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Cover
================================================================ COVER


High-Risk Series

February 1997

DEFENSE FINANCIAL MANAGEMENT

GAO/HR-97-3

Defense Financial Management


Abbreviations
=============================================================== ABBREV

  CBSX - Continuing Balance System-Expanded
  CEFMS - Corps of Engineers Financial Management System
  CFO - Chief Financial Officer
  CPA - certified public accountant
  DFAS - Defense Finance and Accounting Service
  DPAS - Defense Property Accountability System
  DOD - Department of Defense
  FASAB - Federal Accounting Standards Advisory Board
  FMFIA - Federal Managers Financial Integrity Act
  GMRA - Government Management Reform Act of 1994
  PMO - Program Management Office
  REMIS - Reliability and Maintainability Information System

Letter
=============================================================== LETTER



February 1997

The President of the Senate
The Speaker of the House of Representatives

In 1990, the General Accounting Office began a special effort to
review and report on the federal program areas its work identified as
high risk because of vulnerabilities to waste, fraud, abuse, and
mismanagement.  This effort, which was supported by the Senate
Committee on Governmental Affairs and the House Committee on
Government Reform and Oversight, brought a much-needed focus on
problems that were costing the government billions of dollars. 

In December 1992, GAO issued a series of reports on the fundamental
causes of problems in high-risk areas, and in a second series in
February 1995, it reported on the status of efforts to improve those
areas.  This, GAO's third series of reports, provides the current
status of designated high-risk areas. 

This report describes GAO's concerns about the Department of
Defense's inability to put in place the financial management
operations and controls required to produce the information it needs
to ensure adequate accountability and support decision-making.  It
focuses on the need for the Department to transform candid
acknowledgements of problems in six critical areas into
comprehensive, realistic corrective actions. 

Copies of this report series are being sent to the President, the
congressional leadership, all other Members of the Congress, the
Director of the Office of Management and Budget, and the heads of
major departments and agencies. 

James F.  Hinchman
Acting Comptroller General
of the United States


OVERVIEW
============================================================ Chapter 0

The Department of Defense needs accurate financial information and
appropriate internal controls to effectively manage the Department's
vast resources--over
$1 trillion in assets, 3 million military and civilian personnel, and
a budget of an estimated $250 billion for fiscal year 1997.  However,
long-standing, serious weaknesses in the Department's financial
operations continue not only to severely limit the reliability of
DOD's financial information, but also have resulted in wasted
resources, and undermined the Department's ability to carry out its
stewardship responsibilities.  GAO and DOD auditors doing financial
audits under the Chief Financial Officers Act have made hundreds of
recommendations to help resolve these weaknesses. 

The Department has candidly acknowledged its manifold weaknesses and
has a number of initiatives underway to address them.  However, much
remains to be done, and full corrective action will take more
sustained, concerted efforts by DOD top officials. 

THE PROBLEM

Defense's financial management systems, practices, and procedures
continue to be hampered by significant weaknesses.  The Department
does not yet have adequate financial management processes in place to
produce the information it needs to ensure adequate accountability
and to support its decision-making process.  No military service or
other major DOD component has been able to withstand the scrutiny of
an independent financial statement audit.  This situation is one of
the worst in government and is the product of years of neglect. 

The Department has acknowledged that it is struggling to overcome
decades-old financial management problems.  Its annual reports to the
President and the Congress have highlighted a series of financial
management problems confronting DOD, including billions of dollars in
disbursements not matched to specific obligations, overpayments to
Defense contractors, Anti-Deficiency Act violations, and issuance of
paychecks to soldiers after their discharge.  The Department
concluded that its systems and practices required a major overhaul. 

The financial management weaknesses that the Department must overcome
fall into six areas: 

  -- the lack of an overall integrated financial management system
     structure,

  -- no reliable means of accumulating actual cost data to account
     for and manage resources,

  -- continuing problems in accurately accounting for billions of
     dollars in disbursements,

  -- the critical need to upgrade its financial management workforce
     and organization,

  -- breakdowns in rudimentary required financial control procedures,
     and

  -- antiquated bureaucratic practices that underscore the need for
     progress in reengineering business practices. 

PROGRESS MADE

Since 1990, we and the DOD auditors have made over 400
recommendations aimed at correcting the Department's most pressing
financial management weaknesses.  The past few years have been marked
by DOD's financial management leadership, under the direction of the
Department's Chief Financial Officer (CFO), recognizing the
importance of tackling the broad range of problems in this area.  The
Department's "blueprint" for reforming financial management
represents an important first step towards resolving DOD's
long-standing problems.  Through his 5-Year Plan, the CFO has also
put in place a vision statement to guide the Department's reform
efforts.  As a result, the importance of greater financial
accountability is now clearer throughout the Department. 

To support its blueprint and CFO vision, the Department has begun a
number of initiatives intended to address its long-standing financial
management weaknesses.  For example, DOD is working on several fronts
to resolve its problems in accounting for disbursements.  Other
initiatives include a set of projects intended to standardize
selected financial systems, and another set of projects directed at
DOD-wide data standardization including implementing the U.S. 
Government Standard General Ledger, a basic requirement. 

OUTLOOK FOR THE FUTURE

DOD still has a long way to go to meet the challenges of managing its
vast and complex operations with greater accountability and
efficiency demanded by the Congress and the American public.  The
reforms mandated by the Chief Financial Officers Act of 1990, as
expanded by the Government Management Reform Act of 1994, and the
Federal Financial Management Improvement Act of 1996 serve as
important catalysts for focusing attention on the financial problems
facing the Department. 

The requirements for audited annual DOD financial statements
beginning with fiscal year 1996 have generated increased pressure on
DOD management to fix its long-standing financial problems.  These
audits have already resulted in a number of specific recommendations
for interim improvements.  In addition, we have work ongoing or
planned to identify further opportunities for improvement. 

Signs of DOD top leadership emphasis on and commitment to resolving
the Department's financial management problems are encouraging.  It
is now critical that DOD take the next steps in transforming these
candid acknowledgements of problems into comprehensive, realistic
action to effectively bring about their resolution. 

However, the Department must effectively address challenges in the
six critical areas highlighted in audit reports--systems, cost
accounting, disbursements, personnel, internal controls, and business
processes--if its envisioned financial management reforms are to
realize meaningful financial management improvements.  It will take a
focused, sustained effort for DOD to fully resolve these challenges. 


BACKGROUND
============================================================ Chapter 1

The massive scope of DOD's operations is unparalleled in either the
private or public sectors.  The challenges that DOD faces in managing
such a huge and complex organization are compounded by its
long-standing financial management weaknesses.  We added this area to
our high-risk list in 1995.\1 As the agency responsible for about 50
percent of the government's discretionary spending, DOD's financial
management problems result in a lack of accountability over a
substantial portion of the government's resources.  These problems
have also led to inaccurate information being provided to the
Congress and the inefficient use and waste of resources. 

Correction of DOD's widespread and severe financial management
problems is also critical to the resolution of the department's other
high-risk areas included in this series.  (See reports HR 97-4, 97-5,
97-6, and 97-7.)

Resolving these long-standing problems with millions of dollars in
erroneous contract payments, weapon system cost overruns, excessive
inventories, and unwieldy infrastructures will be greatly aided by
reliable financial management information.  For example, better
information on the quantity and location of items would help prevent
inventory managers from procuring additional items at one location
that are already on hand at another DOD location. 

LEGISLATION PROVIDES A FRAMEWORK
FOR IMPROVEMENT


Key Legislation for DOD's
Financial Reform Efforts

Chief Financial Officers Act of 1990


Government Management Reform
Act of 1994 (GMRA)

Federal Financial Management
Improvement Act of 1996
----------------------------------------------------------------------
The CFO Act charges agency CFOs with (1) directing, managing, and
providing policy guidance and oversight of all agency financial
management personnel, activities, and operations, (2) developing and
maintaining integrated accounting and financial management systems,
(3) implementing agency asset management systems, including systems
for cash management, (4) monitoring the financial execution of the
agency budget in relation to actual expenditures, and (5) overseeing
the recruitment, selection, and training of personnel to carry out
agency financial management functions. 

GMRA made the CFO Act's requirement of annual audited financial
statements permanent and expanded it to include virtually the entire
executive branch.  Under this legislative mandate, DOD is to annually
prepare and have audited DOD-wide and component--including Army,
Navy, and Air Force--financial statements, beginning with fiscal year
1996.  These audited statements will provide for an annual public
scorecard to measure agencies' progress in resolving financial
management deficiencies. 

In addition, the Federal Financial Management Improvement Act of 1996
provides a legislative mandate to implement and maintain financial
management systems that substantially comply with federal systems
requirements, applicable federal accounting standards, and the
standard general ledger.  As discussed in the following section, the
act's provisions will have a significant impact on DOD because (1)
few of its systems meet federal financial management systems
requirements and (2) DOD has not yet comprehensively identified and
assessed all of its financial management systems. 

The act also noted that the Federal Accounting Standards Advisory
Board (FASAB), established in 1990, has made substantial progress
toward developing and recommending a comprehensive set of accounting
concepts and standards for the federal government.\2

The act states, "When the accounting concepts and standards developed
by [FASAB] are incorporated into Federal financial management
systems, agencies will be able to provide cost and financial
information that will assist the Congress and financial managers to
evaluate the cost and performance of Federal programs and activities. 
.  .  ."

If properly implemented, these standards will provide the impetus not
only for the Department to improve its financial management
operations and reporting, but also to strengthen its ability to meet
critical mission objectives because more accurate information will be
provided to decisionmakers.  However, to bring about the kind of
fundamental changes in financial management envisioned by the
Congress in enacting these reforms will require a focused effort to
use the Department's resources efficiently and the full support of
DOD's leadership.  Only in this way will sorely needed financial
management improvements be achieved in a reasonable time frame. 


--------------------
\1 High Risk Series:  An Overview (GAO/HR-95-1, February 1995). 

\2 FASAB recommends accounting standards, and the Office of
Management and Budget (OMB), and Treasury, and GAO decide whether to
adopt the recommended standards; if they are adopted, the standards
are published by OMB and GAO and become effective. 


FINANCIAL AUDITS PROVIDE FOCUS AND
IMPROVED BASIS FOR MEASURING
PROGRESS
============================================================ Chapter 2

Financial audit reports have continued to provide a clearer picture
of DOD's financial position and provide a basis for measuring
progress.  These reports have highlighted significant deficiencies
across the spectrum of DOD's financial management and reporting
operations.  None of the financial statements prepared by the
military services or major DOD components have yet been able to
withstand the scrutiny of a financial statement audit.  As a result
of these deficiencies, the DOD Inspector General has stated that
auditable financial statements for the Department would not be likely
until the next century. 

While it may take several more years until the Department can expect
an acceptable audit opinion, if used effectively, the results of the
CFO Act financial statement audits can help focus reform efforts and
establish priorities so that the time frame needed to correct DOD's
major problems can be minimized.  The Congress and the American
public should expect to see the problems identified by the auditors
in these annual reports diminish over time. 

The deficiencies identified in auditors' reports have prevented DOD
managers from obtaining reliable financial information needed for
sound decision-making.  These reported deficiencies identified in the
DOD audit community\1 reports and in our own financial audits and
reviews of Air Force, Army, Navy, and the Defense Business Operations
Fund fell into six common areas. 


Six Areas Presenting Greatest
Challenges

 Integrating accounting and financial
management systems

 Accumulating accurate cost
information

 Resolving problem disbursements

 Upgrading financial management
workforce and organization

 Strengthening internal controls

 Reengineering business practices
----------------------------------------------------------------------
Auditors' reports have also pinpointed actions to help resolve DOD's
continuing problems in these areas.  Since 1990, we and the DOD
auditors have made over 400 recommendations to help provide focus and
perspective on the most pressing financial management weaknesses
facing the Department. 

DOD's leadership has recognized the financial management problems
highlighted in the audited financial statements and has taken
seriously the need to bring about their resolution.  The Department's
February 1995 "blueprint" for reforming its financial management
operations represents an important first step towards resolving the
Department's long-standing problems.  The action areas specified in
the blueprint are closely linked to the six problem areas identified
in recent financial audits and reports.  As a result, DOD financial
managers are beginning to act based on a better understanding of the
implications of the lack of reliable financial information on their
overall accountability and the effective management of critical
mission operations. 

However, the Department's long-standing weaknesses are the product of
decades of neglect.  Identifying and implementing solutions will
require a sustained, long-term commitment and focus on priorities. 

To support its blueprint and CFO vision statement, the Department has
undertaken a number of initiatives intended to improve financial
management.  The following sections outline DOD's reform initiatives
in the six key problem areas identified by GAO and DOD auditors.  We
also (1) identify additional actions the Department must consider if
it is to realize genuine reform and meet the basic goals of the CFO
Act and other management mandates and (2) provide an overview of our
ongoing work in each of these areas to identify future suggestions
for improvement. 

INTEGRATE ACCOUNTING AND FINANCIAL
MANAGEMENT SYSTEMS

Audit reports have repeatedly pointed out that DOD's existing
accounting and financial management systems are not integrated and
lack a standard general ledger.  An integrated, general ledger
controlled system is necessary to provide oversight and control to
ensure accurate and complete accounting for DOD's resources.  Under
an integrated system structure, DOD's accounting, finance, logistics,
personnel, and budgetary systems would be closely tied together. 
However, DOD has acknowledged that its operations are constrained by
the military services operating unique systems, many of which are
incompatible. 

An example of the effect of DOD's nonintegrated systems is in the
inventory management area.  Specifically, auditors reported that, at
least in part as a result of the lack of integration between DOD's
accounting and logistics systems, DOD purchased unneeded materials
and DOD management and oversight officials lacked complete
information on the costs incurred to acquire and operate weapon
systems.  Effectively addressing these systems integration
deficiencies will necessitate the development of unified actions
bringing together the organizational support and commitment of the
Department's logistics, personnel, and budget components, as well as
its financial organizations. 

In describing the goals of the Department's October 1995 5-Year Plan,
the DOD CFO stated that "In terms of payback for the department, the
most important goal is the consolidation of, and improvements to, its
finance and accounting systems." DOD has recognized that of the 249
financial systems included in its required annual reporting, only 5
conformed with governmentwide standards for financial systems.  One
of DOD's principal initiatives in this area has consisted of
identifying financial management systems in the Department's
inventory, modifying them to meet departmentwide requirements, and
consolidating them as migration or interim migration\2 systems. 

Auditors have made numerous specific recommendations over the past
few years to improve DOD's financial systems operations and the
reliability of the financial information they produce.  For example,
as a result of our review of the Navy's financial reporting, we
recommended (1) the use of standard data elements, such as object
class codes, because we found that existing systems capabilities were
not used to their full potential in controlling, managing, and
reporting on the Navy's operations and (2) a series of actions needed
to develop an overall system architecture to effectively guide the
enhancement efforts for the system selected to perform the Navy's
general fund accounting. 

DOD established a Defense Accounting System Program Management Office
(PMO) in April 1996 to provide centralized management control and
oversight for all Defense Finance and Accounting Service (DFAS)
accounting systems.  The PMO is intended to manage the reduction of
existing accounting systems in accordance with DFAS goals and
objectives.  For example, the PMO is overseeing modifications to the
Army Corps of Engineers Financial Management System (CEFMS), which
was selected to become the general funds accounting migratory system
for the Army and Air Force. 

We are encouraged that the Department has established an office to
help provide focus for its system improvement efforts.  We will be
looking closely at whether the strategy pursued by the PMO will
enable the Department to put an integrated system structure in place. 

In addition to the specific recommendations we made previously, we
believe that efforts to improve DOD's financial systems must be based
on a comprehensive understanding of all systems currently relied on
to carry out the Department's financial operations--
including those managed by DFAS and those operated by the military
services.  In addition, a comprehensive inventory is especially
important in light of the enhanced systems requirements included in
the Federal Financial Management Improvement Act of 1996. 

We recently reported that DOD's inventory of financial management
systems recognized in its annual reporting did not include all DOD
systems used to carry out the Department's financial operations. 
DOD's reporting excluded hundreds of "mixed" financial
systems--systems including both financial and programmatic
elements--from the inventory of the systems.  Because many of these
mixed systems are relied on to record, accumulate, classify, and
report financial information, it is critical that they are recognized
in the Department's system inventory. 

Once a complete inventory is established, the Department will be
better able to define its target system architecture, including all
system interfaces and data flows.  With this target structure in
place, DOD can more effectively prioritize system improvements,
identify data requirements, and begin integration.  In this regard,
we are currently evaluating whether there are additional actions DOD
can take to improve its capability to successfully develop
application software used in carrying out the Department's financial
operations. 

We are also assessing possible actions DOD can take to improve its
ability to produce reliable information for the Department's
substantial investment in property and other equipment.  For example,
we have ongoing reviews of specific general ledger or mixed system
applications such as the Defense Property Accountability System
(DPAS), the Air Force's Reliability and Maintainability Information
System (REMIS), and the Army's Continuing Balance System-Expanded
(CBSX). 

ACCUMULATE ACCURATE COST DATA

DOD has acknowledged, and the CFO Act financial statement audits have
confirmed, fundamental problems with the Department's ability to
accumulate reliable cost information.  The Department's annual report
to the President and the Congress in February 1996 acknowledged that
inaccurate and incomplete cost accounting information was a
Department-wide problem.  Auditors' reports have confirmed that DOD
does not have accurate cost data for almost all of its noncash
assets, such as inventories, equipment, aircraft, and missiles, nor
can the Department accumulate reliable information on the cost of its
business activities and critical operations, such as the costs
associated with maintaining its weapon systems in a high state of
readiness. 

For example, our review of the Navy's financial operations disclosed
that billions of dollars associated with building aircraft and
missiles and modernizing weapons systems were not included in the
Navy's financial reports.  It is critical that managers have accurate
information on actual operating and capital costs to consider when
making decisions to replace or upgrade weapons systems.  In addition,
in analyzing DOD's most recent round of base closure and realignment
recommendations, we found that the quality of existing cost data
limited their usefulness.  Specifically, the existing data could not
be relied on to provide decisionmakers with the actual costs or
savings associated with alternative base closure and realignment
options. 

Not unmindful of the need for such information, the Department has
taken action intended to improve its financial operations in this
area.  One of the major initiatives the Department undertook to
improve its cost accounting capabilities was the establishment of the
Defense Business Operations Fund. 

This Fund, with estimated annual revenues of about $75 billion, was
established in October 1991 by consolidating nine existing industrial
and stock funds and five other activities operated throughout DOD. 
The Fund's primary goal was to focus attention on the total costs of
carrying out certain critical DOD business operations--many of which
are essential to maintaining weapon system readiness--and to help
manage those costs more effectively.  The Fund was intended to
operate on a break-even basis by recovering the current costs
incurred in conducting its operations. 

However, since its inception, the Fund was plagued with
implementation problems.  We made a number of recommendations
intended to help improve the Fund's operations and financial
reporting. 

In recognition of the Fund's implementation problems resulting from
the lack of clear delineation of responsibility for managing Fund
activities, in December 1996, the Department's CFO announced the
Fund's elimination.  In its place, he established four working
capital funds.\3 The CFO has stressed his intention that these
working capital funds retain the essential purposes for which the
Fund was established, such as increasing visibility for the total
cost of the Department's support structure. 

However, these new working capital funds have also inherited their
predecessor's operational and financial reporting problems.  We will
continue to monitor the Department's business activities carried out
through these working capital funds and have efforts underway to
identify opportunities for improvements in the area of pricing these
funds' goods and services. 

RESOLVE PROBLEM DISBURSEMENTS

Auditor reports have served to highlight the scope and severity of
the problems the Department must resolve if it is to accurately and
promptly account for all its disbursements.  Auditors reported that
billions of dollars in disbursements could not be promptly or
accurately matched with related obligations, and identified the
Department's inability to ensure that disbursements were charged to
the correct appropriation. 

Until these problems are corrected, DOD's ability to detect and
correct illegal acts, and ensure that funds are spent as directed by
the Congress will continue to be impaired.  Because of the large
amount of funds DOD obligates and disburses each year, resolving its
disbursement problems is critical to improving its financial
management operations. 

The Department has recognized this as a major area of concern and is
working hard to reduce current problem disbursements.  In accordance
with its blueprint, the Department developed a prevalidation policy
and in July 1995, began matching disbursements to obligations, prior
to payment, for payments of $5 million or more.  The threshold amount
was reduced to $1 million by October 1995 for all but DOD's primary
location for contract payments.  However, even at this location, DOD
recently reduced the prevalidation threshold to $4 million, and plans
further reduction of that threshold. 

The Department has many other short-term initiatives and long-term
plans to reduce its problem disbursements.  The scope of these
efforts ranges from processing changes that affect one type of
payment at a single location to complete system redesigns. 

DOD's short-term initiatives focus primarily on stemming the tide of
additional problem disbursements, which appears to be a reasonable
approach.  However, the Department also needs to supplement this
approach with an effort to determine what factors are contributing
most significantly to the problem and the extent to which its
numerous initiatives will improve these significant problem areas. 
In this way, DOD can best ensure that its resources are properly
allocated to the initiatives with the greatest potential payoff.  For
example, are the resources allocated to preventing new problem
disbursements appropriate if they take away from the resources that
could be used to resolve existing problem transactions?  DOD must be
able to ensure that such trade-offs are worthwhile and will yield the
most cost-effective and efficient solutions on a project-by-project
basis. 

DOD's long-term efforts to resolve problem disbursements include
greater use of emerging technologies, such as shared data warehousing
and electronic data management.  DOD also has long-term plans to
develop the Defense Procurement Payment System and the Standard
Procurement System.  These efforts are all in the early stages of
development. 

As of May 1996, DOD reported that its problem disbursements totaled
about $18 billion.  DOD officials have stated that they believe the
Department has reduced its problem disbursements.  In particular,
they cited negative unliquidated obligations and unmatched
disbursements as areas in which the Department has made substantial
progress. 

However, our preliminary work on DOD's reporting of problem
disbursement data indicates that reported amounts are substantially
understated and raises concerns over whether DOD has sufficient,
reliable information to determine the extent to which disbursement
problems have been reduced.  Also, lacking basic quantitative data on
the sources and causes of problem disbursements, DOD cannot reliably
determine whether (1) its short-term initiatives best utilize its
resources to stem the flow of problems and attain accountability, (2)
its long-term initiatives are properly aimed at addressing the
problems, and (3) the scope and size of DOD's disbursement problems
are being reduced. 

We have several ongoing reviews directed at identifying opportunities
for additional corrective actions.  For example, we are reviewing
problem disbursement issues involving progress payments, problem
contracts, and transactions by others. 

UPGRADE FINANCIAL MANAGEMENT
WORKFORCE AND ORGANIZATION

DOD also faces a considerable challenge if it is to meet the CFO Act
objectives of putting in place a quality, professional financial
management workforce with clear organizational, as well as
individual, responsibilities and accountability.  DOD has
acknowledged that, no matter how skilled its financial personnel, its
manifold financial failures reflect a large, complex, antiquated
bureaucratic organization structure.  For example, the Department has
stated that a dozen organizations are involved in making a single
progress payment on a complex weapon system. 

Auditors have reported that financial personnel deficiencies, such as
the lack of accounting experience or competencies, and inadequate
training, have diminished their effectiveness.  For example, we
recently found that at DFAS operating locations--the heart of DOD's
"Accounting Firm" with overall responsibility to account for the
Department's $250 billion annual budget--only about 58 percent of the
key managers had more than the minimum number of accounting hours
necessary to be classified as an accountant in the federal
government.  In addition, only 6 of 107 key managers were CPAs, and
about 60 percent of the 107 managers did not have enough hours in
accounting to sit for the CPA exam in many states. 

As discussed in the following section, one of the common problems
found repeatedly throughout prior financial audits has been DFAS and
military service personnel not following rudimentary required control
procedures.  Without focused efforts to ensure that the Department
has a skilled, professional workforce in place, it is unlikely that
the needed improvements can be made and sustained. 

DOD has not yet established any continuing professional education
requirements for its financial workforce.  Well-qualified personnel
with demonstrated knowledge and technical skills acquired through a
broad base of experience and continuing professional training will be
essential if the Department is to effectively keep pace with emerging
technologies and developments in financial management. 

Our reports issued over the past few years also have included several
other recommendations for actions that the Department could take to
improve financial personnel and organization.  Specifically: 

  -- In our May 1995 testimony, we recommended that DOD (1) determine
     the appropriate number of staff with the requisite skills to
     ensure that the Department's blueprint for financial reform will
     be successfully implemented and (2) establish an independent,
     outside board of experts to provide counsel, oversight, and
     perspective to DOD's reform efforts. 

  -- In our March 1996 report on the Navy, we concluded that greater
     emphasis was needed on determining the skills, experience, and
     number of personnel needed to effectively address the
     fundamental weaknesses we found.  We recommended that staffing
     issues be addressed, such as filling financial management
     vacancies, upgrading the experience of financial managers, and
     using contractors, as necessary, to improve financial management
     operations.  We pointed out that implementing these
     recommendations at the DFAS Cleveland Center--the DFAS location
     with overall responsibility for Navy's accounting and financial
     reporting--was particularly important because of the substantial
     effort that will be required to correct the serious deficiencies
     we found at that location. 

  -- In July 1996, we reported on opportunities to better focus
     hiring practices at DFAS operating locations.  We suggested that
     DFAS enhance its hiring criteria to include (1) demonstrated
     experience in successfully implementing accounting or finance
     systems and (2) demonstrated technical competency in accounting. 

DFAS has already acted on our recommendations to fill vacancies and
obtain additional contractor support at its DFAS Cleveland location. 
DFAS has also recently begun developing several major programs to
ensure the professionalism of its financial management workforce. 

First, DFAS is developing a program to improve the technical and
managerial competencies for 5 percent of its workforce selected
competitively on an annual basis.  Under this program, individual
development plans formulated for the program's selectees will guide
the attainment of identified training, education, and rotational
assignments, or professional certifications, such as a Certified
Public Accountant.  Second, DFAS is developing a "Cornerstone
Program," which is intended to improve managerial competencies and
broaden the perspectives of all DFAS employees in GS grades 12
through 15.  Third, it is expanding its existing Career Intern
Program--the primary source for hiring entry-level personnel.  This
program focuses on providing on-the-job training through a series of
rotational assignments. 

To tie these programs together, DFAS is in the process of developing
a "DFAS Career Development System" which will identify competencies
obtained through training, education, organizational assignments, and
self-development initiatives.  These actions, if implemented promptly
and effectively should enhance the capabilities of the staff and
result in improved financial management practices.  Adequate priority
and resources must be dedicated to this area to ensure that these
plans become a reality. 

DFAS has also moved to supplement its financial management
organization with outside contractors.  For example, DFAS entered
into a contract with a large accounting firm to examine the
Department's overall accounting structure, and another to help guide
and direct the Department's "catch up" efforts to prepare credible
Navy financial reports in the near term.  To ensure that this
contract support is effective, DOD must ensure that its contractors
receive adequate information to provide informed advice, and, of
course, must provide the necessary attention and resources to assess
and implement contractors' recommendations. 

To further assist DOD in focusing its reform efforts, our ongoing
work in this area includes a review of the qualifications and
experience of DOD financial management personnel and a benchmarking
study of the qualifications and experience of private and public
sector financial management personnel.  We are also identifying
leading private and public sector organizations' best practices in
financial management--that is, changes in organizational practices,
processes, personnel or systems that have led to greater productivity
and reduced costs. 

STRENGTHEN INTERNAL CONTROLS

The Department is also faced with a considerable challenge in its
efforts to strengthen internal controls.  Currently, required control
procedures were either not in place, or were not followed, for
critical reconciliations, physical counts of inventories,
documentation supporting reported amounts, and reviews and edits of
abnormal balances.  In its February 1996 annual reporting required by
the Federal Managers' Financial Integrity Act (FMFIA), the Department
acknowledged 33 material weaknesses that crossed a broad spectrum of
its operations. 

Adherence to these basic financial controls is necessary to ensure
that DOD's assets are properly safeguarded against unauthorized
acquisition, use, or disposition.  In addition, disciplined adherence
to key internal control policies and procedures could, in the short
term, help mitigate the weaknesses created by DOD's lack of an
integrated financial management system. 

Audits identified many instances in which the Department's inability
to ensure that rudimentary control procedures were followed adversely
affected program operations.  For example, auditors reported that
additional validation of existing real property records was required
to support the Department's base closure and realignment decisions
and millions of dollars in unauthorized military payroll payments
were made because required reconciliation procedures were not
followed.  Audit reports also disclosed that pervasive weaknesses in
the Department's general computer controls placed DOD at risk of
improper modification, theft, inappropriate disclosure, or
destruction of sensitive personnel, payroll, disbursement, or
inventory information. 

Strengthening the Department's internal controls will be critical if
it is to effectively control and account for DOD's estimated
$1 trillion investment in assets worldwide.  The following were among
the recent recommendations we made for improving the Department's
controls. 

  -- In our May 1995 testimony, we recommended that DOD clean up the
     existing data in the financial systems and place special
     emphasis on ensuring that basic accounting policies and
     procedures are followed to improve data accuracy in the current
     systems while new systems are under development. 

  -- In our March 1996 report, we recommended that DOD place high
     priority on implementing basic financial controls, such as
     conducting periodic physical inventories of equipment and
     property, reconciling accounts, and analyzing abnormal balances
     or fluctuations in accounts.  In addition, we recommended that
     the Department improve the data in existing systems, and
     supplement existing policies and procedures by better
     pinpointing individual accountability for carrying out assigned
     responsibilities. 

  -- We also issued a September 1996 report\4 that recommended a
     series of actions needed to strengthen general computer controls
     over DOD's processing of sensitive personnel, payroll,
     disbursement, and inventory data.  Specifically, we recommended
     that the DOD Chief Information Officer develop and implement a
     comprehensive DOD-wide computer security management program. 
     Further, we recommended that such policies and procedures should
     (1) limit computer system access authorizations to only those
     who need access to perform their work, (2) require that
     sensitive data files and critical production programs be
     identified and access to them be monitored, (3) strengthen
     security software standards in critical areas, (4) control
     physical security at computer facilities, and (5) provide for
     completing and testing disaster recovery plans. 

The Department has struggled to put in place the necessary support
throughout its vast financial operations to ensure disciplined

adherence to rudimentary required controls and, recently, to improve
general computer controls.  We are concerned that the Department's
annual reporting under FMFIA may provide an overly optimistic
impression of the nature and extent of its control weaknesses. 
Specifically, while acknowledging material control weaknesses, DOD's
most recent annual report concludes that sufficient compensating
controls are in place.  This assertion is not consistent with the
results of our financial audits. 

Nonetheless, over the past few years, we have seen encouraging signs
that some of DOD's top leaders have made a commitment to improving
adherence to established control procedures.  For example, DOD
leadership directed that senior managers throughout the Department
play a more active role in identifying, reporting, and correcting
poor controls. 

Given the large worldwide network of people and organizations relied
on to carry out the Department's financial operations, improvements
in this area represent a considerable challenge.  In this regard, DOD
is incorporating DOD component regulations into a single
Department-wide DOD Financial Management Regulation.  This effort is
intended to simplify control requirements by eliminating over 70,000
pages of regulations. 

In addition, in September 1995, the Director of the Defense Finance
and Accounting Service issued "lessons learned" guidance to his
center directors requesting their personal involvement in preventing
a repetition of previous years' errors.  We believe this guidance
gets to the heart of DOD's financial management problems and outlines
control techniques that, if implemented, could have detected or
prevented many of the deficiencies auditors observed.  The results of
the fiscal year 1996 audits, expected to be issued in March 1997,
will provide a barometer to gauge the effectiveness of this
directive. 

Continuing and building upon DOD leaders' recent public statements
emphasizing the importance of following rudimentary controls will be
critical if the Department is to realize meaningful, sustained
improvements in its financial operations.  Since it will be at least
several more years before planned system development and improvement
efforts are in place, it will be imperative for the Department to
place special emphasis on improving controls in existing systems so
that decisionmakers have credible financial data in the interim. 

REENGINEER BUSINESS PRACTICES

DOD's financial management operations are plagued with duplicative
processes and business practices that are complex, slow, and
error-prone.  For example, we reported that before the Department
decided to reengineer its travel processes, they were extremely
complicated with over 700 processing centers and 1,300 pages of
regulations, and required the traveler to go through some 40 steps to
get travel authorization and reimbursement. 

In describing conditions that led to its blueprint for reforming the
Department's financial management, DOD leadership provided an
excellent overview of the challenges facing DOD in this area. 
Specifically, the overview acknowledged that the Department confronts
decades-old problems deeply grounded in the bureaucratic history and
operating practices of a complex, multifaceted organization, and that
many of these practices were developed piecemeal over a period of
decades and evolved to accommodate different organizations, each with
its own policies and procedures. 

To its credit, DOD's blueprint set out reengineering the Department's
business processes as one of the key elements of its proposed
financial reform.  Also, the DOD CFO's October 1995 vision statement
recognized business process reengineering, along with system
standardization and consolidation of operations, as the underpinnings
of financial management improvement in the Department. 

In DOD's efforts to reengineer its travel practices, the Department
has taken a broad approach to reengineering--one not bounded by
existing processes and organizations.  This approach, while not yet
completed, holds out the promise for dramatic improvement over
existing practices, and potential savings of hundreds of millions of
dollars. 

Unfortunately, other DOD initiatives intended to "reengineer" other
functional business areas have focused largely on greater use of
technology within existing processes and organizations. 
Consequently, while these initiatives may improve existing practices,
they will have little chance of radically improving the current
processes that the Department has acknowledged are cumbersome and
bureaucratic. 

We have ongoing work to identify specific actions to improve the
likelihood of successfully reengineering the Department's practices
in the travel and disbursement areas.  Successfully reengineering the
Department's business processes is critical if DOD is to effectively
address deep-rooted organizational emphasis on maintaining "business
as usual" across the Department. 


--------------------
\1 The DOD audit community includes not only the DOD Inspector
General, but the Army, Air Force, and Naval audit services. 

\2 DOD's system migration strategy involves, for each DOD function,
(1) selecting one of each military service's systems currently in
operation (i.e., legacy systems), (2) implementing that system across
the service (i.e., an interim migratory system), (3) selecting the
"best" of the services' systems to serve as the DOD system (i.e., a
migratory system), and (4) enhancing the migration system until it
meets all applicable requirements to become DOD's target system. 

\3 Working capital funds were established for the Army, Navy, and Air
Force.  In addition, the CFO established a Defense-wide working
capital fund, and also stated that there may be a fifth working
capital fund established for the commissary area. 

\4 Because of the sensitivity of the issues involved, distribution of
this report was limited to recipients requiring this report for
official use. 


RELATED GAO PRODUCTS
=========================================================== Appendix 3

Financial Management:  DOD Inventory of Financial Management Systems
Is Incomplete (GAO/AIMD-97-29, Jan.  31, 1997). 

DOD Accounting Systems:  Efforts to Improve System for Navy Need
Overall Structure (GAO/AIMD-96-99, Sept.  30, 1996). 

Navy Financial Management:  Improved Management of Operating
Materials and Supplies Could Yield Significant Savings
(GAO/AIMD-96-94, Aug.  16, 1996). 

Correspondence to the Under Secretary of Defense (Comptroller) on
financial management personnel qualifications (July 18, 1996). 

CFO Act Financial Audits:  Navy Plant Property Accounting and
Reporting Is Unreliable (GAO/AIMD-96-65, July 8, 1996). 

Financial Management:  DOD Needs to Lower the Disbursement
Prevalidation Threshold (GAO/AIMD-96-82, June 11, 1996). 

Information Security:  Computer Attacks at Department of Defense Pose
Increasing Risks (GAO/AIMD-96-84, May 22, 1996). 

Navy Anti-Deficiency Act Training (GAO/AIMD-96-53R, Apr.  12, 1996). 

Defense Business Operations Fund:  DOD Is Experiencing Difficulty in
Managing the Fund's Cash (GAO/AIMD-96-54, Apr.  10, 1996). 

CFO Act Financial Audits:  Increased Attention Must Be Given to
Preparing Navy's Financial Reports (GAO/AIMD-96-7, Mar.  27, 1996). 

Financial Management:  Challenges Facing DOD in Meeting the Goals of
the Chief Financial Officers Act (GAO/T-AIMD-96-1, Nov.  14, 1995). 

Financial Management:  Challenges Confronting DOD's Reform
Initiatives (GAO/T-AIMD-95-146, May 23, 1995). 

Financial Management:  Challenges Confronting DOD's Reform
Initiatives (GAO/T-AIMD-95-143, May 16, 1995). 

Financial Management:  Control Weaknesses Increase Risk of Improper
Navy Civilian Payroll Payments (GAO/AIMD-95-73, May 8, 1995). 

Travel Process Reengineering:  DOD Faces Challenges in Using Industry
Practices to Reduce Costs (GAO/AIMD/NSIAD-95-90, Mar.  2, 1995). 

Defense Business Operations Fund:  Management Issues Challenge Fund
Implementation (GAO/AIMD-95-79, Mar.  1, 1995). 


1997 HIGH-RISK SERIES
=========================================================== Appendix 4

An Overview (GAO/HR-97-1)

Quick Reference Guide (GAO/HR-97-2)

Defense Financial Management (GAO/HR-97-3)

Defense Contract Management (GAO/HR-97-4)

Defense Inventory Management (GAO/HR-97-5)

Defense Weapon Systems Acquisition (GAO/HR-97-6)

Defense Infrastructure (GAO/HR-97-7)

IRS Management (GAO/HR-97-8)

Information Management and Technology (GAO/HR-97-9)

Medicare (GAO/HR-97-10)

Student Financial Aid (GAO/HR-97-11)

Department of Housing and Urban Development (GAO/HR-97-12)

Department of Energy Contract Management (GAO/HR-97-13)

Superfund Program Management (GAO/HR-97-14)


























The entire series of 14 high-risk reports can be ordered using the
order number GAO/HR-97-20SET.