March 2011

The Government Accountability Office (GAO) again reported that it

“cannot render an opinion on the 2010 consolidated financial statements of the federal government, because of widespread material internal control weakness, significant uncertainties, and other limitations.”

This has occurred for years. Although each year the federal government states improvements are being made, the bottom line answer remains that the federal government is financially out-of-control. The GAO noted problems that included (i) an estimated $125.4 billion in improper payments and (ii) an inability to account for and reconcile intergovernmental activity and balances.

One of the major offenders is the Department of Defense (“DoD”), whose serious financial management problems “made its financial statements unauditable”. In a September 2010 report, the GAO summarized the situation as follows:

“For more than a decade, DOD has dominated GAO’s list of federal programs and operations at high-risk of being vulnerable to fraud, waste, abuse, and mismanagement. In fact, all the DOD programs on GAO’s High-Risk List relate to business operations, including systems and processes related to management of contracts, finances, the supply chain, and support infrastructure, as well as weapon systems acquisition. Long- standing and pervasive weaknesses in DOD’s financial management and related business processes and systems have (1) resulted in a lack of reliable information needed to make sound decisions and report on the financial status and cost of DOD activities to Congress and DOD decision makers; (2) adversely affected its operational efficiency in business areas, such as major weapons system acquisition and support and logistics; and (3) left the department vulnerable to fraud, waste, and abuse.”

DoD says they have a plan to address the problem. But before starting to breathe easy, consider the following:

  1. Since the 1990s, the DoD has been required by law under the Chief Financial Officers Act to pass annual audits. No such audit has ever been successfully completed.
  2. In 1995, the GAO designated DoD’s financial management operations and controls as a high-risk area. Sixteen years later, this designation remains.
  3. GAO found that the Pentagon’s Defense Contract Audit Agency (“DCAA”), who is responsible for providing accounting and auditing oversight of military contractors, failed to meet professional auditing standards on prior audits. The failings included (i) deleting key audit steps because “The contractor would not appreciate it” and (ii) deleting references to unfavorable results so that contractors would not be disappointed.
  4. The current plan is for the overall DoD to be “audit-ready” by September 30, 2017. This is not a typo – the DoD thinks it is satisfactory to take six and a half years to do something that practically every major public, private, and non-profit organization in the United states does annually as a matter of routine. However, past plans have included “audit-ready” deadlines of 1996 and 2007.

This incredible lack of accountability exposes the vast DoD spending to mismanagement, waste, and fraud. Incredibly, DoD Comptroller Robert Hale offered the following assurance:

”the fact that we can’t pass commercial audit standards does not mean we have no idea where we’re spending the money that you send us….if we had no idea what we were doing with the money, we’d have rampant Anti-Deficiency Act violations. Over the last five years, about two-tenths of our budget has been associated with ADAs. That’s more than I’d like, but it’s pretty small.”

In case you read that too quickly, he said that taxpayers should take comfort in the fact that the DoD only gets cited for overspending the budget 20% of the time.

The DoD attempts to justify its lack of control on the fact that their spending is so high. This logic is obviously backwards, since large spending means that the risks and need for controls is higher. A business person might be forgiven for not keeping track of smaller amounts, but large amounts deserve and get attention. Not so at the DoD. Here is their explanation:

“The DoD obligates an average of $2 billion to $3 billion every business day and handles hundreds of thousands of payment transactions, which take place in thousands of worldwide locations, including war zones. Because of DoD’s size and mission requirements, it is not feasible to deploy a vast number of accountants to manually reconcile our books.”

One must wonder why the DoD thinks that accounting records and reconciliations must be done manually in the current age.

Elsewhere, the DoD estimates that 0.1% of payments to employees and contractors are outright improper. One must wonder how reliable this guess is, since the DoD conceded that they have insufficient controls to reliably report either total payments or the levels that may be improper. Nevertheless, accepting this estimate, this means there is about $2-3 million per day that is paid improperly.

Here is a refresher on the most basic functions of an audit that are being violated. As professional accountants and auditors, here are our thoughts:

  1. The reported failings are fundamental. Outside of the federal government, this situation would not be tolerated for even a few months. These long delays should not be acceptable to Congress or any presidential administration.
  2. The only reason an audit cannot be performed is that the basic underlying transactional support has not been maintained. When something is so convoluted that it cannot be audited, users of that information should be highly skeptical.
  3. As is always the case, the relationship between the auditor and the auditee should be examined. In this case, the lack of independence between the DCAA and the DoD has clearly led to inexcusable failures.
  4. An audit should take place when it is needed (usually at least annually), not when an auditee is “ready”. In many cases, long delays between a closed financial period and the auditee’s readiness to provide information is itself a cause for suspicion.
  5. Materiality is a function of judgment, and may differ based on such factors as the size or nature of the item or the expected user of the information. A small percentage alone does not make an item immaterial.
  6. No accounting problem is really that difficult if those in charge think there is a problem. The real reason that the DoD had these significant problems for years is that the DoD simply does not care sufficiently about making improvements. Continued failures over just a fraction of the time that these problems have occurred means that a management change of attitude (and probably a change of personnel) is needed.

Neither the government nor the investing public would allow the complete disaster of accountability and reliability described above to exist in a publicly-traded company. Government decisions with far-reaching financial and social implications are being made daily based on unreliable information, with no one able to reasonably guess at the degree to which the reported amounts vary from reality. The potential waste of government resources is incredible. There is no good excuse for this ongoing failure.

Fulcrum Inquiry is a licensed as a Certified Public Accounting firm.  We perform financial investigations, royalty audits, and other forensic accounting.