Financial Audit: Air Force Does Not Effectively Account for Billions of Dollars of Resources

Published by the Government Accountability Office on 1990-02-23.

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

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                      United States General Accounting                 Office     / q n b % )

    For Release         Financial         Audit:        Air     Force      Does    Not     Effectively
    on Delivery        Account      for      Billions          of   Dollars       of    Resources
    !I:30 a.m. EST
    February    23,

                       Statement of
                       Charles A. Bowsher
                       Comptroller  General                   of the     United        States
                       Before the
                       Committee on Governmental                        Affairs
                       United States Senate

                                                                                         GAO Form 160 (12/87)
Mr. Chairman               and Members of                the       Committee:

          We are pleased                 to be here               today     to discuss              our    recent        efforts
to audit          the Air           Force's        fiscal          year     1988 financial                 statements.
This      was the          first       time      that       a military            service           developed
financial           statements             and provided              them to GAO for                  audit.            We are
releasing           our     full       report       on our          review         to the       Committee              today,        and
our     testimony           will       summarize            some of         the    key results.                  Before
discussing           our       findings,           I would          like      to put         into     perspective                  why
it     is so important                 now that          government              agencies           - particularly                  the
Defense          organizations                 - take       the     initiative           to establish                  the    kinds
of     systems,       controls,                and procedures               needed       to make them capable                            of
producing           acceptable             financial           statements             that      can be audited                     by an
independent            third         party.

          Quite      simply,           the      successful           preparation              of     financial
statements           demonstrates                that       an organization's                   systems          and
personnel          are capable                 of accumulating,                  analyzing,           summarizing                  and
reporting           on its          financial           condition           and operating                 results.            This
capability           has long           been demanded by the                       Federal           government              for     the
private          sector,           and more recently                 for      state      and local             government
sectors          as well.            More recently,                 several        of    the major             civil         federal
agencies          have used financial                       statements            as a key element                     in their
efforts          to bring           financial           control,           accountability,                 and cost
effectiveness               into       their      operations.                 These      include           GSA, the
Departments           of Veterans                Affairs,           Agriculture,              and Labor,               as well           as
the     iocial       Security           Administration.                     Most      recently            HUD in reaction
to the        scandals         in     its         housing         programs,              has launched                   comprehensive
initiatives            to bring             financial              integrity             to      its      operations.                     The
development            of     financial             statements                 for     audit           represents              a
cornerstone            in HUD's strategy                         for        doing       this.           However,              the
taxpayers            should     not         be expected                    to wait       for      HUD scandals                     to occur
on a case by case basis                            to get         proper             financial            and accounting
procedures            implemented                 one agency                at a time.

          In candor,           I have to tell                     you that             getting            federal
organizations                to prepare             acceptable                 financial               statements              is not           an
easy task.             Change does not                     come easily                  to      federal          operations.                    The
federal        government            has always                  stressed             appropriation                   accounting                and
fund      control,           in other             words      the           budget      process.                This         is certainly
a critical            part     of government                     financial             management;                   unfortunately
in many organizations                        it     may be the                only       part          that      is being
seriously         considered.                     In such situations,                           llH~~ much can I spend"?
overshadows            the     equally             important                question            "How well             am I managing
and controlling                the     resources                 I already             have?"             The latter                 question
becomes even more important                                for         DOD in today's                   environment                  of
looming        reductions            to the              defense            budget.             The military                 services
are     already        responsible                 for     huge amounts                  of assets,                  the     Air      Force
alone      is entrusted              with          assets         reportedly                 valued           at $275 billion.

          Similarly,           today's             environment                will       require              greater          emphasis
on costs        and how to control                         them.             We have            found         that         federal
agencies'         accounting                systems         do not            routinely                accumulate              and report
on the costs              associated                 with         their      various        operations.

         Meaningful              cost         control             requires          knowing       first       Ghat      the     costs
being      incurred             are.          Unfortunately,                  many federal                agencies        do not
have accounting                  systems             to provide              this      information            in a systematic
manner.           Until         they        do,      meaningful              efforts        to control            costs        and
achieve         financial              efficiency                 cannot      take      place.

RELIABLE FINANCIAL                      DATA

         Specifically                  with         regard         to the       Air     Force,        our audit           noted
that     its      accounting                systems           do not         provide        accurate          cost      data      for
almost         80 percent              of     its     non-cash             resources          such as weapons,
inventory,           and equipment.                         Its      accounting            and financial               management
systems         can neither                 provide           complete          and reliable               financial           data
nor be depended                  upon to report                      accurately            on the         resources
entrusted          to     its     managers.                   Much information                 that        is produced            is
not     timely.           Financial                 reports         can only           be developed            with
extensive,           time-consuming                     efforts            to compile         data         from      a variety          of
sources.           These conditions                         adversely           affected          financial            reporting
and management                  at all         levels,             ranging          from    the    Air      Force
consolidated              financial                 statements             down to base            level       financial
           The General              Accounting            and Finance               System was intended                            to
serve        as the Air             Force's        general          ledger,             but     a number of very
significant                accounts         were not         included.                  Certain         data,         such as
aircraft           values          ($82 billion)             and accounts                 payable             amounts          ($18
billion)           had to be derived                  from property                     systems         or from extracts
of budgetary                data        rather     than      from a properly                     designed             financial
management            system.             In short,          the      Air        Force        does not          have basic
double        entry         accounting            control       over         the       bulk       of    its      assets.

           One result              of    these     conditions               is    that         financial             reports            to
the       Office      of Management                and Budget               and the            Treasury          are        also
inaccurate            and unreliable.                     In recent              years         some Air          Force
components            failed            to submit         financial              data         in time         to be included
in the year-end                    Treasury        reports.            As a result,                    March         31 data            was
used       in lieu          of missing            September           30 data.                 Furthermore,                 over        $25
billion        of Air          Force        assets     were not              included             in financial                 reports
to the        Treasury             and an additional                  $10 billion                 in transactions                       were
counted           twice.

           Use of even              the     limited         existing             financial             reports         within            the
Air       Force     was quite              limited.          Analysis             of     the      accounts            used in
preparing           the      financial            reports       showed obvious                     errors            that      were not
corrected           and were not                 investigated               to determine                if     a problem
existed.            As a minimum,                  obvious          mistakes             and significant                     changes
in account            balances            should      be     followed             up to make sure                     that         serious
problems           are addressed.                  Some examples                  of     accounts             that      warranted
further        review          are:

          --   The disbursement                     accounts          at the         Air    Force          Systems
               Command declined                    by 64 percent               between            fiscal       year
               1987 and 1988.                     This       could      indicate           that        information
               is not         being         properly          reported         by payment               centers        or
               the     rate      of progress                 payments         is slowing.                  Management
               needs      to monitor                the      contracts         more closely                  based     on
               this     data.              The same account                  decreased            at    the
               Aeronautical                 Systems          Division         by 97 percent,                  but
               increased              at    the    Rome Air           Development            Center.             For the
               same account,                  another         component--the                Space Systems
               Division         --reported             a zero         account         balance           at    the    end
               of the         fiscal          year.          Obviously,             the Command needed                  to
               followup          on the           activity           in this        account            to determine
               the     abnormal             changes          and reporting             by its           components.

          --   Air     bases          reported         credit         (negative)            balances           of    some
               inventory              accounts         and construction-in-progress
               accounts.               Yet management                 did     not     investigate              the
               cause      of     these         obvious          incorrect           balances.

          We also       found          that       billions           of dollars            in adjustments               were
made which            could      not       be supported               or explained                by Air       Force
officials.             There          can be legitimate                     and necessary               purpose        for
adjustments.              However,             without          adequate        safeguards,                  adjustments
can also     be used       improperly                to cover            up defalcations,                        hide     losses,
or mask errors.            Examples             of     improper              adjustments             and lack             of
reconciliations           were:

       --   The Space Systems                   Division's               trial        balance            for      March         31,
            1988 differed               from     its      subsidiary                 records         by $2.4             billion.
            In order       to get         the        two systems                 to agree,           they         ltplugged'q
            the     accounts.            In order              words,         they        made an unsupported
            adjustment          for      $2.4        billion           without            finding          out       why the
            records       did     not     agree.               As a result,                accountability                   was
            lost     and the          opportunity                  to deal        with       possible             instances
            of mismanagement,                   fraud,             or abuse        was missed.

       --   Similarly,          at the         Systems              Command, our                 audit         tests
            disclosed       unsupported                 adjustments                  of    $500,000              that     were
            made to obligation                   and expenditure                      accounts             for       Operations
            and Maintenance               appropriations                      in September                 1988.
            Officials       could         not        explain           the       adjustments,                  nor      could       they
            find     any documentation                    to show why they                        were made.

       --   At Sembach Air              Force          Base,          we found            that      over         $214,000           in
            undocumented              adjustments,                  a material             amount          for       an air
            base,       were made to force                         control        accounts           to agree             with
            subsidiary          records.               When we researched                         these          adjustments,
            we found       that        some of          the         unsupported              adjustments                 were
            attributed          to the         actions              of a disgruntled                     employee           in the
finance         office          who failed            to properly            process           transactions,
entered         erroneous             data,     and destroyed                source         documents.

At three            ALCs,       the    interfaces             between        the        perpetual
inventory            tracking          systems          and inventory               accounting              system
did      not    function           properly.             As a result,               the     two systems
reported            different          amounts          on hand for               the    same items.            To
compensate,              either        each month             or each quarter,                  the    ALC's
accounting             and finance             office         adjusted            the    accounts           in the
inventory            accounting             system       to     force       them to agree              with     the
perpetual            inventory             tracking         system's         balances.              However,
the discrepancies                     between         the     systems        were not           researched
to determine              their        causes.           The net          effect         of such
adjustments              for      fiscal       year      1988 decreased                  the    inventory
accounts            by about          $361 million.                At our          request,         Ogden ALC
officials            researched             $241 million             of     its     September          30,
1988,       adjustments               and found          that      $114 million                was the
result         of    inventory             system       errors,         while       $127 million
resulted            from coding             and timing            errors.           These errors              had
been masked by the                     improper          adjustments               and would          not
likely         have been detected                     had we not            asked base officials
to    investigate.

         The development                     and acquisition               of weapon systems                    represents             a
major      fiscal          commitment            for     DOD and the              taxpayers.               One of the
greatest         challenges               facing        DOD today          is     to manage reduced                    spending
after      a period             of    large     peacetime             defense       buildup.               Since       the mid
1980s,      DOD's five                year     defense         planning           has been fiscally
unrealistic.                   More weapons             were being          planned          and developed                than
could      be produced                in an economic                 manner       or supported               once they          were
produced.            Since           1982,     DOD five-year               spending          plans         have exceeded
actual      and current                estimated             funding       by over         $2 trillion.                  This     is
not     an effective                 way for       DOD to manage nor does                       it        facilitate
congressional                  oversight        of      the    defense          budget.

         The Air           Force's         costs        of weapon systems                 reported             in the
accounting           system           are vastly             understated.             Aircraft,              missiles,
and engines           are        valued        at an estimated                  standard       or purported
"average         acquisition"                 costs      which        do not       reflect           actual       costs
incurred         to acquire             the      items.          We compared           the     accounting                system
costs      to Selected                Acquisition             Reports           (SARs) reports               and to
expenditures               from       the budgetary              reports          and found           that      actual
costs      are      not        recorded        in the         accounting           systems.               For example,            the
B-1B bomber               is    recorded         in the        accounting           system           at    $150 million
each.       The SARs reported                      $215 million             for     each and we estimated
$219 million               each.        While          the    SARs costs           more closely                approximated
our     estimate          of actual             costs,      we have previously                    reported           that     the
SARs do not             adequately              disclose         all     costs      associated           with        major
weapon systems.                   For example,               SARs often            do not        include        actual
contractor             costs      incurred          to date            or a schedule             comparing           funded
quantities             to planned          and actual              contractor            deliveries.             The SARs
also     do not         reflect          anticipated,              but    not      yet     approved,          cost
estimate         changes.

         The SARs costs                  are derived             from     Air      Force        budgetary        data,        as
are     other         documents          the Air         Force         uses to portray             weapons           systems
cost.         However,          OMB Circular               A-127        requires         that     budgeting           and
accounting             should      be done on the                  same basis            through        integrated
budgeting             and accounting              systems.             Cost     information,            whether
reported         in general              ledger      accounts            and financial              reports          or SARs
should        be consistent.                 There         should        not     be a variety            of different
numbers         for     similar          items      to choose            from.

         Other         costs      that     were not           included           in the         weapons       systems
valuations             are:

         --     Government           furnished             materials,            such as parts,               components,
                assemblies           and raw materials,                       provided          to contractors               and
                incorporated              into      the     weapon systems                are     not    included            in
                the     value      of     the     end items.              We have previously                    reported
                that     long-standing               problems            in controlling              and accounting
                for     government           furnished             materials         preclude           DOD from

             knowing          the exact             amount          of    these          items       in contractors'
             hands.           DOD and the                 services          have no overall                     management            or
             financial            systems           to         independently              verify          contractor
             records          and measure                 the     value         of government                furnished
             material           ultimately                included          in end items.

        --   Over $25 billion                      of modifications                  which          enhance             the mission
             capabilities              and/or             extend         the     service           life      of weapon
             systems          generally             are not            included           in the          valuation         of    the

        Additionally,                the     Air         Force      accounting             systems           do not
capture      all         operating          and support                costs       associated               with        weapon
systems.           In     198'7 the         Senate         Committee             on Appropriations
expressed          its     concern          over         the     long-term          implications                   of
procuring          weapon systems                  which         have     increasingly                expensive
operating          and support              costs.              During      that     same year               we attempted
to review          such costs          but         were         forced      to terminate                  the      review
because      the         needed      cost     data         was simply              not     available.                   There    is
no logical          reason        in today's               world         that      a large,           complex
organization              such as the              Air     Force         should      not         have a sound cost
accounting          system.           This         is absolutely                 essential            for       measuring
costs     and improving               efficiency.


          Inventory         management          for      the         Air         Force      is an extremely
complex       task       due to the          size       of     its         operations,           frequent
technological             obsolescence,               and decentralization                        of storage           for
national         security          reasons.           To maintain                  and support          its
operations           and weapons            systems,          the          Air     Force      manages about            1.6
million       different            spare     parts       and supply                  items     valued         at about
$64 billion.              This      is about          eight          times         larger      than     the
inventories             reported       by General             Motors.               Unfortunately,              systems
used to track             and value          these       immense inventories                          do not      maintain
accurate         data     supporting           either         the          quantities          or values.             Yet
these      are    the     systems          upon which           managers                 must depend          upon in
determining             whether      new items           need to be purchased.                           Using
inaccurate           information            to base purchase                       decisions          can result         in
unnecessary             procurements           and excess                  inventories           in some
instances,           and shortages             in others.

Excess      Inventories             are     Increasinq

          Unrequired         inventories              have grown                  tremendously          in     the
1980s.        The Air        Force         is estimated               to have at              least     $10 billion
of unrequired             inventory.            The growth                  in unrequired              inventory         is
related       to several            factors.            The most common causes                          of     this
growth are           overestimated             use rates              and modifications                  of aircraft
and equipment.                  Other         causes       include       faster            than     expected             phase-
outs      of older          aircraft,            fluctuating            war reserve                and safety              level
requirements,               improved           item     reliability,                and items             being
reclassified               as repairable.                  Also,       orders        for     items          in excess           of
requirements               were not           terminated           and procurement                  lead         times        were
overestimated.                  This      problem          is not       Air     Force        specific,               the
amount       of excess             inventory           in the       Department              of Defense               as a
whole       is estimated               at $29 billion.                  We currently                have ongoing
work     that      will        address         matters        related          to    inventory              on a DOD-wide

Inadequate            Accountability                Precludes
Effective          Inventory            Management

         Accountability                 systems         used to track                the     location             and
quantities            of    over       half      the    Air    Force's           inventory               items       do not
provide         reliable,           accurate           inventory         data        to managers.
Inaccurate            inventory           records          can cause           critical            supply         shortages,
prolonged          delays          in filling           requisitions,                or unnecessary
procurements               resulting           in accumulation                 of excess                inventory.
Although         the Air         Force         has recently             improved            the     accuracy             of    its
data      in automated              perpetual            inventory            systems        and generally                    takes
accurate         physical           inventory           counts,         we believe                the     perpetual
records         are    still        too       unreliable           to make effective                      and efficient

Inventory            Valuations
are      Inaccurate

          The Air            Force      did     not        consistently               apply       its      inventory
pricing          policies             to value         inventories               of    investment               items.         The
Air      Force       assigns           values         to    inventories               of    spare        parts        and
supplies          based         on the        item's          latest         acquisition                cost.
Basically,             the     Air      Force     multiplies                 this      cost       times         the    number of
units       in stock            to arrive         at        the     total        inventory              value.         Air
Force       policy           states      that     the        standard            price        generally           represents
the      last     acquisition             cost         of    an inventory                  item     plus        a surcharge
for     government              furnished         materials                 and transportation                    costs.
Therefore,             all      items     of a particular                     stock         number are            valued        at
the     same price.

          Under        this      practice         when items                 are purchased                 at higher
prices,          the    value         of all      such            items      are adjusted                upward.             Unless
the     accounting             statements              reflect            such      increases            as occurring
from changes                 in valuation,                 they     are misleading                  because           the
readers         cannot         readily          determine              whether         the     growth           represents            an
increase          in     items        on hand or simply                      increased            values         of current

Inventory          Values              are Not
Adjusted          for      Condition

             Inventory          values              are not         adjusted        to        reflect             the      condition
of     the     items       in     inventory.                  Although            about         $7 billion                 of       the
inventory           items         at the             three     ALC's         we visited                were unserviceable,
they      were valued                  the     same as new inventory                            items.              This        practice
results          in a significant                      overstatement                 of       inventory              values           and is
misleading              because              (1)     the     true      inventory              value          is     less        than
shown and           (2)        there          is a substantial                    additional                 cost        to bring
unserviceable                  items          to an usable                condition.

          The military                  services             maintain          a large              number of
unserviceable                  items          in their          inventories               for        a variety                 of
reasons.           For example,                      components            that     are         very         expensive               to
repair         and not          in high              demand can be better                           controlled                 and
scheduled          for         repair          only        when needed.                 The Air              Force         has
determined              that      it     is more efficient                        to maintain                 the        unusable
item      under         normal          inventory             control          and repair               it        when necessary.
Although          this         approach              may be effective                   for         certain             inventory
management              purposes,              it     is not         acceptable               for      financial                reporting
purposes.               To show these                  items         at    the     same value                 as fully
serviceable              items,          when many require                        the     investment                 of
significant              dollars              before         they     can be used,                   distorts              the
financial          statements.                       The Air         Force        needs         to develop                 a
methodology              to     regularly              adjust         the      unserviceable                      portion            of   its

inventory         to    reflect          costs         associated               with      repairing          the      items.


         The Air        Force      audit          illustrates               why we do need reliable
financial         statements             for      federal           agencies.              There       are    still       some
who insist         that      traditional                federal          financial            management
practices         are     adequate             and that            financial            statements           and audits
are not      needed         in federal             operations.                   I would       like      to put          these
notions      to rest.

         Almost        universally,              our       financial             audits       of civil            agencies,
as well      as the        Air     Force,          have       revealed            systems         problems            which
are   so severe           that     the         financial            information             needed       to manage
agency      operations            as well          as prepare               agency         financial          statements
are seriously             deficient.               These problems                      are generally              more
serious      and deep-seated                    than       either       we or the             agency         managers
realized      before         the      audit.           We believe                the     process        of    trying          to
prepare      financial            statements               forces        full          recognition           of    the
systems      problems.             The process                is     like        an early         warning          system,
an often       overlooked             value        which        derives           from      the      preparation              of
agency      financial            statements.

          Our financial               audits         have disclosed                 that        those       systems          which
do exist        are not            designed          to aid        government              managers          to operate
in a cost-effective                       manner,       or to prevent                mismanagement,                    fraud,
waste       and abuse.              These essentials                     must be addressed                   when
reliable        financial             statements             must be prepared.                       This         is because
statements            cannot        be prepared              without            addressing             systems         issues
and related            internal            controls.

          Reliable        cost        information              needed           to manage in a cost-
effective        manner            flow      from      the     good accounting                    systems          necessary
to prepare            financial            statements.              Management              controls              which
operate        to prevent            mismanagement,                  fraud,         waste         and abuse           are     also
required        to produce                reliable        financial              statements.                The appalling
list      of high-risk              areas       recently           published             by OMB highlights                      the
need for        reliable            financial           statements               prepared           by federal
agencies.             Most     of the          items      OMB identified                   result        from        and are
related        to accounting                 systems         problems.

          Why can't          the     agencies           just       fix     the      systems          and not          bother
with      financial          statements?                Theoretically                possible,              but
practically            impossible.               The agencies               need the            discipline              of
having        to prepare            reliable           financial           statements               which         satisfy
standards        set      by independent                  auditors              in order          to focus           on fixing
the    underlying            systems.            You might               view     audited           financial
statements            as a report             card      which       will         point      out      seriously
deficient        systems,            help       quantify           the     extent          of    the     problem            and
highlight          what       needs       to be done.                 Until         an agency           can achieve
unqualified             financial            statements,              its      systems          will      be seriously
deficient,            the     information              derived          from         those      systems          that      goes
to the Congress                and others              will         be incorrect,               and it         cannot       be
cost      effective.               That's        the     financial             statement              report      card.

          Also,       I want         to emphasize              that         improving           financial
management            in the         federal       government                has been an important
objective          of GAO, OMB and Treasury.                                  In 1988 the              Secretary           of    the
Treasury;          Director,            Office         of Management                  and Budget;              and I
collectively                issued      standards             for     core         financial           system
requirements.                 Those standards                  represent              a major          step      in
improving          federal           financial          management                 systems           and will         provide
greater        consistency              and reliability                     to department                and agency
financial          systems           and improve              financial              reporting.

          What we have               found       in our        audits          of     the      Air     Force      and other
agencies          and government                 corporations                 is     that      the
true      financial           situation           of    these         entities              had not       been disclosed
to the       public,          the Congress,               OMB and the                 Treasury.             What we have
found       is that          the     agency       managers            did      not      understand             the
financial          condition            of     their      agencies             before          they      tried        to
produce        auditable             financial          statements.                   As the          report
demonstrates,                the     financial           information                 reported          to Congress              and
OMB by the            Air     Force       was wrong            by significant                   amounts.

         In addition,                we noted          that      Air     Force          statement           line        items
should         be adjusted              by amounts            which      are not           calculable              at this
point         in time.           We roughly            estimate          that      equipment              and missiles
are misstated                 by billions            of dollars            and aircraft                  and inventories
are misstated                 by tens        of billions               of dollars.

         Moreover,              additional           analysis           during          our     fiscal       year        1989
audit       shows that             the budgetary               system          processed           about        $12 billion
in budgetary              transactions               (expenditures)                 in 1988 that                was not
recorded          in the         general       ledger          accounting               system.           For      fiscal
year     1989,         we estimate            that      an additional                   $23 billion             was not
recorded          in the         system.         Air      Force         finance          officials           estimate           .
that     several          billions           of dollars           of expenditures                    were       for
classified             assets        which     are not           recorded           in the accounting                       system
for     security          reasons.            While       they         could     not       specify          the       amounts
for     the     remaining            expenditures,               they      agreed          that      they       represent
assets         that     are      (1)     recorded         in the         accounting               systems          at
different             costs      than     actually            incurred,           (e.g.,          weapons          systems)
(2) government-furnished                         materials              provided           to contractors,                   and
(3) consumed              inventories.

         Despite          the     conditions            I have described,                       I would         like        to end
my testimony              on a positive                note.         The Air            Force      showed
initLative             and leadership                in being           the     first         DOD organization                  to

attempt          to prepare           financial           statements.             That     task     proved       to be
more formidable                than       either       GAO or the           Air    Force       anticipated;
nonetheless             both    of us have learned                    a great       deal       and much has
been accomplished.                     Our report           provides         a blueprint             for
corrective          action         and DOD has concurred                     or partially                concurred
with    all       of our       recommendations.                     You may be sure               that     we will
continue          our    efforts          with      the    Air      Force    to    improve         its     financial
operations          and it         is our          intention         to review           the   Army next         and
later      the     Navy.

        Mr. Chairman               this     concludes            my prepared             statement.           I will
be please          to answer           any questions                from    you and other                Committee