.

                               The Air Force awarded a contract in October 1999 to procure engineering
                               and technical services and spare parts to maintain the Army Data Link
                               System. Over the next 3 years, the contract was modified numerous times
                               to increase the requirements for engineering and technical services and
                               spare parts, along with the necessary incremental funding amounts to
                               support these requirements. As additional funds were added to the
                               contract, (1) new ACRNs were added or obligation balances for existing
                               ACRNs increased and (2) the payment percentages were modified to reflect
                               the new obligation balances of the affected ACRNs. For example, the Air
                               Force modified contract line item number 0006 for engineering services
                               three times over a 2-month period to incrementally fund these services.
                               Each time, the Air Force changed the ACRN payment percentages funding
                               the contract line item.

                               Our analysis of the contract showed that allocating payments on this
                               contract has been very difficult, and voucher examiners could easily
                               misinterpret the payment instructions because of the numerous contract
                               modifications that changed ACRN payment percentages. These
                               instructions were complex and difficult to administer because
                               (1) modifications frequently changed the payment instructions and
                               (2) many ACRNs were financing numerous contract line items. The
                               percentages changed so frequently that DFAS Columbus voucher
                               examiners could not keep track of ACRN balances in order to allocate
                               payment percentages properly. Also, when many ACRNs financed
                               numerous contract line items, DFAS Columbus had difficulty identifying
                               how much of an ACRN’s obligation amount related to each line item.
                               Therefore, many payments were not allocated in accordance with the
                               current modification, and adjustments were needed to correct these
                               allocations. Figure 5 illustrates the current funding structure for 3 of the 66
                               contract line items on the Air Force contract.




                               Page 21                                        GAO-03-727 DOD Contract Payments
Figure 5: Contract Funding Structure for Three Contract Line Items on the Air Force
Contract


                                                        Air Force contract

                        CLIN                                   CLIN                                   CLIN
            1016 1st Military Intelligence         1018 15th Military Intelligence       1019 224th Military Intelligence
             Specialized Repair Activity            Specialized Repair Activity            Specialized Repair Activity
                $55,000 (41%) into BV                   $44,996 (16%) into AJ                  $152,764 (55%) into BV
                $77,580 (59%) into BZ                  $100,000 (35%) into BV                  $124,977 (45%) into BZ
                                                       $100,000 (35%) into CD
                                                        $38,212 (14%) into DK




              S                          S                        S                          S                    S
             AJ                        BV                        BZ                         CD                   DK
                                                      5 ACRN "Accounts"

Source: GAO illustration of contract funding structure contained in Air Force contract modification P00073.



As shown above, the relationship of CLINs to ACRNs is complex because
there is not a one-to-one relationship. This makes it difficult for DFAS
Columbus to accurately allocate payments to ACRNs. Because the
contract funding structure was complex, DFAS Columbus voucher
examiners did not properly allocate payments to the correct ACRNs. Thus,
DFAS Columbus sent the contractor’s invoices to its contract reconciliation
branch for payment. In addition, beginning in the fall of 2001, the
contractor began providing a detailed payment distribution schedule with
each invoice submitted to DFAS Columbus to assist it in properly allocating
payments to the correct ACRNs. We found that an invoice totaling
$94,237.18 contained 31 pages of contractor costs and billing charges for 45
contract line items charging 56 different ACRNs. The amounts charged to
the ACRNs by the contractor were as little as $.59 to as much as $88,107.03.




Page 22                                                                          GAO-03-727 DOD Contract Payments
DOD Initiatives to    DOD officials acknowledged that there have been long-standing contract
                      payment allocation problems that have required DFAS Columbus to
Address Payment       undertake time-consuming and costly reconciliations to correct allocation
Allocation Problems   errors. DOD has initiated a major long-term effort to develop and
                      implement an enterprise architecture, which is intended to improve its
                      business operations, including its acquisition and disbursement activities.
                      If implemented successfully, this initiative may help correct many of the
                      contract payment allocation problems. In the interim, DOD has several
                      initiatives under way to address the payment allocation problems caused
                      by complex contracts with confusing payment instructions. First, DFAS
                      plans to bill reconciliation costs to contracting offices that contribute to
                      payment allocation problems. Second, DFAS Columbus is briefing the
                      DOD acquisition community on methods for presenting payment
                      instructions in contracts. Finally, a DOD working group is examining
                      payment allocation problems and plans to develop and implement payment
                      allocation options for presenting standard payment instructions on
                      contracts DOD-wide to address these problems.



System Improvement    Since 1995, DOD had been attempting to develop a new system—DPPS—to
Initiatives           replace MOCAS, which was developed in the 1960s. DPPS was being
                      designed to resolve DOD’s long-standing disbursement problems,
                      streamline contract and vendor payment processes, and reduce manual
                      interventions. However as we previously reported,14 DOD terminated
                      DPPS in December 2002, after 7 years in development at a cost of over
                       $126 million, because of poor program performance and increasing life
                      cycle costs. DOD officials informed us that enhancements to MOCAS are
                      now being considered to provide some of the automated capabilities that
                      DPPS had been attempting to achieve.




                      14
                       U.S. General Accounting Office, DOD Business Systems Modernization: Continued
                      Investment in Key Accounting Systems Needs to be Justified, GAO-03-465 (Washington,
                      D.C.: Mar. 28, 2003).




                      Page 23                                            GAO-03-727 DOD Contract Payments
                           The failure of DPPS to become DOD’s standard procurement payment
                           system is indicative of DOD’s long-standing inability to efficiently and
                           effectively modernize its financial management and business systems. For
                           example, we recently reported15 that over $300 million has been invested to
                           develop several DFAS financial management systems and that DOD has not
                           demonstrated that this investment will substantially improve the financial
                           management information needed for decision-making and financial
                           reporting purposes. To help avoid this type of result, we recommended in
                           2001 that DOD develop and implement an enterprise architecture, an
                           essential modernization management tool.16

                           As part of its current effort to transform its business operations, DOD is
                           developing a business enterprise architecture. A key area of focus is DOD’s
                           acquisition and disbursement activities. As we have previously reported,
                           DOD contract management has been a high-risk area within the department
                           since 1992.17 To address these problems, DOD’s business enterprise
                           architecture development effort is intended to (1) incorporate federal
                           accounting and financial management requirements, (2) consider leading
                           practices in procurement and contract payments, and (3) reengineer its
                           business processes. If implemented as planned, this initiative has the
                           potential to address many of the contract payment allocation problems
                           discussed in this report. However, this is a long-term effort that will take
                           many years to implement.



DFAS Plans to Bill         As pointed out earlier, the contracting offices that contributed to payment
Contracting Offices That   allocation problems have insufficient incentives to structure their
                           contracts, including payment instructions, in a manner that would reduce
Contribute to Payment
                           payment errors and related reconciliation costs. This condition exists
Allocation Problems        because DFAS Columbus currently bills DOD activities (for example, the
                           Army) for contract pay services based solely on the number of lines of
                           accounting on an invoice. DFAS Columbus officials recognized this
                           shortcoming in establishing their billing rates and have informed us that


                           15
                                GAO-03-465.
                           16
                            U.S. General Accounting Office, Information Technology: Architecture Needed to Guide
                           Modernization of DOD’s Financial Operations, GAO-01-525 (Washington, D.C.: May 17,
                           2001).
                           17
                            U.S. General Accounting Office, High-Risk Series: An Update, GAO-03-119 (Washington,
                           D.C.: January 2003).




                           Page 24                                             GAO-03-727 DOD Contract Payments
                           they plan to use a separate billing rate, based on DFAS contract
                           reconciliation costs, to bill customers for reconciling, adjusting, and
                           correcting contract payments beginning in fiscal year 2004. According to
                           the officials, the direct billing hour rate for reconciliation services will be
                           $74.55 in fiscal year 2004 and will be billed to the contracting offices
                           responsible for writing the contracts that require reconciliation. According
                           to the Deputy Director of DFAS Columbus’s Commercial Pay Services,
                           separately billing contracting offices for the reconciliation work should
                           provide an incentive to those offices to reduce the number of payment
                           allocation problems that result in adjustments. In our view, this billing
                           initiative should encourage contracting offices to structure contracts,
                           including payment instructions, in a manner that should help reduce
                           payment errors and reconciliation costs.



DFAS Columbus Briefs DOD   DFAS Columbus, in partnership with the Defense Contract Management
Acquisition Community on   Agency, is providing formal briefings to the DOD acquisition community on
                           various issues related to contract administration, payment, and closeout.
Contract Administration,
                           These briefings are designed to give contracting, procurement, and budget
Payment, and Closeout      personnel throughout DOD better insight into the contract entitlement,
Issues                     payment, and accounting processes provided by DFAS Columbus. They
                           also help to promote teamwork between DFAS Columbus and the
                           acquisition community and provide an opportunity to enhance the
                           communications link that is necessary for these organizations to
                           interoperate efficiently and effectively. These briefings began in November
                           2001 and have been provided to numerous activities across the military
                           services. As of March 2003, presentations had been provided to 18 major
                           acquisition organizations, such as the Army Aviation and Missile Command,
                           the Navy Space and Naval Warfare Systems Command, and the Air Force
                           Space and Missile Systems Center.

                           Among the topics included in these briefings are methods for correctly
                           presenting payment instructions in contracts. The briefing materials
                           emphasize that payment instructions provide a method for assigning
                           payments to the appropriate ACRNs, based on anticipated work
                           performance. Specifically, the materials discuss payment instruction
                           requirements for fixed price and cost reimbursement contracts and provide
                           recommendations for contracting officers to consider when they develop
                           payment instructions. Reference materials that provide additional
                           payment instruction information, available on the Internet, are also cited in
                           these briefings.




                           Page 25                                        GAO-03-727 DOD Contract Payments
DOD Working Group      In September 2002, DOD formed a working group18 to review contract
Examines Payment       payment instructions. The working group’s results were incorporated into
                       a broader DOD initiative to identify needed improvements and reductions
Instruction Problems   to procurement policies, procedures, and processes in DFARS. The
                       working group completed the first phase of its work by researching the
                       types of payment instructions that have caused payment allocation
                       problems and developing proposed changes to DFARS. The working group
                       concluded that payment allocation errors at DFAS Columbus (1) were
                       often the result of problems experienced with confusing payment
                       instructions and (2) were further compounded because DOD did not have
                       payment allocation options for including standard contract payment
                       instructions for use on DOD contracts. As illustrated earlier in this report,
                       payment instructions can be unique to each contract. For example, DFAS
                       Columbus made $2.4 million in payment allocation errors on the Army
                       contract because the voucher examiners made errors when they manually
                       applied payment amounts to ACRNs following complex, nonstandard
                       payment instructions that changed several times. This makes it difficult for
                       DFAS Columbus personnel—who must process the payments and make the
                       adjustments manually—to properly allocate the payments to the correct
                       ACRNs.

                       In the second phase of this effort, the working group developed proposals
                       for regulatory changes to address the types of standard payment
                       instructions applicable to specific contracting situations. Depending on
                       their specific requirements, contracting officers would be able to choose a
                       contracting option that would include the standard payment instructions
                       applicable to that particular situation. For example, the working group is
                       evaluating several different standard payment instructions that DOD
                       contracting offices may use on contracts, including standard payment
                       instructions (1) for ensuring that funds are used before they are no longer
                       available for expenditure and (2) for ensuring that funds can be allocated to
                       the various contract ACRNs based on the balance available on each
                       contract ACRN. The group’s consensus was that such standardization
                       should enable DFAS Columbus to substantially increase its level of
                       automated payments.




                       18
                          The working group consists of representatives from the Offices of the Under Secretary of
                       Defense (Comptroller) and the Under Secretary of Defense (Acquisition, Technology, and
                       Logistics), DFAS Columbus, and the Defense Contract Management Agency.




                       Page 26                                                GAO-03-727 DOD Contract Payments
              During phase three, the final phase that began in May 2003, the working
              group’s proposals will be presented to the Defense Acquisition Regulations
              Council19 and other experts for review. The results from this review
              process will eventually determine whether the working group’s proposals
              will be accepted. DOD has not yet established a milestone date for
              completing the third phase of this effort and has not yet made the final
              decision to implement the options for presenting standard payment
              instructions. While the working group did not study the possibility of
              automating the standard payment instructions, it informed us that
              automating them would be the next logical step if they were implemented.

              Our analysis of the working group initiative to develop standard payment
              instructions showed that it is a good first step because it should reduce
              some of the payment allocation errors that were the result of DFAS
              Columbus voucher examiners misinterpreting contract payment
              instructions. However, even with the standard payment instructions, DFAS
              Columbus will still manually allocate payments to contract ACRNs on
              complex contracts such as the two mentioned in this report. As we
              previously stated, manual payment allocations increase the opportunity for
              errors. In order to eliminate payment allocation errors, DFAS should take
              the next step and automate the standard payment instructions so that
              DFAS Columbus can electronically process the payments with minimal
              manual intervention.



Conclusions   Resolving DOD’s long-standing contract payment problems will require
              major improvements to its processes and systems. One key element of
              DOD’s efforts to improve its business operations is its effort to develop an
              enterprise architecture to guide and constrain its ongoing and planned
              investments in business systems. Another key element to resolving
              contract payment problems would be to determine whether DOD can
              reengineer the way its contracts are written, including the length of time
              covered by a contract as well as the number of modifications made to the
              contract. If successful, these efforts could result in reengineered business
              processes and financial management systems that could address many of
              DOD’s long-standing contract payment allocation problems that have
              required DFAS Columbus to undertake time-consuming and costly


              19
               Pursuant to DOD Instruction 5000.63, subject: Defense Acquisition Regulations System,
              July 31, 2002, the Defense Acquisition Regulations Council is responsible for developing
              fully coordinated recommendations for revisions to the FAR and the DFARS.




              Page 27                                               GAO-03-727 DOD Contract Payments
                      reconciliations to correct allocation errors. However, these reengineered
                      processes and systems are years from becoming reality.

                      In the interim, DOD is addressing some of the fundamental weaknesses
                      that have resulted in billions of dollars of adjustments to correct contract
                      payment allocations annually. However, DOD has not yet completed its
                      work to (1) provide information to the procuring activities on the correct
                      methods for presenting payment instructions on contracts, (2) develop and
                      implement standardized payment instructions to be used DOD-wide, and
                      (3) fully automate the payment process using these instructions. Without
                      standardized and automated payment instructions, DOD will continue to
                      spend millions of dollars each year to process payments manually and then
                      adjust those payments. Further, DOD activities must follow existing
                      regulations and procedures covering payment instructions to help ensure
                      that payment data are accurately recorded against the correct obligations.
                      Until DOD successfully modernizes its business operations, these interim
                      steps will help avoid the inaccurate contract payment data that have
                      hindered DOD’s ability to accurately account for and report on contract
                      disbursements.



Recommendations for   We recommend that the Secretary of Defense direct the Under Secretary of
                      Defense (Acquisition, Technology, and Logistics) to
Executive Action
                      • develop payment allocation options for presenting standard payment
                        instructions in contracts containing multifunded contract line items and

                      • issue guidance to the contracting community reiterating the
                        requirement in DFARS that all contracts containing multifunded
                        contract line items contain payment instructions and that these
                        instructions be revised when additional ACRNs are added.

                      We also recommend that the Secretary of Defense direct the Under
                      Secretary of Defense (Comptroller) to direct the Director of the Defense
                      Finance and Accounting Service to

                      • automate the standardized payment instructions in MOCAS once the
                        standard payment instructions are adopted and

                      • issue guidance reiterating DFAS’s internal requirement that when a
                        contract does not contain payment instructions and the contractor
                        invoice does not contain payment instructions, the payments for costs



                      Page 28                                      GAO-03-727 DOD Contract Payments
                           and services must be allocated to ACRNs financed on a cost
                           reimbursable basis in accordance with DFAS’s desk procedures.



Agency Comments and   DOD provided written comments on a draft of this report. In its comments,
                      DOD concurred with two of the four recommendations and partially
Our Evaluation        concurred with the remaining two recommendations. DOD’s comments
                      are reprinted in appendix II.

                      For the two recommendations with which it concurred, DOD stated that
                      the department will issue memorandums to (1) contracting personnel
                      reiterating the requirements contained in DFARS and (2) DFAS personnel
                      to adhere to DFAS policies and procedures, especially as they relate to the
                      lack of definitive payment instructions in the contractual documents.

                      Regarding the two partial concurrences, DOD stated that it would establish
                      a standard section of the contract for placement of payment provisions,
                      which would include any payment allocation provisions. In addition, DOD
                      agreed that it would, as part of the working group effort referred to in this
                      report, evaluate the feasibility of developing and automating payment
                      allocation options to include in standard payment instructions. However,
                      until the coordination and review process within DOD is complete, DOD
                      stated that it could not commit to the development and automation of
                      standard payment instructions.

                      We understand that actions to develop and automate standard payment
                      instructions must be coordinated with interested parties throughout DOD.
                      At the same time, a clear commitment to completing this effort in a timely
                      manner is critical if DOD is to resolve its long-standing problem of
                      spending tens of millions of dollars each year to make tens of billions of
                      dollars in adjustments to correct the payment allocation problems. When
                      $1 out of every $4 in contract payment transactions continues to be for
                      adjustments to previously recorded payments, decisive steps towards a
                      lasting solution are essential. One concern that we have is that DOD has
                      not indicated any time frame for completing the coordination and review
                      process referred to in its response. As we recently testified,20 cultural
                      resistance to change, military service parochialism, and stovepiped


                      20
                       U.S. General Accounting Office, Department of Defense: Status of Financial
                      Management Weaknesses and Progress Toward Reform, GAO-03-931T (Washington, D.C.:
                      June 25, 2003).




                      Page 29                                          GAO-03-727 DOD Contract Payments
operations have played a significant role in previous failed attempts to
implement management reforms at DOD. Breaking down these barriers
will be critical to successfully reforming DOD’s contract payment
processes and saving the millions of dollars currently spent annually on
inefficient and inaccurate manual processes.

In addition, DOD stated that our findings were based on a review of only
two contracts that had known problems. DOD recommended that the
report specifically state that, due to the nature of this review, the results
cannot be extrapolated to other DOD contracts. The draft report already
included such a statement. The report states that the two contracts we
reviewed are not representative of all DOD contracts but, based on our
experience, have characteristics similar to other complex contracts. DFAS
Columbus provided these contracts as examples of complex contracts with
which they had encountered problems in correctly allocating payments to
ACRNs. We selected these two contracts so we could identify the root
cause of payments not being properly allocated to ACRNs and to determine
what actions DOD is taking to address the problem. We believe that the
two contracts provide a good perspective regarding the types of serious
problems that have long plagued DOD’s contract payment process.


As agreed with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days from its
date. At that time, we will send copies of the report to interested
congressional committees. We will also send copies of this report to the
Secretary of Defense; the Under Secretary of Defense (Comptroller); the
Under Secretary of Defense (Acquisition, Technology, and Logistics); the
Secretaries of the Army, Navy, and Air Force; and the Director of the
Defense Finance and Accounting Service. We will make copies available to
others upon request. In addition, the report will be available at no charge
on the GAO Web site at http://www.gao.gov. If you or your staff have any
questions regarding this report, please contact me at (202) 512-9505 or
kutzg@gao.gov or Greg E. Pugnetti, Assistant Director, at (703) 695-6922 or




Page 30                                        GAO-03-727 DOD Contract Payments
pugnettig@gao.gov. Major contributors to this report are acknowledged in
appendix III.

Sincerely yours,




Gregory D. Kutz
Director, Financial Management and Assurance




Page 31                                    GAO-03-727 DOD Contract Payments
Appendix I

Scope and Methodology                                                                     AA
                                                                                           ppp
                                                                                             ep
                                                                                              ned
                                                                                                n
                                                                                                x
                                                                                                id
                                                                                                 e
                                                                                                 x
                                                                                                 Iis




             To determine the magnitude of adjustments that affected previously
             recorded payments and Defense Finance and Accounting Service (DFAS)
             Columbus’s reported cost to make these adjustments in fiscal year 2002, we
             obtained and analyzed a Mechanization of Contract Administration
             Services (MOCAS) database of contract payment transactions, including
             disbursements, collections, and adjustments, made for fiscal year 2002. We
             then determined the dollar amount and percentage of those adjustments
             that were made to previously recorded payments. We also interviewed and
             obtained cost information from DFAS officials to determine the costs for
             the DFAS Columbus commercial pay services, including the cost incurred
             by DFAS Columbus to make adjustments to previously recorded payments.

             To determine why contracts, including payment instructions, were
             complex, we reviewed applicable laws, Department of Defense (DOD)
             memorandums, regulations, administrative guidelines, policies, and
             procedures governing contract payments. These included a review of the
             key contract payment provisions provided in the Defense Federal
             Acquisition Regulation, DOD acquisition guidance, and DFAS policies. We
             also requested that DFAS Columbus provide us with several contracts that
             created problems for DFAS Columbus technicians when recording
             payments. DFAS Columbus officials provided us with 10 contracts that
             contained problems that DFAS Columbus was having with properly
             allocating payments to accounting classification reference numbers
             (ACRN), such as (1) missing payment instructions, (2) complex payment
             instructions, or (3) the contracting office changing payment instructions.
             Based on our review of contract documentation and interviews with DFAS
             Columbus officials, we selected two contracts for a detailed review to
             determine why the contracts, including payment instructions, were
             complex and caused payment allocation problems.

             The two contracts selected were an Army missile contract (contract
             number DAAH01-98-C-0093) and an Air Force communications contract
             (contract number F09604-00-C-0090). In selecting these two contracts, we
             considered several factors, including (1) goods and/or services purchased,
             (2) the dollar amount of obligations and disbursements made on the
             contract, (3) the number of modifications made to the contract, (4) the
             number of ACRNs financing the contract, (5) payment provisions on the
             contract, and (6) the number of contract reconciliations performed by
             DFAS Columbus. Because contract data were constantly changing, we
             used a cutoff point of September 30, 2002, to gather, review, and analyze
             data on the two contracts.




             Page 32                                     GAO-03-727 DOD Contract Payments
Appendix I
Scope and Methodology




To determine the key factors that caused DFAS Columbus to make
payment adjustments for the two contracts reviewed, we obtained the
contracts, purchase requests, contract modifications, vouchers, invoices,
and other contract documentation. We reviewed this information and
analyzed in detail (1) the payment instructions contained in the contract
and contract modifications, (2) the purpose for and the number of ACRNs
funding the contract, and (3) the number, dollar amount, and reasons for
adjustments on the contracts. To determine why these adjustments were
necessary, we analyzed 2 of the 67 reconciliations performed by DFAS
Columbus (1 review for each contract), which resulted in $160 million of
the $264 million in adjustments.

Finally, to determine what steps DOD has taken or planned to address the
adjustment problem, we (1) reviewed applicable DOD policies to identify
changes in payment instruction guidance, (2) interviewed DFAS officials
responsible for system development projects that affected MOCAS
payments, and (3) interviewed DFAS officials on a working group formed
to improve payment instructions. In addition, we discussed with officials
from DFAS and the Office of the Under Secretary of Defense (Acquisition,
Technology, and Logistics) why the contract payment instructions were so
complex, whether they needed to be so complex, and what the officials
were doing to address this problem.

We performed our review at the headquarters Offices of the Under
Secretary of Defense (Comptroller) and the Under Secretary of Defense
(Acquisition, Technology, and Logistics), Washington D.C., and DFAS,
Arlington, Virginia; DFAS, Columbus, Ohio; Army Aviation and Missile
Command, Redstone Arsenal, Alabama; and Air Force Materiel Command,
Robins Air Force Base, Georgia. Our review was performed from August
2002 through July 2003 in accordance with U.S. generally accepted
government auditing standards, except that we did not validate the
accuracy of (1) DFAS Columbus disbursement data pertaining to the dollar
amount and percentage of those adjustments that were made to previously
recorded payments and (2) the cost incurred to reconcile DFAS Columbus
contracts. We also did not review the DOD acquisition process, including
how contracts are written. We did analyze the payment instructions in the
two contracts that we reviewed. We requested comments on a draft of this
report from the Secretary of Defense or his designee. DOD provided
written comments on July 3, 2003, which are discussed in the “Agency
Comments and Our Evaluation” section of this report and are reprinted in
appendix II.




Page 33                                     GAO-03-727 DOD Contract Payments
Appendix II

Comments from the Department of Defense                      Appendx
                                                                   Ii




              Page 34         GAO-03-727 DOD Contract Payments
Appendix II
Comments from the Department of Defense




Page 35                                   GAO-03-727 DOD Contract Payments
Appendix II
Comments from the Department of Defense




Page 36                                   GAO-03-727 DOD Contract Payments
Appendix III

GAO Contact and Staff Acknowledgments                                                       Appendx
                                                                                                  iI




GAO Contact       Greg E. Pugnetti, (703) 695-6922



Acknowledgments   Staff members who made key contributions to this report were Francine M.
                  DelVecchio, Francis L. Dymond, Dennis B. Fauber, Keith E. McDaniel, and
                  Harold P. Santarelli.




                  Page 37                                    GAO-03-727 DOD Contract Payments
Related GAO Products


             Canceled DOD Appropriations: Improvements Made but More Corrective
             Actions Are Needed. GAO-02-747. Washington, D.C.: July 31, 2002.

             DOD Contract Management: Overpayments Continue and Management
             and Accounting Issues Remain. GAO-02-635. Washington, D.C.: May 30,
             2002.

             Canceled DOD Appropriations: $615 Million of Illegal or Otherwise
             Improper Adjustments. GAO-01-697. Washington, D.C.: July 26, 2001.

             Financial Management: Differences in Army and Air Force Disbursing
             and Accounting Records. GAO/AIMD-00-20. Washington, D.C.: March 7,
             2000.

             Financial Management: Seven DOD Initiatives That Affect the Contract
             Payment Process. GAO/AIMD-98-40. Washington, D.C.: January 30, 1998.

             Financial Management: Improved Reporting Needed for DOD Problem
             Disbursements. GAO/AIMD-97-59. Washington, D.C.: May 1, 1997.

             Contract Management: Fixing DOD’s Payment Problems Is Imperative.
             GAO/NSIAD-97-37. Washington, D.C.: April 10, 1997.

             Financial Management: Status of Defense Efforts to Correct
             Disbursement Problems. GAO/AIMD-95-7. Washington, D.C.: October 5,
             1994.




(192069)     Page 38                                  GAO-03-727 DOD Contract Payments
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