Federal Aviation Administration: Financial Management Issues

Published by the Government Accountability Office on 1999-03-18.

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

                          United States General Accounting Office

GAO                       Testimony
                          Before the Subcommittee on Government Management,
                          Information and Technology, Committee on Government
                          Reform, House of Representatives

For Release on Delivery
Expected at
2 p.m.
                          FEDERAL AVIATION
March 18, 1999            ADMINISTRATION

                          Financial Management
                          Statement of Linda M. Calbom
                          Director, Resources, Community, and Economic
                          Development Accounting and Financial Management
                          Accounting and Information Management Division

                       Mr. Chairman and Members of the Subcommittee:

                       I am pleased to be here today to discuss financial management issues at the
                       Federal Aviation Administration (FAA). In January 1999, we designated
                       FAA financial management as a high-risk area because of serious and long-
                       standing accounting and financial reporting weaknesses. These
                       weaknesses render FAA vulnerable to waste, fraud, and abuse; undermine
                       its ability to manage operations; and limit the reliability of financial
                       information provided to the Congress. Beginning with fiscal year 1994, the
                       Department of Transportation’s Office of the Inspector General (OIG) has
                       audited FAA’s financial statements and has consistently been unable to
                       determine whether the financial information is reliable. This pattern of
                       negative financial audit results continues today with the OIG’s recent
                       financial audit report--a disclaimer of opinion 1--on FAA's fiscal year 1998
                       financial statements.2 The OIG was unable to substantiate billions of
                       dollars in major assets, or determine the accuracy of the reported $9 billion
                       of costs for FAA’s programs.

                       My testimony today will

                       • provide a brief history of FAA’s financial management weaknesses,
                       • discuss the identified fundamental problems which FAA must resolve in
                         order to achieve financial accountability, and
                       • highlight corrective measures the agency has under way.

History of Financial   Beginning with fiscal year 1994, the first year that the OIG performed an
                       audit of FAA’s financial statements, significant problems with FAA’s
Management             accounting for billions of dollars of inventory and property, plant, and
Weaknesses             equipment (PP&E) were disclosed, including the agency’s failure to
                       properly capitalize the costs of major assets. Because of the pervasive
                       uncertainties surrounding these major assets, the OIG could not determine
                       the reliability of the fiscal year 1994 financial statements and issued a

                       1A disclaimer of opinion means that the auditor is unable to form an opinion on the financial
                       statements. A disclaimer results when a pervasive material uncertainty exists, or there is a significant
                       restriction on the scope of the audit.

                         Report on Fiscal Year 1998 Financial Statements, Federal Aviation Administration, Department of
                       Transportation Office of Inspector General, (FE-1999-070) dated March 8, 1999.

                       Page 1                                                                            GAO/T-AIMD-99-122
disclaimer of opinion on those statements.3 Similar results occurred for
fiscal years 1995 through 1997.

Again in fiscal year 1998, the IG was unable to express an opinion on the
reliability of FAA’s financial statements, citing as a primary reason the
inability to verify PP&E reported at a cost of $11.9 billion. The OIG
reported, as it had for fiscal year 1994, that PP&E was significantly
understated due to FAA’s improper expensing of capital assets.
Additionally, the OIG reported other significant accounting and reporting
issues related to the reliability of FAA’s financial statements and the
records that support those statements.

We have previously reported that problems in accounting for PP&E and
inventory affect FAA’s ability to efficiently and effectively manage
programs that use these assets and expose the agency to waste, fraud, and
abuse.4 Recently, we reported that FAA needs to improve its accountability
over its field spares inventory.5

Many problems in the PP&E and inventory accounts result from the lack of
a reliable system for accumulating project cost accounting information.
The lack of cost accounting information limits FAA’s ability to make
effective decisions about resource needs and adequately control major
projects, such as its multibillion-dollar air traffic control (ATC)
modernization program. This mission-critical capital investment program,
aimed at modernizing FAA’s aging ATC infrastructure, was begun in 1981 to
combat the strain on the current ATC system, which has experienced
sustained growth and aging equipment.

The modernization program currently consists of over 200 separate
projects estimated to cost over $42 billion through fiscal year 2004. It
includes acquisition of new radar and automated data processing,
navigation, and communications equipment, as well as new computer
software, facilities, and support equipment. As these items are placed in

  The OIG report specifically disclaimed on the Statement of Financial Position and stated that its audit
work was limited to that statement because the balances for inventory and PP&E could not be
validated, and those balances materially affected the other statements presented.

4Financial Management: Federal Aviation Administration Lacked Accountability for Major Assets
(GAO/AIMD-98-62, February 18, 1998).

 Financial Management: Briefing on the Federal Aviation Administration’s Inventory Accountability
(GAO/AIMD-99-98R, March 3, 1999).

Page 2                                                                            GAO/T-AIMD-99-122
                              service, FAA is required to capitalize them and report them as property and
                              equipment assets in its financial statements. However, as the OIG reports
                              have shown, FAA for years has erroneously expensed many of these
                              investments to current operations, thereby losing track of the specific cost
                              of individual assets and the accumulated cost of major projects.

Fundamental Problems          Four fundamental problems must be resolved before FAA can achieve the
                              most basic level of financial accountability.
Need Resolution
                              • First, FAA must resolve the basic problems related to accounting for
                                property, plant, and equipment, and institute systems, procedures, and
                                controls to ensure that accountability is maintained on an ongoing basis.
                              • Second, FAA must complete its improvements to its inventory
                                accounting system, particularly those related to field spares.
                              • Third, FAA must implement a cost accounting system capable of reliably
                                accumulating full project cost information.
                              • And, finally, FAA must address its other financial reporting issues that
                                preclude it from preparing meaningful financial statements.

                              I will now discuss each of these issues in a little more detail.

Property, Plant, and          During fiscal years 1982 through 1998, FAA spent approximately $26 billion
Equipment Accountability Is   on capital improvement programs; however, as of September 30, 1998, the
                              agency had reported less than $12 billion in gross property, plant, and
                              equipment asset costs–a difference of $14 billion. Although some portion
                              of the $14 billion was undoubtedly properly charged to expense accounts, a
                              significant portion was improperly expensed. Since fiscal year 1994, the IG
                              has consistently reported that assets are being inappropriately expensed or
                              otherwise unaccounted for.6 During the audit of the fiscal year 1998
                              financial statements, the OIG specifically identified $1 billion in assets that
                              were not recorded on the balance sheet. More recently the IG testified that

                                Some of these capital improvement program costs relate to terminated or cancelled programs that
                              should not currently be reported as assets. However, because the costs related to these programs were
                              never fully captured, it is impossible to tell how much of the $14 billion relates to terminated projects.
                              Other costs relate to the acquisition of spare parts, which are reported in a different asset category–
                              inventory--which totaled less than $1 billion as of September 30, 1998. Further, some costs may be
                              appropriate expenses because they are for services unrelated to property acquisition.

                              Page 3                                                                            GAO/T-AIMD-99-122
the total understatement for all equipment “could be as much as
$10 billion.”7

The OIG’s audit report on the fiscal year 1998 financial statements
identified numerous errors and weaknesses in FAA’s process for keeping
track of amounts related to PP&E. Specifically, the OIG found that:

• The reported $2.1 billion in the “work- in- process” account, which is
  supposed to be used to accumulate the costs of projects under
  development, could not be substantiated because FAA did not have an
  effective process to accumulate and document these costs, nor to
  eventually record them in the appropriate PP&E accounts. For
  example, FAA was unable to provide supporting documentation for 34
  percent of the $887 million in work-in-process items selected for testing,
  including a flight service station with recorded costs of $1.2 million, of
  which FAA could only provide information for costs of $123,000.
• The work-in-process account included an estimated $1.3 billion that
  related to projects that had been completed for at least 6 months. These
  completed project costs should have been moved to the appropriate
  property and equipment accounts, with related depreciation expense
  being charged to operations. Unrecorded depreciation expense related
  to these projects amounted to at least $62 million.
• Real property (land, buildings, and structures), reported at $2.5 billion,
  included significant amounts of items that were not properly valued, or
  had no support for the values assigned. Additionally, a number of real
  property items were identified that were not recorded at all, while
  others that were recorded did not currently exist. For example, FAA
  was only able to provide supporting records for $3.6 million of the
  $20 million recorded for a power supply system installed in 1992. In
  another example, FAA’s records included $1 million for a building that
  had been demolished over 10 years ago.
• Personal property (equipment), reported at $4.1 billion, was understated
  by at least $1 billion due to FAA’s long-standing practice of expensing
  rather than capitalizing material portions of major equipment systems.
  For example, voice switching control systems with an estimated cost of
  $1.1 billion were recorded on the books at a total cost of $234 million.

  This statement was made by the Honorable Kenneth M. Mead, Inspector General of the U.S.
Department of Transportation before the Subcommittee on Transportation and Related Agencies,
House Committee on Appropriations, on March 9, 1999, in his testimony Federal Aviation
Administration: Financing and Cost Control.

Page 4                                                                      GAO/T-AIMD-99-122
                           These deficiencies affect FAA’s ability to properly manage these assets,
                           thus giving rise to potential operational inefficiencies. For example,
                           mission-critical equipment, such as radar and other air-traffic-control
                           equipment, may be difficult to locate when needed, which could exacerbate
                           an emergency situation. Also, asset theft could go undetected, and funds
                           could be spent unnecessarily to acquire equipment that is already on hand.
                           Problems in accounting for property and equipment also affect FAA’s ability
                           to properly maintain these assets, including estimating maintenance and
                           deferred maintenance funding needs, and impair long-range planning for
                           future facilities and equipment needs.

Inventory Accountability   Problems similar to those just discussed for PP&E have also plagued FAA’s
Has Improved But           inventory accounting, although the amounts involved have not been as
                           significant. FAA inventory, reported at almost $820 million as of September
Uncertainties Remain
                           30, 1998, primarily consists of spare parts located at the FAA Logistics
                           Center in Oklahoma City and at about 34,000 field locations (referred to as
                           field spares).

                           The Logistics Center is the central warehouse for operating materials and
                           supplies and uses an automated inventory system, which continuously
                           updates the reported quantities on hand as parts are received and issued to
                           the field.8 Although some ongoing minor issues remain, the accounting for
                           inventory quantities on hand at the Logistics Center has improved
                           significantly over the last year, and as of September 30, 1998, inventory
                           quantities were reasonably stated in the accounting records. 9

                           However, the accuracy of FAA’s accounting for field spares quantities
                           remains uncertain. Field spares are mission-critical parts that support the
                           National Airspace System and are maintained at locations near the facilities
                           they support. As of September 30, 1998, the reported value of field spares
                           inventory was $338 million. Based on our analysis of the OIG’s field spares
                           inventory workpapers, we were unable to satisfy ourselves about the
                           accuracy of reported field spares inventory quantities. In addition, FAA did
                           not have a reliable system in place to track and control field spares on a
                           continuous basis. In its review of fiscal year 1998 field spares inventory,

                           8This system, commonly referred to as a perpetual inventory system, updates inventory quantities at
                           various points in time, depending on the situation at hand. Updates may be performed immediately,
                           daily, or on some other periodic basis.

                               Neither the OIG nor we validated the reported inventory values as of September 30, 1998.

                           Page 5                                                                            GAO/T-AIMD-99-122
                         the OIG tested data for 14 sites with a recorded value of $14 million, and
                         found numerous errors in inventory recordkeeping. For example:

                         • At one site, FAA had not recorded $106,000 of communication
                           equipment spares for newly commissioned systems.
                         • At another site, 11 items valued at over $39,000 that support new
                           systems were not included in the records, while 21 items valued at about
                           $67,000 could not be located.
                         • At a third site, numerous errors resulting from inaccurate or incomplete
                           recordkeeping totaled $380,000.

                         The lack of physical controls over field spares increases the risk that theft
                         or loss could go undetected. Additionally, inaccurate information about
                         field spares could result in shortages of critical parts or unnecessary
                         ordering of parts already on hand. The latter situation may lead to excess
                         or obsolete stock requiring storage, control, and other activities that
                         consume operating resources.

Cost Accounting          The inadequacy of FAA’s cost accounting system has been identified by
Implementation Delays    GAO,10 the OIG, and others as a weakness that prevents the agency from
                         having reliable and timely information about the full cost of program
Have Pervasive Effects
                         activities. The objective of a cost accounting system is to provide this
                         information by accumulating basic financial cost data, such as contractor
                         invoices and agency labor and overhead costs, and allocating these costs,
                         by category, to the applicable program activities. Although FAA originally
                         expected that a cost accounting system would be fully implemented by
                         October 1, 1998, this objective was not met. It subsequently revised this
                         goal to implementation of a partially operational system by December 31,
                         1998, and a fully operational system by March 31, 1999. FAA now projects
                         partial implementation in June 1999 and full systems implementation by
                         March 31, 2001.11

                         10AirTraffic Control: Improved Cost Information Needed to Make Billion Dollar Modernization
                         Investment Decisions (GAO/AIMD-97-20, January 22, 1997).

                           Statement of Federal Financial Accounting Standards No. 4, Managerial Cost Accounting Standards,
                         (SFFAS No. 4), effective in fiscal year 1998, requires agencies to accumulate and report the full costs of
                         their activities. FAA officials told us that the cost accounting system they are implementing goes well
                         beyond the requirements of SFFAS No. 4 and that they believe they will be in compliance with SFFAS
                         No. 4 for fiscal year 1999.

                         Page 6                                                                             GAO/T-AIMD-99-122
                           The lack of reliable and timely information about the costs of program
                           activities limits the ability of FAA management and other decisionmakers
                           to use past costs to help estimate future costs in preparing and reviewing
                           budgets, to control and reduce costs, and to identify and avoid waste. For
                           example, without reliable cost information, FAA and other decisionmakers
                           may not be able to effectively

                           • compare, during the budgeting process, expected costs with expected
                             benefits, identify activities that add value, and make fully informed
                             decisions about whether to expend resources for activities that are not
                             cost effective;
                           • compare and identify the causes of cost changes over time;
                           • identify and reduce excess capacity costs (the cost to maintain a level of
                             service that may not be needed), if any;
                           • choose among alternative actions such as whether to perform a project
                             in-house or contract it out, to accept or reject a proposal, or to continue
                             or eliminate a product or service; and
                           • compare costs of similar activities and find causes for cost differences,
                             if any.

                           The lack of reliable cost information also limits the ability of FAA
                           management and other decisionmakers to establish fees for services based
                           on the cost of the services provided. The Federal Aviation Reauthorization
                           Act of 1996 (Public Law 104-264) directed FAA to establish user fees not to
                           exceed $100 million for selected services, including aircraft overflight, and
                           to directly relate these fees to the costs of providing the service rendered.
                           A recent federal court decision, which resulted in FAA refunding
                           $12 million in fees already collected, reemphasized that these fees must be
                           based on cost.12

Reporting Weaknesses       Audited financial statements are designed to provide a public report of how
Undermine the Usefulness   taxpayer money provided to a given agency was spent. This information
                           can then be linked with performance measures such that taxpayers can be
of Financial Statements
                           apprised of what they received for their money. Further linkage of this
                           information to budgetary accounts could also provide some level of
                           assurance over the amounts reported in the budget as actual expenditures,
                           which are considered in determining budgeted amounts for future years.

                            Asiana Airlines, et al., Petitioners v. Federal Aviaiton Administration and Barry Valentine, Acting
                           Administrator, 134 F. 39 393 (D.C. Cir. January 30, 1998).

                           Page 7                                                                            GAO/T-AIMD-99-122
                      However, until basic accountability over the amounts reported in the
                      financial statements is achieved, none of these benefits can be realized.
                      FAA lacks this basic accountability.

                      In addition to the accounting and reporting weaknesses already discussed,
                      the OIG’s audit disclosed the following deficiencies in the fiscal year 1998
                      financial statements.

                      • The Statement of Net Cost13 could not be substantiated because it could
                        not be determined if expenses were charged to appropriate accounts,
                        whether total expenses charged to the accounts were accurately
                        accumulated, and whether administrative overhead expenses were
                        accurately included.
                      • Material items included in the Statement of Budgetary Resources,14
                        including the $7.2 billion reported unobligated balance, could not be
                      • A difference of $877 million between the Statement of Budgetary
                        Resources and the Statement of Net Cost could not be explained.
                      • FAA’s accounting system was not able to generate the required financial
                        statements, and the agency made 349 adjustments to its accounting
                        records, totaling $51 billion, in the process of manually preparing the

                      These conditions, which are indicative of the inability of FAA’s systems to
                      support financial management and to efficiently prepare reliable, auditable
                      financial statements, along with the other significant recordkeeping
                      deficiencies discussed above, mean that FAA faces significant challenges in
                      order to meet its goal of a clean audit opinion for fiscal year 1999.

Corrective Measures   FAA senior management has indicated that they recognize the urgency of
                      correcting their financial management deficiencies and have recently taken
Are Under Way         steps to address them, including the following.

                      13The Statement of Net Cost presents the cost of major lines of business, which are intended to relate to
                      FAA’s performance measures.

                       The Statement of Budgetary Resources shows what budgetary resources were available to spend
                      during the year, how much was spent, and how much remained obligated and unobligated at year-end.

                      Page 8                                                                            GAO/T-AIMD-99-122
                   • A comprehensive effort is being undertaken to identify all major PP&E
                     assets and to develop accurate, supportable historical cost information
                     for those assets.
                   • The agency is in the process of establishing a perpetual inventory
                     system for its field spares and plans to conduct a 100 percent field
                     spares physical inventory for fiscal year 1999.
                   • Efforts continue to develop a cost accounting system that is capable of
                     accumulating the full cost of program activities on a timely basis. As
                     previously discussed, FAA expects to have this system partially in place
                     in June 1999 with a fully operational system expected to be in place in

                   While these actions are a step in the right direction, FAA is still far from
                   achieving financial accountability. Until the agency is able to correct its
                   basic accounting deficiencies and produce a complete set of auditable
                   financial statements, it will not fulfill its responsibility to the taxpaying
                   public to be a responsible steward for the billions of dollars it is provided
                   annually to carry out its mission.

                   Mr. Chairman, this concludes my statement. I would be happy to answer
                   any questions that you or the Members of the Subcommittee may have.

(913853)   Leter   Page 9                                                       GAO/T-AIMD-99-122
Page 10   GAO/T-AIMD-99-122
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