Department of Defense: Improving the DOD Payment Process, Using Recovery Auditing and Changing the Prompt Payment Act

Published by the Government Accountability Office on 1999-06-16.

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

                                      United States General Accounting Office

GAO                                   Testimony
                                      Before the Subcommittee on National Security,Veterans’
                                      Affairs, and International Relations, Committee on
                                      Government Reform, House of Representatives

For Release on Delivery Expected at
10:00 a.m.,
                                      DEPARTMENT OF
June 16, 1999

                                      Improving the DOD
                                      Payment Process, Using
                                      Recovery Auditing and
                                      Changing the Prompt
                                      Payment Act
                                      Statement of David Cooper, Associate Director, Defense
                                      Acquisition Issues, National Security and International
                                      Affairs Division

                      Mr. Chairman and Members of the Subcommittee:

                      I appreciate the opportunity to discuss the Department of Defense’s (DOD)
                      payment problems and how recovery auditing is being used to identify and
                      recover overpayments. I will also make some comments on changes to the
                      Prompt Payment Act. To put these issues in perspective, in fiscal year 1998,
                      DOD spent about $115 billion contracting for goods and services. DOD
                      contract dollars account for about two-thirds of total federal government
                      contract spending for goods and services. Thus, it is vital that DOD have
                      sound controls to ensure that contract payments are proper, accurate, and

Results in Brief      The need for DOD to achieve effective control over its payment process
                      remains an imperative. If DOD does not, it will continue to risk
                      erroneously paying contractors hundreds of millions of dollars and
                      perpetuating other financial management and accounting control
                      problems. Further, improving the efficiency of the payment process could
                      save millions of dollars annually in reduced processing costs.

                      While DOD is taking steps to improve its payment process and controls, it
                      will likely take many years before DOD gets its payment problems under
                      control. The focus of DOD’s actions needs to be on making better use of
                      technology to improve and integrate its payment systems and to streamline
                      and simplify its payment requirements. These actions will, however,
                      require sustained top-management efforts.

                      DOD needs to also concentrate on reducing overpayments and, recognizing
                      that some overpayments are inevitable, adopt best practices to quickly
                      identify and recover them. We believe that recovery auditing offers a
                      low-risk opportunity to achieve both these goals, and we are supportive of
                      the recently introduced legislation to require federal agencies to use
                      recovery auditing.

                      Currently, contractors are not required to inform the government when
                      they have been overpaid. Contractors should be required to notify the
                      government of overpayments when they become aware of them. This
                      requirement should not impose a significant burden on the contractor.
                      Once notified, government contracting personnel should immediately ask
                      contractors to refund the overpayment.

              Leter   Page 1                                                    GAO/T-NSIAD-99-193
                      It may be time to raise the minimum dollar threshold required by the
                      Prompt Payment Act. Currently, the Defense Finance and Accounting
                      Service (DFAS) pays interest amounts that are less than it costs them to
                      process the checks. However, raising the threshold should be part of an
                      overall assessment of the efficiency of the payment process.

Erroneous DOD         In recent years, our reports have identified hundreds of millions of dollars
                      in erroneous government payments, and interest expense on late payments,
Payments Are a        and other financial management problems. For example, in March 1994,
Long-standing Issue   we reported that during a 6-month period in fiscal year 1993, DFAS in
                      Columbus, Ohio—a principal DOD contract paying activity—processed
                      $751 million in payments returned by defense contractors. 1 Our
                      examination of about one-half of these checks disclosed that about 78
                      percent represented overpayments by the government. We also found that
                      while some contractors returned overpayments, others did not. In one
                      case, an overpayment of $7.5 million was outstanding for 8 years. We
                      estimate that the government lost interest on the overpayment amounting
                      to nearly $5 million. We concluded that neither DOD nor some contractors
                      appeared to be aggressively pursuing resolution of payment discrepancies.

                      DOD continues to make substantial erroneous payments to its contractors.
                      For example, in the 5 years between fiscal year 1994 and 1998, defense
                      contractors returned about $4.6 billion to DFAS Columbus—in fiscal year
                      1998, they returned $746 million. However, some contractors were still
                      retaining overpayments. For example, 4 of the 13 contractors we visited
                      during a recent review were retaining overpayments totaling about
                      $1.1 million. At each location contractor personnel told us that they had a
                      practice of retaining overpayments until the government issued a demand
                      letter requesting the overpayments be returned. 2 There is no requirement
                      for contractors who have been overpaid to notify the government of
                      overpayments or to return overpayments prior to the government issuing a
                      demand letter for a refund. The magnitude of overpayments defense
                      contractors are retaining is not known.

                      DOD Procurement: Millions in Overpayments Returned by DOD Contractors (GAO/NSIAD-94-106,
                      Mar. 14, 1994).
                       A demand letter is a formal notification to the contractor that it owes the government money.

            Leter     Page 2                                                                         GAO/T-NSIAD-99-193
                          We have also found problems that contribute to improper and fraudulent
                          payments. For example, in September 1998, we reported on internal
                          control and system weaknesses that contributed to two cases of Air Force
                          vendor payment fraud—one resulting in the embezzlement of over $500,000
                          and the other resulting in embezzlement of $435,000 and attempted theft of
                          over $500,000.3 We found that the lack of segregation of duties and other
                          control weaknesses created an environment where employees were given
                          broad authority and the capability, without compensating controls, to
                          perform functions that should have been performed by separate individuals
                          under proper supervision. We also found that over 1,800 DFAS and Air
                          Force employees had access to the vendor payment system that allowed
                          them to submit all the information necessary to create fraudulent and
                          improper payments.

                          In testimony before the Congress earlier this year, the DOD Inspector
                          General commented on the vulnerability of DOD finance operations,
                          particularly to fraud in the vendor pay area. According to the Inspector
                          General, the Defense Criminal Investigative Service (DCIS), an arm of the
                          DOD Inspector General, is working with the DFAS to decrease that
                          vulnerability through such measures as increased fraud awareness training.
                          She said at the time that DCIS has about 80 open criminal investigations
                          related to finance operations.

Factors Contributing to   In an April 1997 report,4 we concluded that DOD’s erroneous payments are
Erroneous Payments        due, in part, to (1) nonintegrated computer systems that often require data
                          to be entered manually, and with data that are often erroneous or
                          incomplete and (2) payments that are required to be allocated among
                          numerous accounting classifications. In addition, these factors increase
                          the cost of paying contract invoices.

                          The need for DOD to effectively control its payment process remains
                          imperative. If DOD does not, it will continue to risk erroneously paying
                          contractors hundreds of millions of dollars and perpetuating other financial
                          management and accounting control problems. Further, improving the
                          efficiency of the payment process would save additional millions of dollars

                           Financial Management: Improvements Needed in Air Force Vendor Payment Systems and Controls
                          (GAO/AIMD-98-274, Sept. 28, 1998).
                            Contract Management: Fixing DOD’s Payment Problems Is Imperative (GAO/NSIAD-97-37,
                          Apr. 10, 1997).

                          Page 3                                                                   GAO/T-NSIAD-99-193
                                        annually in reduced processing costs. Two key areas where DOD needs to
                                        focus its efforts are (1) better using available technology by developing
                                        seamless, fully integrated payment systems and (2) streamlining and
                                        simplifying, to the extent practical, its payment processes.

Detailed Accounting                     Let me give a few examples of the detailed accounting requirements that
Requirements Are a Burden on            DFAS payment personnel are faced with when paying a bill. These
Payment Process                         examples clearly suggest the need for simplification.

                                        DOD uses what is called a “long line of accounting” to accumulate
                                        appropriation, budget, and management information for contract
                                        payments. For all contracts, the buying activity assigns a two-character
                                        code called an accounting classification reference number (ACRN) to each
                                        accounting line containing unique information. Figure 1 is an example of
                                        an accounting line—the type and quantity of information varies among the

Figure 1: Example of DOD’s Long Line of Accounting

                                        Source: DOD.

                                        Page 4                                                   GAO/T-NSIAD-99-193
Contracts can be assigned anywhere from 1 to over 1,000 ACRNs. A
contract with numerous ACRNs may involve extensive data entry,
increasing the chance for errors and manual payment processing. Manual
payment processing costs an average of $15 per ACRN, according to a
consulting firm’s study.

Payment allocations to numerous ACRNs can be time consuming and may
not provide useful or reliable management information. For example, in
one case we reviewed, a single payment on a contract with many ACRNs
took 6 to 8 hours to process. The contractor, required to bill by ACRN, took
487 pages to assign $2.1 million in costs and fees to 267 ACRNs. Ten of the
ACRNs cited by the contractor had insufficient obligation balances to cover
the payment, according to DFAS records. The remaining 257 ACRNs
corresponded to 8 annual appropriations covering from 1 to 5 fiscal years
and included Army, Air Force, and general defense funds. Of the
257 transactions processed, 38 were for less than $10, and some involved
debits or credits for pennies. Unresolved discrepancies, such as
insufficient funds on some ACRNs, have persisted for about 3 years.

Even for a simple purchase, assigning numerous ACRNs can cause
extensive and costly rework and provide information of questionable
management value. For example, a $1,209-Navy contract for children’s
toys, candy, and holiday decorations for a child care center was written
with most line items (e.g., bubble gum, tootsie rolls, and balloons) assigned
a separate ACRN. A separate requisition number was generated for each
item ordered, and a separate ACRN was assigned for each number. In total,
the contract was assigned 46 ACRNs to account for contract obligations
against the same appropriation. To record this payment against the
1 appropriation, DFAS had to manually allocate the payment to all 46
ACRNs. Figure 2 is an actual portion of this contract showing the ACRNs
assigned to each item.

Page 5                                                     GAO/T-NSIAD-99-193
Figure 2: Contract Excerpt

                             Source: DOD.

                             The contract was modified three times—twice to correct funding data and
                             once to delete funding for out-of-stock items. The modification deleting
                             funding did not list all of the affected ACRNs. DFAS personnel made errors
                             in both entering and allocating payment data, compounding errors made in
                             the modification. Consequently, DFAS allocated payment for the toy
                             jewelry line item to fruit chew, jump rope, and jack set ACRNs—all of
                             which should have been deleted by the modification. Contract delivery
                             was completed in March 1995, but payment was delayed until October
                             1995. DFAS officials acknowledged that this payment consumed an
                             excessive amount of time and effort when compared to the time to process
                             a payment charged to only one ACRN. The contract could have been
                             assigned a single ACRN, according to a Navy official, thus making it easier
                             to pay without losing useful information. A single ACRN would also have
                             significantly reduced the amount of data entered into the system and the
                             opportunities for errors.

                             User requirements for detailed accounting place unreasonable or
                             unachievable demands on the payment system. Moreover, DOD’s current
                             pricing structure does not reflect the time it takes DFAS to meet user

                             Page 6                                                   GAO/T-NSIAD-99-193
                            requirements. Thus, the user has little incentive to critically evaluate the
                            level of detail being required and its associated costs.

DOD Is Taking Actions to    DOD is taking steps to address its payment problems. Its initiatives include
Address Payment Problems    testing and adopting some best practices. In the long term, it is developing
                            procurement and payment systems that will be linked by sharing common
                            data. This linkage is expected to allow one-time entry of contract data
                            critical to making correct payments. In the meantime, DOD is enhancing
                            its current technologies to further automate the payment process. It is also
                            testing streamlined payment practices and making efforts to reduce the
                            number of contract fund citations. But, as we point out in our January 1999
                            recent high-risk report,5 it will be many years before DOD gets its payment
                            problems under control.

Additional Steps Could Be   Recognizing DOD’s actions and the fact that DOD continues to overpay its
Taken                       contractors, one question is: are there additional steps that DOD might take
                            to improve the process for both identifying and collecting overpayments?
                            The answer is yes.

                            First, we believe that defense contractors should be required to promptly
                            notify the government of overpayments when they become aware of them.
                            This seems simple enough, but currently a contractor is not required to
                            return an overpayment until the government becomes aware of the
                            overpayment and issues a demand letter for repayment. And, as pointed
                            out earlier, the true magnitude of contractor retention of overpayments is
                            not known. In this regard, we will shortly begin a review to assess the
                            extent to which defense contractors are retaining and not promptly
                            returning overpayments to the government.

                            Second, we believe that DOD should take advantage of best practices that
                            commercial companies use to identify and recover overpayments. One
                            such practice is the use of recovery auditing procedures. For both private
                            industry and government agencies, some payments are processed
                            incorrectly for a variety of reasons. For instance, vendors make pricing
                            errors on their invoices, forget to include discounts that have been
                            publicized to the general public, neglect to offer allowances and rebates, or
                            miscalculate freight charges. Government payment activities may also

                             Major Management Challenges and Program Risks, Department of Defense (GAO/OCG-99-4, Jan. 1999).

                            Page 7                                                                   GAO/T-NSIAD-99-193
                        neglect to take discounts to which they are entitled. These mistakes, when
                        not caught, result in overpayments. Identifying and recovering
                        overpayments is referred to as recovery auditing.

Recovery Auditing       Recovery auditing started about 30 years ago, and it is used in several
                        industries, including the automobile, retail store, and food service
Offers Potential to     industries. Within DOD, the Army and the Air Force Exchange Service, and
Identify Overpayments   the Navy Exchange Service use recovery auditing. An external audit
                        recovery group may be the only group used by an organization or it may be
                        used in combination with an internal group that examines invoices for
                        overpayments prior to an external group’s review.

                        Recognizing its potential value to the government, the Fiscal Year 1996
                        National Defense Authorization Act required the Secretary of Defense to
                        conduct a demonstration program to evaluate the feasibility of using
                        recovery auditing to identify overpayments made to vendors by DOD.
                        Authority to expand the program was provided in the Fiscal Year 1998
                        National Defense Authorization Act.

                        The DOD demonstration program began in September 1996, when the
                        Defense Supply Center, Philadelphia (DSCP), competitively contracted
                        with Profit Recovery Group International (PRGI). The contract covers
                        purchases made during fiscal years 1993-95 and requires PRGI to identify
                        and document overpayments and to make recommendations to reduce
                        future overpayments. PRGI receives a fee of 20 percent of net collected

                        In our review of the demonstration program, we concluded that recovery
                        auditing offers potential to identify overpayments but implementation
                        problems hindered DOD from fully realizing the benefits of the program.6
                        As of August 1998, PRGI had identified $19.1 million in overpayments.
                        However, recoveries of overpayments amounted to only $1.9 million, in
                        large part, because vendors took issue with some of the overpayments.
                        This caused the recovery process to virtually stop for 8 months while DSCP
                        reviewed the merits of the vendors’ issues. DSCP has concluded that the
                        claims of overpayment are valid. However, according to the contracting
                        officer, his letter of final decision regarding vendors’ indebtedness has not

                          Contract Management: Recovery Auditing Offers Potential to Identify Overpayments
                        (GAO/NSIAD-99-12, Dec. 3, 1998).

                        Page 8                                                                      GAO/T-NSIAD-99-193
                     been issued. PRGI continues to identify overpayments. As of June 1999,
                     according to PRGI, it had identified $29.3 million in overpayments, and
                     collections by DOD amount to $2.6 million.

                     PRGI has also made recommendations to DFAS and DSCP to reduce future
                     overpayments, but, at the time of our review, DOD had not implemented
                     them. In addition, PRGI identified about $1.8 million in overpayments that
                     were outside the scope of its contract, either because they were not within
                     the contractual review period or because they involved other government
                     agencies. Neither DFAS nor DSCP chose to pursue payment recovery or
                     inform the other government agencies of the overpayments so that they
                     could pursue recovery and take steps to avoid future overpayments.

DOD Is Slow to Use   DOD has been slow to embrace recovery auditing. For example, in House
Recovery Auditing    Report 105-532, which related to a bill providing for fiscal year 1999 DOD
                     authorizations, DOD was directed to use recovery auditing by selecting at
                     least two commercial functions within its working capital fund and issuing
                     a competitive request for proposal by December 31, 1998. We found,
                     however, that DOD had not done either.7 While DOD issued an August 1998
                     memorandum encouraging the use of recovery auditing, and some
                     activities have expressed interest, no contracts had been awarded at the
                     time we completed our work in March 1999. In June 1999, we checked with
                     the recipients of the August 1998 memorandum and, with the exception of
                     the U.S. Transportation Command, which told us it just entered into a
                     contract for recovery auditing services, no other contracts have been let.
                     The Defense Commissary Agency said it has completed a statement of
                     work, and plans to have a contract by July 30, 1999. The Defense Logistics
                     Agency told us it issued a solicitation on May 28, 1999, to expand the use of
                     recovery auditing from the demonstration program in place at DSCP to its
                     other four supply centers. The Defense Logistics Agency said it plans to
                     have a contract by August 31, 1999. Each of the services and the Defense
                     Information Services Agency also expressed an interest in recovery
                     auditing and they are evaluating whether to use it.

                      Contract Management: DOD Is Examining Opportunities to Further Use Recovery Auditing
                     (GAO/NSIAD-99-78, Mar. 17, 1999).

                     Page 9                                                                   GAO/T-NSIAD-99-193
Issues Related to Using   While we believe that recovery auditing could be beneficial to DOD and
Recovery Auditing         other federal agencies, there are some important implementation issues
                          that need to be considered as federal agencies evaluate using recovery
                          auditing to identify and recover overpayments. First, it is not clear how
                          DOD agencies should organize to perform recovery auditing. Should it be
                          contracted out? Should it be performed with in-house personnel? Should
                          some combination of the two be used? We believe that agencies need to
                          carefully consider the extent to which recovery auditing is applicable to
                          their operations and, if applicable, if it would be cost-effective to undertake
                          moderate internal recovery auditing efforts to pick the “low hanging fruit”
                          before turning audit recovery efforts over to an external group.

                          Second, it is important that there be (1) periodic reporting by those
                          performing recovery auditing on the factors causing overpayments and on
                          recommendations to reduce overpayments and (2) a process to evaluate
                          these recommendations and implement those that make sense. One of the
                          criticisms we made of the demonstration program was that DOD did not
                          implement the contractor’s recommendations to reduce overpayments.

                          These issues have been addressed in the “Government Waste Corrections
                          Act of 1999” (H.R. 1827), introduced on May 17, 1999, by Congressmen
                          Burton, Armey, and Ose. We believe the bill is a positive step in the
                          government’s effort to reduce overpayments and to obtain timely
                          identification and recovery of overpayments when they occur.

Prompt Payment Act        Mr. Chairman, you also asked us for our views on how the Prompt Payment
                          Act could be improved to support DOD’s efforts to reduce the risk of
Issues                    overpayments.

                          The Prompt Payment Act of 1982, as amended, provides governmentwide
                          guidelines for establishing due dates on commercial invoices and paying
                          interest on invoices paid late. Except where otherwise specified within
                          contracts, the act provides that agencies should pay within 30 days after
                          the designated office receives the vendor invoice or the government
                          accepts the items ordered as satisfactory, whichever is later. The act also
                          states that if a payment is late, a business concern shall be entitled to any
                          interest penalty of $1 or more from the government (interest penalties of
                          less than $1 are not required to be paid).

                          Page 10                                                     GAO/T-NSIAD-99-193
        In a report we issued in May 1997,8 we stated that small interest payments
        made by the DFAS Columbus Contract Entitlement Directorate comprised
        a large portion of the number of payments made but accounted for a very
        small portion of the total interest dollars paid. For example, of the 47,773
        interest payments in fiscal year 1996, 10,789, about one quarter of all
        interest payments, were for $5 or less, and totaled $28,701—less than one
        quarter of 1 percent of total interest payment dollars. Interest payments up
        to $25 comprised over 50 percent of all interest payments but less than
        2 percent of total interest dollars paid.

        DOD officials said that the current minimum payment of $1 might need to
        be increased because the benefits from such small interest payments may
        not justify the costs of making the payments. According to DOD, it takes an
        average of 45 minutes to process each interest payment at DFAS,
        Columbus, and that the time spent processing such payments could be
        better spent on other high priority tasks.

        We recently obtained updated information on the interest payments made
        by the DFAS Columbus Contract Entitlement Directorate under the act.
        This information shows that in fiscal year 1998, the directorate issued
        23,355 checks totaling $15 million in interest payments to defense
        contractors. Thirty-eight percent were for payments of $25 or less.
        According to the Contract Entitlement Directorate, its cost to process an
        interest payment check in fiscal year 1998 was at least $24. DFAS issues a
        separate check for interest payments.

        Through the first half of fiscal year 1999, the DFAS Columbus Contract
        Entitlement Directorate issued 30,781 checks totaling $16.6 million in
        interest for late payments. About 41 percent of these checks representing
        less than 1 percent of the dollars were for $25 or less. According to
        directorate personnel, the increase in interest payments is due to a priority
        initiative to reduce the backlog of late payments.

        Given the cost of processing an interest payment check, it might be
        cost-effective to increase the minimum dollar requirement for paying
        interest under the act. Alternatively, the late payment interest could be
        included in the same check with the principal payment, which would
        significantly reduce the costs of processing interest payments. We believe

        Financial Management: The Prompt Payment Act and DOD Problem Disbursements (GAO/AIMD-97-71,
        May 23, 1997).

Leter   Page 11                                                               GAO/T-NSIAD-99-193
                      that any initiative to change the minimum interest payment should consider
                      the efficiency of agency payment processes.

Conclusions           In closing, Mr. Chairman, DOD needs to achieve more effective control
                      over its payment process. If DOD does not, it will continue to risk
                      erroneously paying contractors hundreds of millions of dollars and
                      perpetuating other financial management and accounting control

                      Recovery auditing, which has a long-standing track record in the private
                      sector, offers a low-risk opportunity to identify overpayments and to
                      recover them and we are supportive of the recently introduced legislation
                      to require federal agencies to use recovery auditing.

                      Currently, contractors are not required to inform the government when
                      they have been overpaid. Contractors should be required to notify the
                      government of overpayments when they become aware of them. Once
                      notified, government contracting personnel should immediately ask
                      contractors to refund the overpayment.

                      Finally, it may be time to raise the minimum dollar threshold required by
                      the Prompt Payment Act. However, raising the threshold should be part of
                      an overall assessment of the efficiency of the payment process.

                      Mr. Chairman, this concludes my statement. I will be glad to answer any
                      questions you or the other Members of the Subcommittee may have at this
                      time. Major contributors to this testimony were Daniel J. Hauser and
                      Charles W. Thompson.

(707429)      Leter   Page 12                                                  GAO/T-NSIAD-99-193
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