DOD Financial Management: More Reliable Information Key to Assuring Accountability and Managing Defense Operations More Efficiently

Published by the Government Accountability Office on 1999-04-14.

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

                          United States General Accounting Office

GAO                       Testimony
                          Before the Subcommittee on Readiness and Management
                          Support, Committee on Armed Services, U.S. Senate

For Release on Delivery
Expected at
2 p.m.
                          DOD FINANCIAL
April 14, 1999            MANAGEMENT

                          More Reliable Information
                          Key to Assuring
                          Accountability and
                          Managing Defense
                          Operations More
                          Statement of Gene L. Dodaro
                          Assistant Comptroller General
                          Accounting and Information Management Division

Mr. Chairman and Members of the Subcommittee:

Thank you for the opportunity to discuss the steps needed to improve
financial management at the Department of Defense (DOD). Having
reliable, timely financial information is important to ensure accountability
over DOD’s extensive assets and resources in order to efficiently and
economically manage the department. Accomplishing this goal is a
tremendous challenge given the worldwide scope of DOD’s mission and
operations; the diversity, size, and culture of the organization; its estimated
trillion dollars of assets and liabilities; and its hundreds of billions of
dollars in annual appropriations.

DOD has created and maintains the world’s most powerful fighting force
and its effectiveness in protecting the safety and security of our nation and
national interests is unparalleled. Yet, without more reliable financial and
other management information, DOD cannot ensure adequate
accountability to the President, the Congress, and the American public. In
addition, decisionmakers and managers are deprived of valuable tools to
control costs and address pressing management issues that drain resources
that could be better used to increase readiness and meet other priorities,
such as weapon system modernization.

Central to achieving accountability are effective financial management
operations. However, pervasive weaknesses in DOD’s financial
management operations led us in 1995 to designate DOD financial
management as a high-risk area vulnerable to waste, fraud, abuse and
mismanagement--a situation that continues today.1 Also, taken together,
the material weaknesses in DOD’s financial operations represent the single
largest challenge to getting an unqualified opinion on the U.S. government’s
financial statements.

While in the past we have questioned the department’s commitment to
fixing these long- standing problems, DOD has started to devote additional
resources to correct its financial management weaknesses. The
atmosphere of “business as usual” at DOD has changed to one of marked
effort at real reform. DOD is working on short-term actions to improve
financial reporting and to help support the President’s goal to obtain an

 High-Risk Series: An Overview (GAO/HR-95-1, February 1995), High-Risk Series: Defense Financial
Management (GAO/HR-97-3, February 1997), and Major Management Challenges and Program Risks: A
Governmentwide Perspective (GAO/OCG-99-1, January 1999).

Page 1                                                             GAO/T-AIMD/NSIAD-99-145
                      unqualified opinion on the federal government’s financial statements. In
                      addition, DOD has recently submitted to the Congress its Biennial
                      Financial Manageme’t Improvement Plan. This plan presents, for the first
                      time, the department’s strategies, including a concept of operations for
                      modernizing its financial management activities. The plan, which DOD has
                      now committed to updating annually, is an ambitious undertaking that
                      encompasses over 900 pages and represents an important step toward long-
                      term improvements.

                      These initiatives are all very important steps in the right direction, but it is
                      essential to keep in mind the magnitude of DOD’s financial management
                      problems. These problems are pervasive and entrenched in an extremely
                      large decentralized organization. It will take considerable effort, time, and
                      sustained top management attention to turn reform efforts into day-to-day
                      management reality.

                      My comments today will focus on

                      • the impact of financial management weaknesses on DOD’s ability to
                        efficiently and economically carry out its operations;
                      • efforts DOD has initiated, and additional actions that are necessary, to
                        improve financial management systems and controls in the short term;
                      • enhancements needed in updating DOD’s Financial Management
                        Improvement Plan--its long-term blueprint for financial management

Impact of Financial   Recent audits of the fiscal year 1998 financial statements for DOD and the
                      individual military services, performed by the DOD Inspector General (IG)
Management            and the service audit agencies, and our report on the U.S. government's
Weaknesses on the     financial statements have highlighted many critical DOD financial
                      management problems.2 These problems not only hamper the
Economy and           department’s ability to produce timely and accurate financial management
Efficiency of DOD     information, but also significantly impair efforts to improve the economy
Operations            and efficiency of its operations. Key areas of concern relate to ineffective
                      asset control and accountability, which affects DOD’s visibility over
                      weapons systems and inventory, and unreliable cost and budget

                          See appendix I for a complete list of DOD’s 1998 financial statement audit reports.

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                             information, which affects DOD’s ability to effectively measure
                             performance, reduce costs, and maintain adequate funds control.

Control and Accountability   DOD primarily relies on various logistical systems to carry out its
for Assets Impaired          important stewardship responsibility over an estimated $1 trillion in
                             physical assets, ranging from multimillion dollar weapon systems to
                             enormous inventories of ammunition, stockpile materials, and other
                             military items. These systems are the primary source of information for
                             (1) maintaining visibility over assets to meet military objectives and
                             readiness goals and (2) financial reporting. However, these systems have
                             material weaknesses that, in addition to hampering financial reporting,
                             impair DOD’s ability to (1) maintain central visibility over its assets,
                             (2) safeguard assets from physical deterioration, theft, or loss, and
                             (3) prevent the purchase of assets already on hand.

                             Overall, these weaknesses can seriously diminish the efficiency and
                             economy of the military services’ support operations. For example, DOD’s
                             lessons learned studies from Operation Desert Storm highlighted combat
                             support problems associated with tracking the status and location of
                             personnel and supplies.

                             In response to this problem, the department initiated programs or renewed
                             its emphasis on implementing existing measures that would improve asset
                             visibility and tracking. For example, the Global Combat Support System
                             (GCSS), led by the Defense Information Systems Agency, was established
                             in September 1995 to reengineer processes and procedures and provide a
                             technological base, including a common environment and shared
                             infrastructure needed to rapidly deploy support to the warfighter. In
                             addition, DOD renewed its Total Asset Visibility (TAV) initiative to provide
                             department-level access to timely, accurate information on the status,
                             location, and movement of units, personnel, equipment and supplies--
                             including weapon systems, secondary inventory,3 and ammunition.

                             The effectiveness of these programs in achieving their common objectives
                             of supporting the warfighter will depend on the accuracy and timeliness of
                             information provided by the underlying systems. This includes the
                             equipment and inventory data provided by numerous logistic systems such

                              Secondary inventory includes spare parts, clothing, and medical supplies to support DOD operating
                             forces worldwide.

                             Page 3                                                                GAO/T-AIMD/NSIAD-99-145
                                as the Defense Logistics Agency’s (DLA) Distribution Standard System and
                                the Army’s Continuing Balance System (CBS-X). As discussed in the
                                following sections, information in these logistic systems on DOD’s weapon
                                systems and inventories does not meet accuracy objectives and unless
                                substantive improvements in producing reliable, timely data are made, it
                                will be difficult for efforts such as GCSS and TAV to achieve their

Weapon Systems Accountability   While necessary to effectively implement the department's overall
                                objective to maintain visibility over all deployable DOD weapon systems,
                                many of the military services’ logistics systems used to track and support
                                weapon systems and support equipment were unable to be relied on to
                                accurately provide information to support DOD’s asset visibility and

                                Audits of this information in fiscal year 1997 included specific tests to
                                validate the data in the logistics systems reporting military equipment.
                                Because of the sensitive nature of the equipment items selected for
                                existence testing, auditors’ fiscal year 1997 financial audit tests were
                                designed to either “pass” or “fail” the accuracy of logistical system
                                information. For a number of critical systems tested, it was agreed”with the
                                military leaders who used those systems that a system would “pass” only
                                where all assets selected from the system were found. For other systems,
                                which generally carry information on less critical assets, it was agreed that
                                up to two errors could be identified with the system still receiving a passing

                                Auditors tested recorded information for 11 categories of Navy military
                                equipment. Fiscal year 1997 testing of critical Navy logistics systems
                                showed that the Navy’s systems failed for 3 of 11 categories of military
                                equipment tested. Specifically, auditors determined that the Navy systems
                                relied on for visibility or accountability over active boats, service craft, and
                                uninstalled engines failed because the data were either incomplete or
                                included assets that no longer existed. For example, tests of these mission
                                critical systems found the following:

                                • Of 45 boats selected for examination, 2 were included in the Combatant
                                  Craft and Boat Support System even though they had been disposed of
                                  or sold.
                                • Of 79 inactive service craft reported in the Naval Vessel Register (NVR)
                                  and tested by auditors, 6 could not be located. Fifteen other service craft
                                  had been sold or disposed of but were still included in the NVR as

                                Page 4                                                  GAO/T-AIMD/NSIAD-99-145
  inactive, indicating their availability to meet rapid mobilization
• Of 105 uninstalled engines sampled, 10 valued at up to $4 million could
  not be found.

Because of the severity of these problems, a working group was
established in 1998 to address the issue. The Navy, however, has not yet
implemented any significant corrective actions to address deficiencies that
continue to impede the Navy’s accountability over these weapon systems.
Since these problems remained unaddressed, Navy auditors did not repeat
these tests for the 1998 audit.

For 1997, Air Force logistic systems tested, including those supporting
aircraft, missiles and uninstalled engines, passed auditors’ tests and
auditors made recommendations to correct the minimal number of
inaccuracies found during the tests. However, as part of the fiscal year 1998
financial statement audit work, auditors were unable to verify the reported
data on 8,387 uninstalled engines, with an estimated value in excess of
$8 billion. This occurred because the Comprehensive Engine Management
System (CEMS) which is used to report data on these assets, could not
separately identify additions and deletions of engines during the fiscal
year--a basic control for ensuring accountability over assets.

Audit tests in 1997, using the pass-fail approach previously discussed,
found that the Army property books maintained by the local units were
generally accurate for major equipment items held by those units. However,
the CBS-X, which is intended to provide Army leadership with worldwide
visibility over the Army’s reportable equipment items, has significant
accuracy problems. For example, we have reported4 that CBS-X was
inaccurate because it (1) does not effectively capture data on equipment
transactions from all Army units, (2) reflects software errors, and
(3) contains transaction posting errors. In addition, like the Air Force’s
CEMS, CBS-X does not provide accountability and control over Army
assets by tracking additions and deletions to asset quantities on hand.

Recognizing that CBS-X could not provide effective visibility over
equipment maintained by Army units, the Army used a data call to
complete its financial reporting for fiscal year 1998 of this equipment and to

 Army Logistics Systems: Opportunities to Improve the Accuracy of the Army’s Major Equipment Item
System (GAO/AIMD-98-17, January 23, 1998).

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                           correct inaccuracies in CBS-X. The Army Audit Agency reported that this
                           data call and other procedures identified 1,837 items, which included 10
                           Army reconnaissance aircraft, 81 Tow missile launchers, and 174 Javelin
                           command-launch units that were not reported to CBS-X. Because these
                           results were based on only 78 percent of the units reporting as of
                           October 28, 1998, the Army continued to follow up with units that had not
                           reported and, by mid-December, 90 percent of the units had reported. For
                           example, as a result of these additional units reporting, the Army identified
                           another 43 reconnaissance aircraft that were not reported in CBS-X.

Inventory Accountability   Audit work has shown that inventory5 accountability data are inaccurate
Weaknesses                 and include omissions. Further, DOD has large quantities of inventory
                           beyond its requirements that may contribute to its inability to maintain
                           accurate inventory quantity information. Incomplete and inaccurate data
                           will hamper the department’s ability to meet and sustain the goals of TAV
                           and other DOD-wide asset visibility initiatives, as well as adversely impact
                           DOD's financial reports. In addition, inaccurate and omitted data increase
                           the risk that responsible inventory item management may request funds to
                           obtain additional, unnecessary inventories of items that are on hand but
                           not reported. Finally, DOD is incurring unnecessary holding costs.

                           DOD's 1999 Annual Report to the President and the Congress incorporated
                           the TAV initiative goals, including a target of 90-percent visibility of DOD
                           materiel assets by 2000. TAV’s longer term target is 100 percent visibility by
                           2004. The overall objective of TAV is to use the information to improve
                           DOD's logistics practices, including sharing assets within component
                           commands and/or among components. DOD cannot attain its overall TAV
                           objective without both complete and accurate data.

                           With regard to incomplete inventory data, financial statement audits have
                           found that the department generally excludes information in several
                           inventory accountability systems from financial reports, including reports
                           provided to the Congress on inventory levels, and from overall visibility
                           systems. For example, Navy omissions, which primarily relate to spare and
                           repair parts, included an estimated (1) over $9 billion in items warehoused
                           on board ships, (2) over $3 billion of inventory items held by engineering

                            DOD inventory includes ammunition (such as machine gun cartridges, rocket motors, and grenades),
                           consumables (such as clothing, bolts, and medical supplies), repairable items (such as navigational
                           computers, landing gear, and hydraulic pumps), and stockpile materials (such as industrial diamonds,
                           rubber, and tungsten).

                           Page 6                                                                GAO/T-AIMD/NSIAD-99-145
and ordnance activities, and (3) $650 million of items at redistribution
centers. In addition, about $19 billion of government owned material held
by contractors is omitted from inventory reports provided to the Congress.

With regard to accurate inventory data, financial audits have repeatedly
found large differences between on hand and recorded inventory
quantities. For example, in 1996 the DOD IG reported an overall 24-percent
error rate at DOD’s primary storage locations. In 1997, Navy auditors
reported a 23-percent error rate for the 13 major storage locations they
visited. Finally, in 1998, for the 14 depots we visited holding 82 percent of
depot inventory, the reported depot accuracy rates were below DLA’s
targeted 95-percent accuracy mark, with only 2 depots reporting inventory
record accuracy rates above 90 percent. Further, our preliminary
observations over the physical inventory count procedures and the
accuracy of those rates show that improvements are needed to strengthen
controls over inventory. We will soon be providing DOD with specific
recommendations on how it can improve these inventory controls.

The sheer size and volume of DOD’s on-hand inventories also impede the
department’s efforts to accumulate and report accurate inventory data. We
reported in our high-risk reports on defense inventory management that the
department needs to avoid burdening its supply system with large
unneeded inventories.6 In our soon to be released report, we stated7 that
about 60 percent of on-hand items, or an estimated $39.4 billion of DOD’s
secondary inventory, exceeded DOD’s requirements. The DOD IG has also
recently reported that about $3 billion of DLA’s reported $9.8 billion of
consumable inventory was inactive and of uncertain future utility. DOD
acknowledges the need to reduce its inventories and has established goals
to reduce supply inventory by $12 billion by 2000.

Finally, inaccurate or incomplete data can result in unnecessary purchases.
In addition, unneeded inventory incurs holding costs. For example, in
February 1997, we reported that DOD had ordered $11.3 million in items
such as hydraulic pump valves and circuit card assemblies that were

6Major Management Challenges and Program Risks: Department of Defense (GAO/OCG-99-4, January

 Defense Inventory: Status of Inventory and Purchases and Their Relationship to Current Needs (GAO/
NSIAD-99-60, April 16, 1999).

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                            already in excess supply.8 In addition, we estimated9 that the services could
                            save about $382 million annually in inventory holding costs by eliminating
                            at nonmajor locations inventory that is not needed to meet current

Reliable Cost Information   Reliable information on the cost of operations and the use of budgetary
Not Available               resources is critical to provide accountability for, and to efficiently and
                            economically manage, DOD’s vast resources. Both cost and budgetary
                            information are essential for making important decisions, such as
                            reallocating resources to our fighting forces and considering whether to
                            continue, modify, or discontinue programs and activities. However, DOD’s
                            financial management systems are not designed to capture the full cost of
                            its activities and programs. Also, as the next section discusses further,
                            certain information on DOD’s budget resources is unreliabe

                            To effectively, efficiently, and economically manage DOD’s programs, its
                            managers need reliable cost information for (1) evaluating programs (for
                            example, measuring actual results of management’s actions against
                            expected savings or determining the effect of long-term liabilities created
                            by current programs), (2) making economic choices, such as whether to
                            outsource specific activities and how to improve efficiency through
                            technology choices, (3) controlling costs for its weapon systems and
                            business activities funded through working capital funds, and
                            (4) measuring performance. The lack of reliable, cost-based information
                            hampers DOD in each of these areas, as discussed below.

Evaluating Programs         Accurate cost information is needed to evaluate the results of
                            management’s decisions, including determining whether anticipated
                            savings have been achieved. In this regard, we recently reported10 that
                            DOD relied on budget estimates and projections to determine its estimated
                            savings from base closure activities. We concluded that because of data
                            and record weaknesses, DOD’s estimates should only be viewed as

                              Defense Logistics Much of the Inventory Exceeds Current Needs (GAO/NSIAD-97-71, February 28,

                            9Defense Inventory: Spare and Repair Parts Costs Can be Reduced (GAO/NSIAD-97-47, January 17,

                               Military Bases: Review of DOD’s 1998 Report on Base Realignment and Closure (GAO/NSIAD-99-17,
                            November 13, 1998).

                            Page 8                                                              GAO/T-AIMD/NSIAD-99-145
                          providing a rough approximation of costs and savings rather than a precise

                          In addition, long-term liabilities that affect program costs must be
                          accurately measured and considered in evaluating the status of programs.
                          Without adequate cost data to help determine liabilities, DOD may be over-
                          or understating the future resources that will be required to meet its
                          commitments. For example, inadequate cost data inhibit DOD’s ability to
                          accurately estimate the projected costs of providing health care benefits to
                          future military retirees and their beneficiaries. Currently, for financial
                          reporting, DOD estimates its liability using unaudited budget information,
                          which does not include the full cost of the program. For example, the costs
                          of the treatment facilities and some personnel costs such as pension
                          benefits may not be fully captured. As a result, the liability could be
                          substantially different from the reported balance.

                          Further, DOD’s lack of reported cost data on the disposal of weapon
                          systems, including for example, aircraft, missiles, ships, and submarines,
                          was a significant factor contributing to our conclusion that the liability for
                          such costs on the federal government's financial statements was
                          understated.11 The liability for this disposal activity is a part of the overall
                          life cycle cost of these weapon systems and can contribute to the ongoing
                          dialogue on funding comparable weapon systems.

Making Economic Choices   DOD’s decisions on whether to outsource specific functions are
                          undermined without supporting cost data. Yet DOD, as well as other
                          government agencies, has historically been unable to provide actual data
                          on the costs associated with functions to be considered for outsourcing,
                          particularly with respect to overhead rates. Consequently, to ease concerns
                          about unfair competition, OMB selected a single overhead rate (12 percent)
                          for DOD and other federal agencies to use in A-76 competitions.

                            Financial Management: Factors to Consider in Estimating Environmental Liabilities for Removing
                          Hazardous Materials in Nuclear Submarines and Ships (GAO/AIMD-97-135R, August 7, 1997), Financial
                          Management: DOD's Liability for Aircraft Disposal Can Be Estimated (GAO/AIMD-98-9, November 20,
                          1997), Financial Management: DOD's Liabilities for the Disposal of Conventional Ammunition Can Be
                          Estimated (GAO/AIMD-98-32, December 19, 1997), and Financial Management: DOD's Liabilities for
                          Missile Disposal Can Be Estimated (GAO/AIMD-98-50R, January 7, 1998).

                          Page 9                                                              GAO/T-AIMD/NSIAD-99-145
                    We recommended12 that DOD develop overhead rates that better reflect
                    actual overhead costs, which would promote fairer competition between
                    the government and private sector. Further, DOD is unable to capture
                    complete and reliable data on the capital costs associated with its
                    operations, which adversely affects its ability to develop cost information
                    to compare with the private sector. Specifically, billions of dollars of
                    existing DOD plant, property, and equipment assets have been expensed
                    and, as a result, the costs associated with their acquisition and use may not
                    be adequately considered.

                    Further, inadequate cost information diminishes DOD’s ability to manage
                    military health treatment in areas such as allocating resources, deciding
                    whether to provide services internally or by outsourcing, setting third-party
                    billing rates, and benchmarking its health delivery system with those of
                    other providers. Specifically, the preliminary results of our review of key
                    DOD data for estimating these costs identified inconsistent data collection
                    and reporting and incomplete accounting for all relevant expenses and

                    Finally, the Clinger-Cohen Act mandates performance-based and results-
                    oriented information for all major information technology (IT)
                    investments. As we have reported,13 lack of cost information prevents DOD
                    from properly compiling the total cost of its IT investments, as required by
                    the Clinger-Cohen Act. This impedes DOD in meeting the act’s requirement
                    to establish goals for improving efficiency through effective use of
                    information technology and benchmarking agency process performance
                    against comparable processes in terms of cost, benefits, and risk.

Controlling Costs   Two of the most prominent areas where DOD has stated a need for more
                    accurate data to control costs are in its weapon systems activities and its
                    working capital fund operations. Specifically, DOD acknowledges that the
                    lack of a cost accounting system is the single largest impediment to
                    controlling and managing weapon systems costs, including costs of
                    acquiring, managing, and disposing of weapon systems. Without accurate
                    information on the life-cycle costs of weapon systems, neither DOD
                    officials nor Congress can make fully informed decisions about which

                    12Defense Outsourcing: Better Data Needed to Support Overhead Rates for A-76 Studies (GAO/NSIAD-
                    98-62, February 27, 1998).

                      Defense Information Management: Continuing Implementation Challenges Highlight the Need for
                    Improvement (GAO/T-AIMD-99-93, February 25, 1999).

                    Page 10                                                            GAO/T-AIMD/NSIAD-99-145
                        weapons, or how many, to buy. DOD is developing, by 2000, a system
                        intended to provide management with improved insight into total costs
                        and the information necessary to make more informed decisions.

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

                        DOD working capital funds charge their customers prices for the support
                        operations provided so that they can recover the full cost of the goods and
                        services provided, including administrative and overhead costs. Every
                        dollar that the military services spend inefficiently on DOD working capital
                        fund purchases results in fewer resources available for other defense
                        spending priorities. Simply stated, working capital fund overcharges could
                        result in the military services using more Operations and Maintenance
                        appropriations in the current year than anticipated; undercharges could
                        result in unanticipated future pricing increases and funding requests.

                        In recent financial audits of DOD working capital funds, auditors found
                        large adjustments to the value of inventory balances. For example, the Air
                        Force and the Army working capital funds had gains and losses of
                        $21 billion and approximately $3.1 billion, respectively, resulting from
                        physical inventory and accounting adjustments. Such large inventory gains
                        and losses, which often were not investigated, are likely to have a
                        significant impact on the funds' costs of operations and the prices charged
                        to the funds' customers for goods and services provided.

                        Finally, DOD working capital funds set sales prices based on projected
                        operating costs and cash flows. In recent years, there have been large
                        fluctuations in prices charged. For example, the Navy surcharge increased
                        from 14 percent in 1996 to 27 percent in 1997 and to 57 percent in 1998,
                        impacting the sales price to customers. For example, an item with an
                        acquisition cost to the working capital fund of $100 in 1996 would have
                        been sold for $114 in 1996, $127 in 1997, and $157 in 1998. Fluctuations of
                        this type make it difficult for the funds' customers to budget the future
                        costs of repairables and other goods and services, leading to funding
                        shortfalls that could affect operations and readiness.

Measuring Performance   DOD is unable to develop reliable, cost-based performance indicators and
                        measures across virtually the entire spectrum of its operations. As part of

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                                its Results Act Performance Plan for fiscal year 2000, DOD has developed
                                43 unclassified performance measures and indicators to measure a wide
                                range of activities--from force levels to asset visibility, but these measures
                                and indicators contain few efficiency measures based on cost.14 Most
                                programs have some form of associated cost consequences that can be
                                directly or indirectly measured and should be considered in assessing
                                program achievement.

Reliable Budgetary Data         In addition to accurate cost data, reliable budget information is essential to
Essential                       ensure that spending of appropriated funds complies with the amount,
                                purpose, and time frame designated by the Congress. To help ensure that
                                this occurs, DOD has implemented systems and controls it relies on to
                                (1) record obligations when it orders goods and services and (2) liquidate
                                the obligations by disbursing funds when goods and services are received.
                                Effective obligation and disbursement practices are essential to ensure that
                                DOD's spending does not exceed appropriated amounts and other spending
                                limits imposed by the Congress.

                                As part of the DOD fiscal year 1998 financial statement audit, auditors
                                found several areas, however, in which the systems and controls over the
                                department's use of its budgetary resources were ineffective. These control
                                weaknesses have left DOD in a situation where it does not know the true
                                amount of funds that are available to obligate and spend in each
                                appropriation account. This situation occurs because obligated balances
                                are not always correct, reconciliations between DOD and Treasury records
                                are not being adequately performed, and certain disbursements are not
                                being recorded promptly in DOD’s accounting records. Either
                                overspending or cancellation of funding authority (not dispersing funds
                                during the period they were made available for spending by Congress
                                results in cancellation of the authority) can result.

Some Recorded Obligations Are   Auditors found that recorded obligations included amounts that were no
Incorrect                       longer correct or were unsupported. Specifically, at the Air Force--the only
                                DOD component performing a full financial audit of its obligated balances--
                                an estimated $4.3 billion of a $34 billion balance in obligations for its
                                general funds were found to be incorrect or unsupported. Further, review
                                of unliquidated Navy contract obligations showed that approximately 17

                                   Results Act: DOD's Annual Performance Plan for Fiscal Year 1999 (GAO/NSIAD-98-188R, June 5,

                                Page 12                                                              GAO/T-AIMD/NSIAD-99-145
                                 percent of the amounts tested ($101 million of $592 million) were no longer
                                 correct. Army auditors also found evidence of unsupported obligations but
                                 were unable to quantify the extent of the problem.

Reconciliations Not Adequately   DOD’s records on its available funds should be reconciled to Treasury
Performed                        records just as an individual reconciles his or her checkbook to a bank
                                 statement. However, comparison of the two records resulted in unresolved
                                 differences amounting to $9.6 billion. These unresolved differences could
                                 significantly affect the status of budget authority available to be obligated
                                 and expended.

                                 Further, DOD’s records show an estimated $823 million held in suspense
                                 accounts at the end of fiscal year 1998 that have not been properly reported
                                 to Treasury and are not reflected in the differences noted above. Until these
                                 transactions are posted to the proper appropriation account, the
                                 department will have little assurance that the collections and adjustments
                                 recorded in these accounts are proper DOD transactions and that its
                                 disbursements do not exceed appropriated amounts. Moreover, this
                                 reported amount represents netting of collections and adjustments against
                                 disbursements, thus understating the magnitude of the problem. For
                                 example, as part of our fiscal year 1997 financial audit, we found that while
                                 the Navy had a net balance of $464 million in suspense accounts recorded
                                 in its records, the individual transactions, collections as well as
                                 disbursements, totaled about $5.9 billion.

Disbursements Not Properly       The concerns the auditors raised with respect to the reliability of the
Recorded                         department's budget information are further exacerbated by the
                                 department's problem disbursements--disbursements that are not properly
                                 matched to specific obligations recorded in the department’s records. DOD
                                 reported these problems at $17.3 billion as of September 30, 1998. To the
                                 extent that these disbursements cannot be matched to existing recorded
                                 obligations, DOD would be required to record an obligation. This obligation
                                 could create an Antideficiency Act violation if the department’s available
                                 unobligated balance was insufficient to cover the amount of the obligation.

Overspending/Cancellation of     Recent audit reports have described the consequences of the department's
Funds Can Occur                  inability to keep track of its obligations and expenditures. Specifically,
                                 auditors found several instances in which the department may have spent
                                 more than authorized amounts. For example, the Air Force’s Depot
                                 Maintenance Activity--a component of one of the department's working
                                 capital funds--may have incurred obligations of $1.1 billion in excess of

                                 Page 13                                               GAO/T-AIMD/NSIAD-99-145
                       available budgetary resources as of September 30, 1998. In addition, as we
                       previously reported,15 according to Navy records, as of September 30, 1997,
                       obligations in 29 canceled and expired appropriations may have exceeded
                       available budget authority by a total of $290 million.

                       The problems affected the reliability of both obligation and disbursement
                       data. As a result, the Congress cannot be assured that DOD did not
                       overexpend its budget authority or spend more for specific programs for
                       which the Congress established spending limits. Conversely, these fund
                       control weaknesses also result in the department’s inability to properly
                       identify and manage remaining budget authority, so that funds the Congress
                       intended for specific DOD programs may be unused and eventually
                       canceled. For example, at the end of fiscal year 1998, the department had
                       $4.3 billion in expired budget authority that was allowed to cancel.

Short-Term Financial   Fully resolving many of DOD’s financial management deficiencies will
                       require long-term actions and technology improvements, as discussed in
Management             the next section. In the interim, however, DOD must work to improve its
Improvement Efforts    existing financial management systems through short-term corrective
                       actions. These efforts focus on improving the credibility of DOD’s financial
Essential              information to improve the reliability of year-end financial statements for
                       DOD and the government as a whole--and on making efforts to strengthen
                       the integrity and controls over existing underlying financial and logistical

                       On May 26, 1998, the President directed the head of each agency designated
                       by OMB to identify corrective actions to resolve financial reporting
                       deficiencies and to make quarterly progress reports to OMB. The
                       administration’s goal is to have individual agencies, as well as the
                       government as a whole, complete audits and gain unqualified opinions on
                       their financial statements. In response, the DOD Comptroller has been
                       developing and implementing short-term steps in collaboration with DOD’s
                       functional and audit communities, OMB, and the GAO. Several of the
                       actions included in DOD’s short-term plan, along with additional short-term
                       actions necessary to provide a solid foundation for the department’s
                       financial management improvement efforts, are highlighted below. These
                       include actions that are needed to (1) ensure feeder system data accuracy,

                         Financial Management: Problems in Accounting for Navy Transactions Impair Fund Control and
                       Financial Reporting (GAO/AIMD-99-19, January 19, 1999).

                       Page 14                                                            GAO/T-AIMD/NSIAD-99-145
                                (2) implement accounting policy guidance, (3) instill fundamental controls,
                                and (4) train financial management personnel.

Ensuring Accuracy of            About 80 percent of the data now relied on for financial management
Feeder System Data              comes from department program operating systems such as logistics,
                                acquisition and personnel. For example, the department relies on data from
                                its personnel systems to provide data to its payroll systems. Effective
                                controls to ensure that only valid and accurate transactions are initially
                                entered into the department’s feeder systems on a timely basis is critical to
                                obtaining reliable data through the department's existing system structure.
                                It also is necessary to achieve an effective transition to the department's
                                envisioned future integrated system structure.

                                The department has acknowledged, and audit reports have confirmed, that
                                the data produced by many of these feeder systems are not yet reliable.
                                Specifically, auditors have identified problems in the accuracy of the
                                department’s feeder systems data relied on to provide information ranging
                                from plant, property, and equipment to the cost of military retiree health
                                benefits to weapon and inventory systems.

                                To help eliminate inaccurate payments in the department's military payroll
                                system, DOD has reported that an interface between its military personnel
                                systems and its military payroll system is scheduled for completion in 2000.
                                As part of their fiscal year 1998 financial audit, Army auditors continued to
                                report major mismatches between military personnel and payroll data, a
                                condition that was previously identified in 1993. The planned interface
                                should reduce some problems identified with inappropriate payments to
                                military personnel; however, it will only do so to the extent that data on
                                personnel actions are entered to the interfaced personnel system
                                accurately and in a timely manner. Until this interface is operational, the
                                Army intends to compare and reconcile military payroll and personnel data

                                DOD also has short-term plans calling for a number of actions by high-level
                                functional and financial personnel intended to improve the accuracy of
                                DOD's inventory, property, plant, and equipment, and military retiree health
                                benefit feeder system data.

Inventory Accountability Data   The DOD Comptroller and Under Secretary of Defense for Acquisition and
                                Technology are responsible for a set of actions intended to improve the
                                accuracy of data in its inventory accountability systems. Specifically, they

                                Page 15                                               GAO/T-AIMD/NSIAD-99-145
                                  plan to require inventory holders to evaluate how inventory transactions
                                  (e.g., receipts and issues) are processed, determine the sources and causes
                                  of processing errors, and develop a remedial plan for correcting those
                                  errors. In addition, they intend to improve the department’s inventory
                                  sampling and physical count procedures to provide more accurate and
                                  meaningful rates for measuring the accuracy of inventory records.

Plant, Property, and Equipment    The DOD Comptroller and Under Secretary of Defense for Acquisition and
Data                              Technology are responsible for actions directed at developing more
                                  credible valuation data for the department’s plant, property, and equipment
                                  by obtaining contractor support for testing the validity of cost data
                                  currently in accountability systems. If the current systems’ cost data are
                                  found to be unsupportable, the contractor will develop a methodology for
                                  approximating historical cost and the required accumulated depreciation
                                  for those assets.

Military Retiree Health Benefit   The Under Secretary of Defense for Personnel and Readiness is responsible
Data                              for providing more reliable data for estimating the future cost of military
                                  retiree health benefits. DOD has developed a high-level data quality task
                                  force to ensure that financial, labor utilization, and workload data in its
                                  primary health care cost system are reconcilable to data in respective
                                  source documents and support systems.

Implementing Accounting           The department also has plans to implement new or revised federal
Policy Guidance                   accounting policies in several areas. For instance, we have reported that
                                  DOD is not following federal accounting standards for accounting for
                                  environmental and disposal liabilities associated with certain major
                                  weapons systems such as aircraft, missiles, ships, and submarines. To
                                  provide better information on these liabilities, DOD is developing policies
                                  and procedures to estimate (1) the expected restoration costs for
                                  contaminated site and hazardous waste removal and (2) the disposal costs
                                  for ammunition, chemical weapons, excess and obsolete structures, and
                                  major weapons systems. Also, to better account for inventory, DOD is
                                  improving procedures related to inventory gains and losses, determining
                                  the value of depot-level repairable inventory, and estimating the cost of
                                  beginning inventory balances.

Instilling Fundamental            DOD has long-standing control deficiencies, including serious computer
Control                           security weaknesses. DOD’s plans call for ensuring that existing

                                  Page 16                                             GAO/T-AIMD/NSIAD-99-145
                       rudimentary accounting and control policies and procedures are followed,
                       through such means as reconciliations of its Fund Balance With Treasury
                       accounts and its inventory asset accounts. We have made a number of
                       recommendations to DOD to instill greater discipline by adhering to
                       fundamental controls. For example, we recently recommended that the
                       department better ensure that existing vendor payment controls are
                       followed, including limiting the number of personnel with access to pay
                       systems. DOD has begun a departmentwide initiative to review access to
                       such systems to identify individuals with unneeded access.

Training Financial     One of the key issues facing DOD is the need to ensure that its financial
Management Personnel   management staff has the knowledge and skills required to carry out
                       complex financial management operations. Our work16 has shown that
                       state governments and private sector organizations place a strong
                       emphasis on training as a means of upgrading financial workforce
                       knowledge of accounting and financial management requirements. In
                       contrast, the results of a survey we conducted of key DOD financial
                       managers showed that over half of those surveyed had received no
                       financial management training during 1995 and 1996.

                       DOD leadership has acknowledged that it needs to improve the capabilities
                       of its financial managers, and DFAS is developing a program intended to
                       identify the kinds of skills and developmental activities needed to improve
                       the competencies of its financial personnel. We have recommended that
                       DOD modify its planned program to better ensure that financial
                       management personnel throughout the department receive the necessary
                       training, including establishing minimum training requirements
                       emphasizing technical accounting and related financial management
                       courses. This recommended approach is similar in scope to the program
                       recently put in place to improve the skills of the department's acquisition

                        Financial Management: Profile of Financial Personnel in Large Private Sector Corporations and State
                       Governments (GAO/AIMD-98-34, January 2, 1988).

                       Page 17                                                               GAO/T-AIMD/NSIAD-99-145
Updates to Long-Term   Completing short-term actions can improve DOD’s financial information
                       and ultimately even result in auditable financial statements. However, an
Improvement Plan       unqualified audit opinion, while certainly important, is not an end in itself.
Need to Incorporate    For some agencies, the preparation of financial statements requires
                       considerable reliance on ad hoc programming and analysis of data
Additional Elements    produced by inadequate systems that are not integrated or reconciled, and
                       often requires significant audit adjustments. Efforts to obtain reliable year-
                       end data that are not backed up by fundamental improvements in
                       underlying financial management systems and operations to support
                       ongoing program management and accountability will not achieve the
                       intended results of the Chief Financial Officers Act--reliable financial
                       management information to support day-to-day decision-making over the
                       long term. Thus, it is essential that DOD also undertake and complete long-
                       term efforts to improve financial management systems and processes.

                       The National Defense Authorization Act for Fiscal Year 1998 (Public Law
                       105-85) required the Secretary of Defense to biennially submit to the
                       Congress a strategic plan for the improvement of financial management
                       within DOD. The plans are to address all aspects of financial management
                       within DOD, including the finance systems, accounting systems, and data
                       feeder systems that support its financial functions, including the
                       department's concept of operations for financial management. Section 912
                       of the Strom Thurmond National Defense Authorization Act for Fiscal Year
                       1999 (Public Law 105-261) required GAO to analyze DOD’s Biennial Plan
                       and discuss the extent to which it is a workable plan for addressing DOD’s
                       financial management problems.

                       DOD submitted its first Biennial Plan to the Congress on October 26, 1998.
                       The department has committed to update the plan annually rather than
                       biennially as required by law. This first plan presents DOD’s concept of
                       operations, the current environment, and the transition plan intended to
                       describe the goals of the department for achieving the target financial
                       management environment and to identify the strategies and corrective
                       actions necessary to move through the transition. It also provides
                       information on the specific financial management improvement initiatives
                       intended to implement the transition plan.

                       Page 18                                               GAO/T-AIMD/NSIAD-99-145
                     We have analyzed DOD’s first plan and, in January 1999, reported17 the
                     results of our analysis to the Senate and House Armed Services
                     Committees. As we said in our report, DOD’s plan represents a great deal of
                     effort and provides a first-ever vision of the department’s future financial
                     management environment. In developing this overall concept of its
                     envisioned financial management environment, DOD has taken an
                     important first step in improving its financial management operations. The
                     department's plan also represents a significant landmark because it
                     includes, for the first time, a discussion of the importance of the
                     programmatic functions of personnel, acquisition, property management,
                     and inventory management to the department’s ability to support
                     consistent, accurate information flows to all information users. In addition,
                     DOD’s plan includes an extensive array of initiatives intended to move the
                     department from its current state to its envisioned financial management

                     If effectively implemented, the initiatives discussed should result in
                     improving DOD’s financial management operations. However,
                     modifications to the plan are needed if DOD is to achieve the full range of
                     reforms needed. To accomplish this, the department's planned update
                     should include

                     • a revised concept of operations to reflect, at a high level, the full range
                       of the department's financial management operations, including its key
                       asset accountability and budget formulation responsibilities;
                     • specific plans on shared servicing and outsourcing strategies;
                     • clarification in the transition plan of the role of each of the described
                       initiatives in bridging the gap between the current environment and the
                       envisioned future concept of operations and the steps the department
                       will take to ensure that it will build reliability into the data provided by
                       its feeder systems; and
                     • concepts established in the Clinger-Cohen Act for effectively
                       implementing the technology initiatives contained in the plan.

Revised Concept of   While the plan's discussion of how DOD’s financial management operations
Operations           will work in the future--its concept of operations--is a good start, it is not
                     complete. It does not address how (1) it will support budget formulation

                        Financial Management: Analysis of DOD's First Biennial Financial Management Improvement Plan
                     (GAO/AIMD-99-44, January 29, 1999).

                     Page 19                                                             GAO/T-AIMD/NSIAD-99-145
and (2) its financial management operations will effectively support not
only financial reporting but also asset accountability and control. DOD
stated that it intentionally excluded budget formulation from its concept of
operations because it is performed as part of the department's Planning,
Programming, and Budgeting System (PPBS). However, budget
formulation is one of the central processes involved in any agency's
financial management operations and must be included in the department's
concept of operations to develop a fully integrated financial management
system that ensures that budgets consider financial implications and that
policy decisions are based on sound financial information.

To effectively support accountability and control, DOD’s systems need to
share information. However, the flow of information among functional
areas, such as how acquisition will share information with property
management, is not clear in DOD’s plan. The figure below is a simplified
example of how a financial management system for asset acquisition
shares information to help achieve greater control and accountability.

Figure 1: Example of How Systems Integration Helps Achieve Greater Control

As shown in this figure, contract data are entered initially by acquisition
personnel when an asset is ordered. This information would be available to
accounting personnel to record the obligation and to property management
to recognize that an asset is to be delivered. Upon asset receipt, property
management personnel enter the asset in property management records.

Page 20                                                GAO/T-AIMD/NSIAD-99-145
                         Those records are available for accounting personnel for payment
                         purposes, for acquisition personnel to monitor contract delivery, and for
                         property management personnel to monitor program results and the use of
                         budgetary resources. Greater asset control and accountability is achieved
                         because data associated with assets acquired are available to accounting,
                         property management, and acquisition personnel.

Shared Servicing and     Many leading organizations have reduced the cost of, and increased the
Outsourcing Strategies   control over, day-to-day accounting activities by processing routine
                         accounting functions at a reduced number of locations, known as shared
                         service centers. These shared service centers provide common services
                         such as accounts payable, fixed asset, and payroll processing to operating
                         locations and business units. In this regard, the National Defense
                         Authorization Act for fiscal year 1998 required the department to address in
                         its first biennial Financial Management Improvement Plan the feasibility of
                         reorganizing DFAS along functional lines.

                         Preliminary results from a study we are completing on financial
                         management best practices indicate that many leading organizations we
                         identified, including the six we visited, used a shared services strategy.
                         While several different organizational structures were used to apply the
                         concept, many followed three stages in implementing this strategy. The
                         first stage is consolidation and includes changing the organizational
                         structure and gaining control over the current business processes. The
                         second stage is standardization and entails changing the current business
                         processes and adopting a common technology platform. The final stage is
                         reengineering and includes leveraging technology through the use of
                         electronic commerce, data warehousing, and document imaging.

                         To date, DFAS has consolidated the activities of 332 installation finance and
                         accounting offices at its headquarters, 5 centers, and 19 operating locations
                         and intends to further consolidate locations. The plan states that DFAS
                         processes are most efficiently performed at a minimal number of locations.
                         As the number of systems is reduced, the number of separate operating
                         locations necessary to operate the systems is also reduced. However, the
                         plan did not provide additional information on the number or nature of the
                         required locations. We will continue to examine this area.

                         The fiscal year 1998 authorization act also required that the plan address
                         the feasibility of outsourcing DOD’s accounting operations. While DOD’s
                         plan identified certain functional areas, such as commissaries and retired

                         Page 21                                               GAO/T-AIMD/NSIAD-99-145
                              annuitant pay, for outsourcing studies under A-76, the plan needs to more
                              clearly articulate a competitive outsourcing strategy. For example, our
                              October 1997 report18 on the results of our survey of selected private
                              sector and nonfederal public organizations’ use of outsourcing identified
                              several factors associated with successful outsourcing.

                              One of the key factors was establishing a competitive outsourcing policy
                              that specifies what process and criteria the organization will follow in
                              making competitive outsourcing decisions to achieve its overall goals. This
                              policy at DFAS might include (1) an outsourcing structure by which the
                              functional areas to be considered for outsourcing are identified and
                              (2) criteria to be used in determining whether or not to outsource a specific
                              function, such as personnel losses, decreased costs, or economic impact to
                              the community. In addition, a schedule with specific time frames for
                              competitively bidding DFAS functions and deciding whether or not to
                              outsource them might be added later. Finally, after an organization decides
                              to outsource, it is key that effective oversight controls be in place to ensure
                              that vendors carry out their responsibilities. Establishing a competitive
                              outsourcing policy that includes these elements as well as adequate
                              oversight controls is fundamental to achieving the projected cost savings,
                              process cycle time reductions, and other related financial management
                              improvement goals established by the department.

Clarification of Transition   In addition, the transition plan, while an ambitious statement of DOD’s
Plan                          planned improvement efforts, has two important limitations: (1) links are
                              not provided between the envisioned future operations and the over 200
                              planned improvement initiatives to determine whether the proposed
                              transition will result in the target financial management environment and
                              (2) actions to ensure feeder systems' data integrity are not addressed--an
                              acknowledged major deficiency in the current environment. Without
                              identifying specific actions that will ensure ongoing feeder system data
                              integrity, it is unclear whether the department will be able to effectively
                              carry out not only its financial reporting, but also its other financial
                              management responsibilities.

                                 Financial Management: Outsourcing of Finance and Accounting Functions (GAO/AIMD/NSIAD-98-43,
                              October 17, 1997).

                              Page 22                                                           GAO/T-AIMD/NSIAD-99-145
Concepts of Clinger-Cohen   Effective implementation of the modernized systems outlined in the
                            Biennial Plan will require following well defined practices for managing
                            investments in information technology--practices that have been lacking in
                            DOD and other agencies across government. Several recent management
                            reforms have introduced requirements emphasizing the need for federal
                            agencies to significantly improve their management processes, including
                            how they select and manage IT resources. For instance, the Clinger-Cohen
                            Act requires agencies to have processes and information in place to help
                            ensure that IT projects are being implemented at acceptable costs, within
                            reasonable and expected time frames and are contributing to tangible,
                            observable improvements in mission performance. We recently testified19
                            before the House Committee on Armed Services’ Subcommittee on Military
                            Readiness about a number of serious management challenges DOD faces
                            regarding technology-driven processes and business systems. Specifically,
                            we highlighted DOD’s lack of effective fundamental management and
                            oversight controls for (1) assessing the costs and risks of proposed
                            information technology projects, (2) ensuring that projects follow
                            departmentwide technical and data standards, (3) measuring performance,
                            and (4) discontinuing projects shown to be technically flawed or not cost
                            effective. DOD has efforts underway to implement required reforms but a
                            great deal more effort is needed. Unless DOD successfully implements
                            these broader information technology reforms, it will be limited in its
                            ability to achieve the financial management system goals outlined in its
                            Biennial Plan.

                            While there is a need to address these problems over the long term, we
                            recognize that in the short term the department still must focus on the Year
                            2000 computing challenge. However, DOD has a unique opportunity to
                            capitalize on the valuable lessons it has learned in its Year 2000 effort and
                            apply them to its overall management of financial management and
                            information technology. Doing so can enable the department to acquire and
                            deploy high performing, cost-effective systems and to avoid repeating
                            costly mistakes. Examples include the following:

                            • Without the continuing, active involvement of top-level managers, major
                              management reform efforts cannot succeed.

                              Defense Information Management: Continuing Implementation Challenges Highlight the Need for
                            Improvement (GAO/T-AIMD-99-93, February 25, 1999).

                            Page 23                                                            GAO/T-AIMD/NSIAD-99-145
• Maintaining a reliable, up-to-date system inventory is fundamental to
  well-managed financial management and information technology
• DOD has spent 3 years identifying system interfaces and implementing
  controls at the system level that should help prevent future data
  exchange problems in its systems and resolve conflicts between
  interface partners.
• Once the Year 2000 effort is completed, DOD can use the operational
  and functional evaluations to further identify and retire duplicative or
  unproductive systems.

The Secretary of Defense has expressed the department's commitment to
financial management reform. He recently announced that he was
expanding his Defense Reform Initiatives to include financial management.
Achieving real reform will entail the involvement and dedication of top
management. Working through the Defense Management Council or a
similar structure of the department's high-ranking leadership, such as that
used to address the Year 2000 computing crisis, is a key factor in achieving
major change within the organization.

In closing, Mr. Chairman, sustained congressional attention on DOD’s
efforts to reform its long- standing financial management weaknesses,
provided in hearings such as this one, will also be critical to ensuring that
DOD is able to provide accountability to the taxpayers and to meet its
operational goals as efficiently and effectively as possible.

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

Page 24                                                GAO/T-AIMD/NSIAD-99-145
Page 25   GAO/T-AIMD/NSIAD-99-145
Appendix I

DOD Fiscal Year 1998 Financial Statement
Audit Reports

                     Department of Defense Agency-wide Financial Statements (March 1, 1999,
                     DOD IG 99-097)

                     Army General Fund Financial Statements (February 18, 1999, AA 99-158)

                     Army Working Capital Fund Financial Statements (February 19, 1999, AA

                     Army Corps of Engineers, Civil Works Financial Statements (February 8,
                     1999, AA 99-157)

                     Air Force General Fund Financial Statements (March 1, 1999, AFAA Project

                     Air Force Working Capital Fund Financial Statements (March 1, 1999,
                     AFAA Project 98068013)

                     Navy General Fund Financial Statements (February 10, 1999, NAS 024-99)

                     Navy Working Capital Fund Financial Statements (February 22, 1999, NAS

                     Defense Logistics Agency Working Capital Fund Financial Statements
                     (March 1, 1999, DOD IG 99-089)

                     Defense Finance and Accounting Service Working Capital Fund Financial
                     Statements (March 1, 1999, DOD IG 99-090)

                     Military Retirement Trust Fund Financial Statements (March 5, 1999, DOD
                     IG 99-104)

(918954)     Leter   Page 26                                           GAO/T-AIMD/NSIAD-99-145
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