Department of Defense: Actions Needed to Reduce Accounting Adjustments

DOD remains the only major federal agency that has been unable to obtain a financial statement audit opinion. One of the contributing factors is DOD's large volume of nonroutine accounting adjustments, which are used for recording corrections or adjustments in an accounting system. This report examines accounting adjustments and their effect on the reliability of DOD's financial information, the extent to which DOD has established and implemented policies and procedures for recording accounting adjustments, and the extent to which DOD has taken actions to reduce adjustments recorded at the consolidated level.

For this report, GAO reviewed DOD and DFAS's policies and procedures, interviewed DOD officials about the adjustment process, and reviewed initiatives to reduce the number of adjustments being recorded. GAO also selected a random sample of 242 adjustments recorded at the DOD consolidated level for the fourth quarter of fiscal year 2018 to determine whether the adjustments were recorded in accordance with established policies.

While the use of accounting adjustments is a common practice, the Department of Defense's (DOD) reliance on a large volume of nonroutine adjustments to prepare its financial statements is primarily a result of deficient business processes and limitations in accounting systems that DOD components use to process financial information. For example, the Defense Finance and Accounting Service (DFAS) continues to rely on forced-balance adjustments to replace the financial information that DOD's components submit to force agreement with Department of the Treasury balances without reconciling and researching the cause of differences (see figure). The recording of these adjustments was identified as a material weakness in DOD's internal control over financial reporting in its fiscal year 2018 financial statement audit.

GAO found that DOD and DFAS policies and procedures for accounting adjustments are insufficient, outdated, and inconsistently implemented. For example, DOD's current policies do not define what constitutes adequate supporting documentation for system-generated adjustments, nor have DOD and DFAS established policies for identifying the cause of the adjustments, developing and implementing action plans to reduce the need for adjustments, and monitoring the effectiveness of those action plans. Because DOD and DFAS are not ensuring that their policies and procedures are up-to-date and consistently implemented, there is an increased risk that inaccurate, invalid, or unapproved adjustments will be recorded in DOD's core financial reporting system, resulting in a misstatement in DOD's consolidated financial statements.

DOD and DFAS have undertaken initiatives to address some of the issues that contribute to the need for adjustments. Both organizations have developed strategies to decrease adjustments; however, neither has developed specific outcomes or detailed procedures for achieving stated goals in the strategies. Without clear procedures on how to implement its initiatives and a complete understanding across DOD of the issues contributing to the need for accounting adjustments, there is an increased risk that management efforts to reduce adjustments at the DOD consolidated level will be inefficient and ineffective.

GAO is making eight recommendations to DOD, which include updating and implementing policies and procedures on recording accounting adjustments and identifying steps to reduce the need for recording adjustments across the department. DOD agreed with all eight recommendations and cited actions to address them.

The Department of Defense (DOD) is responsible for about half of the  federal government’s discretionary spending, yet it remains the only major  federal agency that has been unable to receive an audit opinion of any  kind on its department-wide financial statements. Since 1995, GAO has  designated DOD financial management as high risk because of pervasive  weaknesses in its financial management systems, business processes,  internal controls, and financial reporting. These weaknesses have  adversely affected DOD’s ability to prepare auditable financial  statements, which is one of three major impediments preventing us from  expressing an opinion on the U.S. government’s consolidated financial  statements.

The National Defense Authorization Act for Fiscal Year 2014 required the  Secretary of Defense to ensure that a full audit was performed on DOD’s  fiscal year 2018 financial statements and to submit the results to  Congress no later than March 31, 2019. In fiscal year 2018, DOD  underwent a full audit of its financial statements, which resulted in a  disclaimer of opinion and the identification of 20 material weaknesses in  internal control over financial reporting. One of the material weaknesses  auditors identified related to accounting adjustments.

Accounting adjustments are entries for recording corrections or  adjustments in an accounting system. While the use of adjustments is  common practice, DOD’s reliance on a large volume of nonroutine  adjustments to prepare its financial statements is primarily a result of  deficient business processes. First highlighted by auditors as a material  weakness in fiscal year 2005, DOD’s widespread use of accounting  adjustments continues to affect the reliability of its financial information at  both component and department-wide levels. DOD management  reported in its fiscal year 2018 agency financial report that DOD’s  (1) continuing inability to reconcile detail-level transactions within their  general ledgers, (2) lack of adequate supporting documentation for  accounting adjustments, and (3) inconsistent procedures for recording  accounting adjustments constitute a material weakness in internal control  over financial reporting. Until DOD takes steps to address these  deficiencies, DOD management and Congress will not be able to rely on  financial information in the agency’s core financial reporting system for  obtaining reliable and accurate financial information to support its  decision-making.

You requested that we review DOD’s accounting adjustments recorded at  the consolidated financial statement level and determine the causes of  these adjustments. This report examines (1) accounting adjustments and  their effect on the reliability of DOD’s financial information, (2) the extent  to which DOD has established and implemented policies and procedures  for recording accounting adjustments, and (3) the extent to which DOD  has taken actions to reduce accounting adjustments recorded at the  consolidated level.

To address our first objective, we reviewed DOD and Defense Finance  and Accounting Service (DFAS) policies and procedures related to  accounting adjustments, performed walk-throughs of DFAS’s accounting  adjustment process, and interviewed agency officials to gain an  understanding of the processes and related controls for recording  accounting adjustments at the consolidated level. Additionally, we  obtained and analyzed information for fiscal years 2017 through 2018 for  various types of accounting adjustments.

To address our second objective, we reviewed DOD and DFAS policies  and procedures and interviewed officials from DFAS and the Office of the  Under Secretary of Defense (OUSD) (Comptroller) to identify issues  surrounding accounting adjustments and the procedures used to process,  review, and approve these adjustments in DOD systems. We also  inquired about the procedures used to determine the underlying causes of  accounting adjustments, if action plans to address the causes have been  developed, and the status of these plans and assessed whether the  implemented action plans are monitored for effectiveness. Additionally,  we performed tests of controls on a random sample of 242 accounting  adjustments from a population of 200,468 adjustments recorded at the  consolidated level that impacted the fourth quarter of fiscal year 2018.  The adjustments selected for testing were recorded in DOD’s core  financial reporting system. Specifically, we selected a random sample of  225 adjustments recorded in Defense Departmental Reporting System  (DDRS)-Budgetary (DDRS-B) and DDRS-Audited Financial Statements  (AFS) and all 17 adjustments recorded in the DDRS-AFS Beginning  Balance Adjustments. We were able to project the results of testing the  randomly selected sample to the population of accounting adjustments.  We reviewed documentation to determine whether the adjustments were  properly supported in accordance with DOD policies.

To address our third objective, we reviewed documentation and  interviewed DFAS and OUSD (Comptroller) officials to identify DOD and  DFAS initiatives aimed at reducing the use of accounting adjustments and  the procedures in place for implementing these initiatives. Further details  on our scope and methodology are provided in appendix I.

We conducted this performance audit from November 2018 to January  2020 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.

To ensure sound management and long-term stability in their operations,  organizations track their financial activities (transactions), such as  expenses they incur and income they generate. Organizations record  their daily transactions, which increase or decrease account balances, in  their accounting systems. For example, an organization’s “cash balance”  account increases when customers make payments due for goods or services previously provided, while other account balances, such as  “accounts receivable” (the amount owed to an organization for goods or  services provided), decrease because customers are paying part of what  they owed to the organization.

At DOD, as seen in figure 1, this daily process of recording transactions in  accounting systems occurs at individual DOD components. These  components use multiple accounting systems to record and summarize  their financial transactions. Each month, quarter, and year, components  send summarized financial information to DFAS, the DOD agency that  provides accounting support for DOD. DOD’s core financial reporting  system consolidates the summarized financial information from individual  components into DOD’s department-wide financial information.

Financial statements provide information about an organization’s financial  position—such as assets (what it owns) and liabilities (what it owes)—as  of a certain point in time, in addition to the financial results of its  operations—such as revenue (what came in) and expenses (what went  out)—over a period of time, such as a fiscal year. Financial statements  are prepared based on the summarized, or consolidated, financial  information from an organization’s accounting systems. Their reliability  depends on there being accurate financial information in the accounting  systems.

Federal agencies such as DOD combine summarized financial  information from their subsidiary organizations (e.g., DOD’s military  components—Army, Air Force, Navy, and Marine Corps) to produce  consolidated financial statements, as seen in figure 2. Agency  management takes steps to ensure that the financial information  contained in financial statements is reliable and accurate. Federal  agencies submit their financial information to the Department of the  Treasury (Treasury), which then combines the information for  presentation in the consolidated financial statements of the U.S.  government. Reliable and complete financial information is necessary to  help agency management and Congress understand the agency’s  finances, make informed policy and resource decisions, and hold agency  officials accountable for their use of these resources.

The Role of Accounting Adjustments in the Financial Statement Process

Accounting adjustments are used to record corrections or adjustments to  transactions in an accounting system. They are usually prepared at the  end of an accounting period to adjust ending account balances. For  example, accounting adjustments can be recorded monthly, quarterly, or  annually to  record or accrue an activity that is not accounted for in the  organization’s accounting systems, such as certain payroll  expenses;  correct errors identified in processing financial information;  record transactions based on the result of reconciliations;  record additional information at the request of a subsidiary  organization; or  record necessary accounting adjustments caused by accounting  system limitations or timing differences.

Organizations often record such accounting adjustments when preparing  financial statements. For example, adjustments to eliminate  intragovernmental transactions, such as accounts receivable and sales,  may be recorded. These adjustments are particularly necessary to  consolidate information from subsidiary organizations and properly  present consolidated financial statements.

At DOD, components record accounting adjustments within their own  accounting systems, and DFAS records adjustments at the consolidated  level in DOD’s core financial reporting system. DFAS often has to  reformat the summary information it receives from the components’  accounting systems before DOD’s core financial reporting system can  accept and process it. To address these or other issues in the financial  information it receives as part of the consolidation process, DFAS records  accounting adjustments. See figure 3 for an example of where accounting  adjustments can be recorded during the consolidation process.

DFAS records accounting adjustments both manually and automatically in  an accounting system. DFAS personnel record manual adjustments to  (1) adjust errors identified during the financial statement compilation  process, (2) record necessary accounting adjustments caused by system  limitations or timing differences, and (3) prepare required month-end and  year-end closing adjustments. System-generated adjustments are  automatically recorded in the accounting system without manual  involvement. DFAS uses system-generated adjustments when the  volume of adjustments needed for a particular purpose is too high and  labor-intensive for the adjustments to be recorded manually. For the  fourth quarter of fiscal year 2018, DFAS processed 18,521 manual and  181,947 system-generated adjustments at the consolidated level.

Some Types of Adjustments That DOD Routinely Records Indicate Critical Weaknesses in DOD’s Processes and Affect the Reliability of Its Financial Information

During the fourth quarter of fiscal year 2018, as noted above, DFAS  recorded, at a DOD consolidated level, over 200,000 accounting  adjustments in DOD’s core financial reporting system. The large volume  of these adjustments is one of the major impediments to DOD maintaining  accurate and reliable financial information. While some of these  adjustments are expected in the routine course of business, others—such  as those DOD records to force account balances to match—are not.

We found that DFAS’s lack of reliable business processes and limitations  in the source-level accounting systems that DOD components use to  process financial information leads them to record adjustments to remove  and replace component-submitted financial information in order to force  account balances to agree with Treasury balances. The recording of  these types of adjustments was identified as a material weakness in  DOD’s internal control over financial reporting in its fiscal year 2019  financial statement audit. While DOD has taken steps to address this  issue, because of the multitude of contributing factors involved, DOD  faces significant challenges in its effort to successfully reconcile its  account balances with Treasury and eliminate the need for recording  these adjustments.

Some Adjustments Are Expected and Routine, While Others Are Not

Some manual and system-generated accounting adjustments are  expected in the routine course of business and are recurring in nature.  For example, elimination adjustments for intragovernmental balances, as  previously discussed, are necessary in order to avoid overstating the  account balances of subsidiary organizations in the consolidated financial  information. The need for these types of adjustments occurs on a regular  basis when two or more DOD components enter into business  transactions with each other. For example, when the Army purchases  weapons from the Defense Logistics Agency, the Army records the  transaction as an expense while the Defense Logistics Agency records  this transaction as revenue in its accounting system. At the DOD  consolidated level, both the revenue and expense reported at the  subsidiary level need to be eliminated to avoid overstating revenue and  expense for DOD as a whole. These elimination adjustments are routine,  expected, and recurring because they must be prepared every time DFAS  compiles DOD’s quarterly and annual consolidated financial statements.

Other adjustments, such as those DFAS records in order to force account  balances to match (forced-balance adjustments) are not expected within  the routine course of business. DOD defines a forced-balance adjustment  as any amount recorded, usually at a summary level, to eliminate  differences between the component’s general ledger balance and  Treasury’s control total. Such adjustments, recorded without adequate  supporting documentation at the transaction level, are commonly referred  to by the accounting community as plugs.

Fund Balance with Treasury (FBWT) adjustments are one example of  forced-balance adjustments DFAS records to eliminate differences  between its cash balances and the amounts Treasury reported. In the  federal government, Treasury acts as the government’s bank and keeps  an official record of the remaining spending authority for each agency.  Consequently, reconciling an agency’s FBWT account with Treasury- reported amounts is similar to an individual reconciling a checkbook to a  bank statement. Treasury requires agencies to reconcile their cash  balances each month with the balances reported in Treasury’s records.  However, DOD generally records adjustments to make its FBWT agree with Treasury’s records rather than performing proper research to identify  what caused the differences. (See fig. 4 for more information on forced- balance adjustments.)

DOD’s Use of Certain Forced-Balance Adjustments May Indicate Critical Weaknesses

The use of forced-balance accounting adjustments affects the reliability of  an organization’s financial information and may indicate weaknesses  within its systems and processes. Over the years, DOD’s practice of  recording forced-balance adjustments has been questioned by GAO and  by DOD’s auditors. For example, in an audit of the Army General Fund’s  reconciliation process for the FBWT account, DOD’s Office of Inspector  General (OIG) stated that the Army and personnel in DFAS’s Indianapolis  office “make forced-balance adjustments, which are unsupported manual  and system-generated adjustments.” GAO and an independent  accounting firm both reported similar practices at the Navy and Marine  Corps. These audits have repeatedly identified limitations within the  source-level accounting systems that DOD components use and the  multitude of legacy systems (computer systems that are outdated or that  can no longer receive support and maintenance but are still essential for  an organization) as the main contributing factors for the use of forced- balance adjustments.

DOD’s Financial Management Regulation (FMR) states that a forced- balance adjustment does not represent an adequate reconciliation.  Instead, DOD components are required to maintain detailed reconciliation  documentation to provide an adequate audit trail. Further, according to  the FMR, a reconciliation is not complete until all differences are  identified, accountability is assigned, differences are explained, and  appropriate adjustments are made to records. These activities are  needed to establish an adequate audit trail. Despite this policy, during the  fourth quarter of fiscal year 2018, we found that DFAS recorded  approximately 36,000, or over 17 percent of the total accounting  adjustments, to force the FBWT accounts to agree with Treasury. Out of  the 242 fiscal year 2018 fourth quarter accounting adjustments we  selected for testing, nine were FBWT forced-balance accounting  adjustments related to undistributed collections and disbursements.

Based on our review of these adjustments, we found that DFAS continues  to rely on forced-balance adjustments to correct the differences between  amounts DOD recorded and those that Treasury reported without  properly investigating and resolving the differences. Specifically, we found  that DFAS systematically recorded forced-balance adjustments to replace  information that DOD components submitted with the amounts that  Treasury reported without reconciling and researching the causes of  differences and making any appropriate adjustments. DFAS indicated that  it performs reconciliations on the FBWT accounts when compiling  financial statements and researches the causes of any differences arising  from these reconciliations after it records the forced-balance adjustments.  However, for our sample of nine FBWT forced-balance adjustments  related to undistributed collections and disbursements, DFAS was unable  to provide evidence that these reconciliations were performed or that the  causes of differences were researched or resolved. Rather, DFAS  provided a general description of the reconciliation process it expects  each of the three DFAS sites to perform.

DOD Has Started Addressing FBWT Issues, but Many Challenges Remain

According to DOD officials, DOD has identified some key causes of the  long-standing challenges in reconciling its account balances with  Treasury. As noted above, many of these challenges are caused by  timing issues, limitations in the source-level accounting systems that DOD  components use, or the multitude of legacy systems that different DOD  components use. To address these challenges, DOD is currently  implementing enterprise resource planning (ERP) systems in the military  services, such as the Defense Enterprise Accounting and Management  System that the Air Force uses. These systems will replace the current  legacy systems across DOD with the expectation of a full transition to  ERP systems at all military services by 2025, at which point DOD expects  the need to record forced-balance adjustments to decrease. OUSD  (Comptroller) has a plan for implementing ERP systems at smaller DOD  components that also use legacy systems. However, the challenges that  legacy systems cause are likely to continue until the ERP transitions are  completed and ERP systems are fully implemented at the military  services and smaller DOD components. A DFAS official stated that until  DOD fully implements the ERP systems, DFAS does not have any plans  to modify the current financial management environment to eliminate the  recording of these types of adjustments. As noted earlier, as part of the  routine course of business certain adjustments will still need to be made  following the full implementation of the ERP systems.

Along with DOD’s implementing of the ERP systems, DOD officials stated  that some DFAS sites, in coordination with various DOD components,  have implemented tools to help them reconcile FBWT balances and  research the causes of any differences arising during these  reconciliations. According to DOD officials, these tools have the ability to produce supporting documentation for management and auditors to  use when reviewing FBWT accounts. However, DFAS did not provide  supporting documentation for these reconciliations in order for us to verify  that they had been performed. Until DOD consistently performs and  documents the required reconciliations to identify the causes for these  types of adjustments and takes a holistic approach to resolving them,  DOD’s financial management issues—such as those associated with  FBWT—are likely to continue, resulting in a continued inability to produce  reliable and auditable consolidated financial statements.

DOD and DFAS Policies and Procedures for Recording Accounting Adjustments Are Inadequate and Inconsistently Followed

Establishing clear policies and procedures for recording accounting  adjustments is crucial for (1) ensuring that accounting adjustments are  properly recorded and adequately supported with documentation;  (2) identifying the underlying causes for the recording of adjustments; and  (3) developing, implementing, and monitoring action plans to reduce the  need for accounting adjustments. We found that DOD and DFAS policies  and procedures for recording accounting adjustments were insufficient,  outdated, and not consistently implemented. Additionally, we found that  DOD and DFAS lacked policies and procedures in certain key areas,  such as performing cause analyses and developing action plans to  reduce the need for accounting adjustments. By not ensuring that policies  and procedures are up-to-date and consistently implemented, DOD faces  an increased risk that inaccurate, invalid, or unapproved adjustments will  be recorded in its core financial reporting system, resulting in  misstatements in its consolidated financial statements.

Policies and Procedures for Maintaining Adequate Supporting Documentation for System-Generated Accounting Adjustments Are Insufficient

System-generated accounting adjustments are recorded automatically in  an accounting system and have unique characteristics and processes  that differ from those applicable to manual accounting adjustments.  Unlike manual adjustments, which are initiated, recorded, and approved  in the accounting system by a person, system-generated adjustments are  guided by business rules embedded in an accounting system. These  business rules drive the accounting adjustment process and are  configured to record the adjustment when certain conditions are met. We  found that DFAS lacked documentation to support the business rules,  such as documentation of programming logic that creates the system- generated adjustments.

Based on our review of accounting adjustments at DOD, we found that  system-generated adjustments are recorded in large numbers and  account for the majority of the accounting adjustments that DFAS  recorded. For example, for the fourth quarter of fiscal year 2018, system- generated accounting adjustments accounted for over 90 percent of the  total volume of adjustments recorded in DOD’s core financial reporting  system at the consolidated level. Given the magnitude and unique  characteristics of system-generated adjustments, developing and  maintaining adequate supporting documentation are critical. According to  the FMR, adjustments to the accounting records should be supported with  sufficiently detailed written documentation to provide an audit trail to the  source transaction that requires the adjustment. Further, the FMR  requires supporting documentation to include information such as the  reason for the adjustment, calculation of the adjustment amount, and  evidence of managerial review and approval of the adjustment.

To support certain types of recurring system-generated adjustments,  DFAS developed eight standardized narratives that include the reasons  for the adjustments and the documentation DFAS considers necessary to  support the adjustments. Other recurring system-generated adjustments  are recorded based on System Change Requests, which are proposals to  modify information in an accounting system such as revising  programming logic and coding changes. In the fourth quarter of fiscal  year 2018, DOD determined that 74 percent of the recorded system- generated adjustments related to four of the eight standardized  narratives. Most of the System Change Requests we tested related to  financial information migration from a legacy system to a new responsible  work area for the U.S. Army Corps of Engineers.

DFAS annually selects and reviews a random sample of 40 system- generated adjustments related to each type of narrative for which  supporting packages are prepared. According to DFAS officials, the  supporting package preparation for the selected sample involves verifying  that the adjustments impacted the intended accounts. If no issues are  identified, DFAS concludes that the core financial reporting system  recorded the adjustments as intended, the desired results were achieved,  and the adjustments were supported. Within a given year, if DFAS  sample testing demonstrates that a certain type of system-generated  adjustment was supported, DFAS categorizes all the accounting  adjustments that relate to this particular type as supported for the rest of  the year.

We found that other than the supporting packages created specifically for  the periodic random samples, DFAS maintains no other documentation to  support the system-generated adjustments related to each of the eight  narratives. As part of our audit, we selected for testing 242 accounting  adjustments that impacted the financial statements for the fourth quarter  of fiscal year 2018, of which 93 were system-generated accounting  adjustments. Of these 93 adjustments, DFAS categorized 42 as  unsupported and 51 as supported. DFAS categorized adjustments as  either supported or unsupported depending upon the circumstances. The  circumstances considered include whether it relates to one of the eight  narratives or to specific System Change Requests. When the eight  narratives are tested, if no issues are identified as part of the testing, the  transactions linked to that narrative are considered supported. However,  we determined that the corresponding narratives and System Change  Requests were insufficient support for the 51 adjustments categorized as  supported because we were unable to verify the validity and accuracy of  the adjustments with supporting documentation.

In addition, we found that DFAS did not maintain evidence demonstrating  the review and approval of the programming of predefined business rules  in the systems that recorded the adjustments. When our results are  projected to the fiscal year 2018 fourth quarter population of 181,947  system-generated adjustments, we estimate that at least 96 percent of  the system-generated accounting adjustments were recorded without  adequate supporting documentation, which is required by DOD’s policy  and procedures and federal internal control standards. In 2018, DFAS’s  auditor issued a finding identifying similar issues with DFAS’s system- generated adjustments related to the scope of the eight narratives. As of  November 2019, this finding was still open.

Standards for Internal Control in the Federal Government requires that  management design control activities to achieve objectives and respond  to risks, such as designing controls to help ensure accurate and timely  recording and maintenance of appropriate transaction documentation.  Although the FMR has guidance on supporting documentation  requirements for accounting adjustments, we found that DOD’s FMR  does not clearly define or include examples of what constitutes adequate  supporting documentation of system-generated accounting adjustments.  Specifically, the FMR does not differentiate between documentation  requirements for manual and system-generated accounting adjustments.  Rather, it states that reporting organizations must maintain adequate  documentation, audit trails, and internal controls, and that the  documentation must be made available upon request. Because system- generated accounting adjustments consist of summary-level financial  information, DFAS officials stated that maintaining documentation at a  detailed level would be impractical given the large volume of transactions  at DOD. However, without adequate supporting documentation for the  business rules driving the recording of these adjustments, such as  documentation of the programming logic for these adjustments,  management and others cannot determine whether an adjustment was  recorded for a valid reason or for the correct amount.

DOD’s Policies and Procedures for Categorizing Accounting Adjustments Do Not Reflect the Current Financial Reporting Environment

The March 2002 version of the DOD’s FMR, volume 6A, chapter 2,  established 10 category codes that are used to identify the circumstances  under which accounting adjustments may be recorded. For example,  DFAS uses category A for reversing entries for a prior reporting period  and category B for data call adjustments. Additionally, the FMR  specifies the required documentation needed to support each category.  For example, for category A adjustments, adequate documentation  includes information on the original entry and a statement that the  adjustment is a reversing entry, whereas for category B adjustments,  documentation requirements include information on the summarized  amount and identification of the source or location of the transaction-level  detail for the adjustment. DOD’s core financial reporting system is  designed to allow a DFAS accountant to select one of these 10 codes  when recording an adjustment. Since these codes are used to identify the  required documentation to support the adjustments, it is important that the  codes are periodically reviewed to ensure that they are still relevant in  DOD’s current financial reporting environment and that supporting  documentation requirements are appropriate.

We found that some of the category codes were rarely used and new  codes may need to be added to reflect the current financial reporting  environment. For example, we found that of the 18,521 manual  adjustments recorded in DOD’s core financial reporting system during the  fourth quarter of fiscal year 2018, category F (supply management  inventory) was used only four times. According to DFAS officials, this  code was primarily used to adjust the purchase cost of certain supplies,  but those adjustments are now rarely needed. DFAS officials stated that  the codes had not been reviewed for continued relevance since they were  first established and expressed a need to revisit the current categorization  scheme to determine whether the codes should be redefined. The most  recent update of FMR, volume 6A, chapter 2, in June 2019 included the  addition of category M, the first code added since 2002. According to  DFAS officials, this code was not added based on a thorough review of  the existing codes but because there was already a substantial volume of  data call adjustments taking place in the Data Collection Module.

Further, a DOD official suggested that an additional code may be needed  for tie-point adjustments, which DFAS accountants frequently record as a  result of tie-point reconciliation. We found that 34 of the 149 manual  accounting adjustments we tested related to tie-point adjustments.  Because there is not a designated category code for tie-point  adjustments, we found that accountants used various other category  codes when recording the 34 tie-point adjustments, including D  (Recognition of Undistributed Disbursements and Collections), E  (Reconciliation of Trial Balance and Budget Execution Reports), G  (Reclassification of Accounts), H (Identified Errors and Reasonableness  Checks), I (Adjustment to Balance Reports Internally), or at times no  category code. As a result, there may be inconsistency in the  documentation maintained to support tie-point adjustments. Having a  single category code for tie-point adjustments could standardize recording  by accountants, enabling DFAS to identify the frequency with which tie- point adjustments are recorded and ensure that it maintains adequate  supporting documentation.

Standards for Internal Control in the Federal Government requires that  management implement control activities through policies. To do this,  management periodically reviews policies, procedures, and related  control activities for continued relevance and effectiveness in achieving  the organization’s objectives or addressing related risks. The DOD FMR  Revision Standard Operating Procedures indicates that the FMR is  reviewed every 2 years. However, based on our discussion with DOD  officials, a thorough review of the category codes has not been performed  and is needed to ensure the ongoing applicability of current category  codes or the need for additional codes to reflect the current financial  reporting environment. Without category codes for accounting  adjustments that reflect current business needs, there is an increased risk  that the reasons for recording these adjustments will not be properly  captured and adequate supporting documentation will not be specified or  maintained, hindering DFAS’s ability to provide DOD management or  auditors with reliable information about recorded accounting adjustments.

Policies and Procedures for Recording Accounting Adjustments Were Not Consistently Implemented

The FMR identifies critical elements that need to be included as part of  the supporting documentation package when recording manual  accounting adjustments. These elements include (1) correct appropriation  and accounting information, (2) balanced adjustments, (3) approvals,  (4) supporting documentation, and (5) valid U.S. Standard General  Ledger (USSGL) account numbers. The FMR further states that  supporting documentation included in the package must include, among  other things, elements to enable the assessment of the (1) accuracy and  completeness of financial information recorded, (2) applicable criteria to  support the reason for recording the adjustment, (3) specific expenditure  or receipt accounts used, and (4) calculation of the dollar amount of the  adjustment.

For the fourth quarter of fiscal year 2018, we selected a sample of manual  and system-generated adjustments to determine if the supporting  documentation for these adjustments included the critical elements  described in DOD’s FMR. We found that DFAS accountants did not  consistently follow the DOD FMR and DFAS’s policies and procedures for  some of these critical elements, resulting in (1) the failure to maintain  adequate supporting documentation, (2) the recording of out-of-balance  accounting adjustments, and (3) the use of account numbers that do not  comply with the USSGL.

Inadequate supporting documentation: We found that 51 of the 87  manual adjustments we reviewed that DFAS categorized as  supported did not contain supporting documentation required by the  DOD FMR. For example, we found instances where supporting  documentation packages were missing information to support the  reason for recording the adjustment or detailed worksheets to support  the calculation of the adjustment amount. DFAS officials explained  that 30 of the 51 adjustments resulted from a major change in how  DFAS processes U.S. Army Corps of Engineers’ financial information.  Because of time sensitivity and based on a risk analysis, management  decided to process over 3,000 manual adjustments for the fourth  quarter of fiscal year 2018, including the 30 that were selected for our  sample, without preparing supporting documentation for these  individual adjustments.

We also found that not all supporting documentation packages  included a DFAS Form 9339, DFAS Journal Voucher Catalog and  Checklist, as required by DFAS’s Interim Policy Memorandum. This  memorandum requires that all manual accounting adjustments,  whether classified as supported or unsupported by DFAS, include a  Form 9339 to help ensure the inclusion of the appropriate supporting  documentation. We reviewed 149 manual adjustments and found that  94 included a Form 9339. Our review of these 94 accounting  adjustments found that 28 lacked the required information. For  example, nine packages did not include one or more of the necessary  elements required by Form 9339. We found instances where source  information, customer coordination, document labeling, before and  after trial balances, narratives, or a combination of these were  missing. For six of the nine packages, DFAS agreed that some of the  necessary data elements were missing; for the remaining three  packages, DFAS’s response did not fully address the reasons for the  missing documentation. DFAS officials stated that one of the reasons  why these errors may have occurred was because the implementation  of the Interim Policy Memorandum was in its beginning stages when  we selected our fourth quarter fiscal year 2018 sample. The policy  memorandum was dated June 11, 2018, and was effective  immediately.

We also found that 19 adjustments lacked the required root cause  indicator code on the Form 9339. According to DFAS officials, DFAS  Cleveland prepared those 19 forms. DFAS Cleveland officials  explained that in collaboration with the Navy Financial Management  Office, DFAS Cleveland’s senior leadership decided to deviate from  the Interim Policy Memorandum and not include the root cause  indicator code in the Form 9339 when recording Navy’s related  accounting adjustments. Rather, DFAS Cleveland developed its own  system to identify root causes by using a unique identifier code.  However, the Interim Policy Memorandum does not exclude any  DFAS site from adhering to the requirement, and DFAS was unable to  provide documentation to demonstrate that DFAS Cleveland had  authorization to deviate from this policy. According to DFAS officials,  DFAS Cleveland will begin including the root cause indicator code on  the Form 9339, starting second quarter of fiscal year 2020.

Out-of-balance adjustments: We found that about 2,800 manual  adjustments, or approximately 15 percent of all manual adjustments  recorded at the DOD consolidated level for the fourth quarter of fiscal  year 2018, were out-of-balance. For example, we identified one  adjustment in which DFAS decreased its FBWT account by  $14,232,000 without recording a change to a corresponding account.  DOD’s FMR requires that all recorded accounting adjustments be  balanced. Additionally, we found that the FMR does not identify any  situations where an out-of-balance adjustment is allowable, despite  DFAS officials stating that out-of-balance adjustments are sometimes  necessary.

Auditors of the military services found that reasons for out-of-balance  financial information include (1) service-level general ledger systems  are not effectively designed to prevent incomplete transactions from  being recorded and (2) controls are not in place at the service level to  detect these errors in a timely manner. According to DFAS officials,  out-of-balance adjustments are recorded to correct out-of-balance  financial information received from DOD components’ accounting  systems.

Use of non-USSGL-compliant accounts: During our review of fourth  quarter fiscal year 2018 manual and system-generated adjustments,  we found that over 13,000 adjustments (over 6 percent) recorded at  the DOD consolidated level used non-USSGL-compliant accounts,  which are not allowed by the Treasury Financial Manual or DOD FMR.  The Federal Financial Management Improvement Act of 1996  requires certain federal agencies, such as DOD, to use the specific  and standardized set of accounts referred to as the USSGL in their  financial reporting systems. Treasury maintains this set of accounts  annually to help ensure the comparability of financial information  across the federal government. DFAS officials stated that these  noncompliant accounts are referred to as memo accounts and were  primarily used for management planning purposes. They further  explained that DOD had controls in place to prevent financial  information recorded in memo accounts in DOD’s core financial  reporting system from being transferred into the financial reporting  systems, which Treasury uses to compile the U.S. government  consolidated financial statements.

DOD OIG also reported issues related to DOD’s use of noncompliant  accounts, which it identified in fiscal year 2018. In addition, in DOD’s  Fiscal Year 2018 Agency Financial Report, management  acknowledged that DOD’s financial management systems did not  comply with the USSGL at the transaction level. In response, the DOD  Deputy Chief Financial Officer issued a memorandum on March 15,  2019, acknowledging that DOD components must use the established  USSGL accounts identified in the Treasury Financial Manual for  financial reporting purposes. Additionally, the memorandum stated  that supporting documentation must be maintained for any accounting  adjustments recorded using memo accounts. However, for the seven  non-USSGL-compliant adjustments included within our sample of  manual and system-generated adjustments, we found that  documentation had not been maintained.

Proper recording of adjustments is crucial for ensuring that the financial  information accurately reflects the financial transactions that have  occurred. This includes maintaining adequate supporting documentation  and implementing review procedures to help ensure controls are in place  to detect errors in a timely manner. Failure to fully adhere to established  procedures increases the risk that inaccurate accounting adjustments will  be recorded, thereby reducing the reliability of reported financial  information and potentially causing misstatements in the DOD  consolidated financial statements.

DOD and DFAS Lack Policies and Procedures for Analyzing and Addressing Necessary Root Causes of Accounting Adjustments

Organizations use root cause analysis as a tool to identify and evaluate  systems, processes, or both that prompted the recording of an accounting  adjustment. For certain adjustments, it may be determined that a root  cause analysis or action plan is not necessary—for instance, if the  adjustment is onetime or nonroutine. However, information obtained  through a root cause analysis may be used to make system or process  changes within a specific program, thus reducing the need to record  adjustments. Once a root cause has been identified and analyzed, an  organization should create an action plan that describes the steps to be  taken to address the root cause and monitors the effectiveness of the  actions taken. Figure 5 illustrates the identification, implementation, and  monitoring of accounting adjustment root causes and related action plans.

We found that although DFAS headquarters and its individual sites  perform root cause analysis and develop and take some actions to  address the identified causes, neither DOD nor DFAS has established  policies and procedures that require staff to perform root cause analysis;  develop and implement action plans for issues that DFAS staff identified;  or monitor the effectiveness of action plans in eliminating the need for  accounting adjustments. DFAS officials acknowledged that there are no  policies in place requiring DFAS to perform root cause analyses that  would permit them to compare root causes for accounting adjustments at  a consolidated level across the DFAS sites.

DFAS and its sites identify root causes for individual accounting  adjustments when accountants select a root cause indicator code when  recording the adjustment. DFAS staff also identify root causes for  accounting adjustments at an aggregate level when preparing summary  metrics on adjustment types. For example, we found that in addition to  the requirements previously discussed, Form 9339 requires accountants  across all DFAS sites to prepare “white papers/narratives (white papers)  each time a manual adjustment is recorded.” Our review of these white  papers identified that some DFAS sites use the white papers to document  the root cause analyses while others do not because DFAS has not  provided a template that identifies the minimum required information to be  included in the white papers. As a result, we found that individual DFAS  sites do not use standardized white paper templates and that the  information included in the white papers was not always consistent  between and within the DFAS sites.

Inconsistency between DFAS sites: Our review of 52 white papers  found that DFAS Indianapolis was the only site to include information  such as scope, source system, and financial statement impact of the  accounting adjustment in its white papers, while DFAS Columbus was  the only site that included corrective actions taken. (See fig. 6.)

Inconsistency within a DFAS site: Our review of 52 white papers  found that DFAS Indianapolis did not consistently include background,  purpose of the adjustment, a description of the root cause, posting  logic, financial statement impact, pending action, source system, and  scope in all white papers it prepared. Some white papers had these  elements and others did not. We found similar issues with the white  papers prepared by DFAS Columbus and DFAS Cleveland. Figure 7  illustrates information included in white papers that was inconsistent  within a DFAS site.

We also found that DFAS does not have policies and procedures  requiring the identification and implementation of action plans to address  the cause of and need for accounting adjustments that staff identified  internally. This resulted in inconsistencies in how the different DFAS sites  developed and implemented action plans. For example, we found that 73  of the 98 manual and system-generated unsupported adjustment  packages that included a root cause analysis that we reviewed did not  include an action plan to address the root cause. Based on this testing,  we estimate that at least 88 percent of fourth quarter fiscal year 2018  unsupported adjustments for which a root cause analysis was performed  did not have a documented action plan. For the remaining 25 packages  with documented action plans, we found that only two included steps  documenting how the action plan was to be implemented. The remaining  23 packages with documented action plans lacked implementation  details, and DFAS officials stated that they were waiting for resolution  from the relevant DOD components.

DFAS officials stated that they prepare and document action plans for  issues that affect multiple accounting adjustments but not for issues that  affect only one adjustment (unique root cause). Unique root causes do  not necessitate action plans and are resolved the following month through  DFAS working with the affected DOD components. According to DFAS  officials, many of the action plans are discussed in biweekly and monthly  meetings, but these action plans are not documented.

Finally, we found that DOD and DFAS do not have policies and  procedures requiring management to monitor the results of action plans  that individual DFAS sites prepared or to measure whether implemented  action plans are effective in addressing the causes for accounting  adjustments. DFAS management activities were limited to periodically  reviewing summary metrics on the numbers and types of accounting  adjustments recorded. These metrics did not contain detailed information,  such as the causes of accounting adjustments to be addressed,  accountable officials responsible for implementing action plans, expected  time frames for the implementation of action plans, or specific steps to be  performed to address the causes. Additionally, the metrics did not include  any information on action plans to address system-generated accounting  adjustments, which account for the majority of the adjustments. This type  of detailed information is critical to DOD management and DOD external  stakeholders for evaluating the department’s progress in correcting the  issues. GAO has previously reported that a lack of comprehensive  information on corrective action plans limits DOD’s and Congress’s ability  to evaluate DOD’s progress toward fully, timely, and efficiently correcting  its long-standing financial management deficiencies.

Office of Management and Budget Circular A-123 requires agencies to  perform cause analysis of deficiencies identified to ensure that  subsequent strategies and plans address the causes of the problem and  not just the symptoms. Additionally, Standards for Internal Control in the  Federal Government requires that management implement control  activities through policies. To do this, management documents in its  policies the internal control responsibilities of the organization. In addition,  management periodically reviews policies, procedures, and related  control activities for continued relevance and effectiveness in achieving  the entity’s objectives or addressing related risks. Without policies that  require consistent processes across DOD for identifying and addressing  the causes of accounting adjustments, from the identification of  underlying root causes to the development, implementation, and  monitoring of action plans, it is likely that DOD’s efforts to reduce  accounting adjustments will be inefficient and ineffective.

DOD and DFAS Have Taken Actions to Reduce Accounting Adjustments but Lack Procedures for Implementing a Department-Wide Strategy

The large number of accounting adjustments that are recorded in the  preparation of DOD’s financial statements presents audit challenges. To  address this issue, DOD and DFAS have established multiple initiatives  aimed at reducing accounting adjustments. While these initiatives have  resulted in fewer adjustments of certain types being recorded at the  component and consolidated levels, the current focus has been on  reducing the number of adjustments recorded without adequate  supporting documentation within their responsible work areas, not on  reducing the need for recording accounting adjustments department-wide.

Both DFAS and OUSD (Comptroller) have developed department-wide  strategies to decrease accounting adjustments; however, neither DFAS  nor OUSD (Comptroller) have developed procedures for implementing the  department-wide strategies. Without a clear department-wide approach to  reducing accounting adjustments across all DOD components, there is a  risk that DOD’s effort to reduce accounting adjustments will be  unsuccessful, which in turn hinders its ability to produce reliable and  auditable consolidated financial statements.

DOD Has Undertaken Initiatives to Reduce Accounting Adjustments

To reduce accounting adjustments, OUSD (Comptroller) and DFAS have  undertaken many initiatives over the last few years. In fiscal year 2018,  OUSD (Comptroller) determined that a large number of accounting  adjustments at the consolidated level resulted from data calls. To  decrease the need for recording these adjustments at the consolidated  level, DOD established the Data Call Journal Voucher (JV) Migration  Initiative with the goal of eliminating data call adjustments in its core  financial reporting system to the maximum extent possible.

The first phase of this initiative moved the recording of adjustments for  the Federal Employees’ Compensation Act (FECA) liability to the DOD  component level responsible for the underlying transaction. According to  OUSD (Comptroller), this initiative resulted in the successful migration of  the recording of the Missile Defense Agency’s FECA liability from DOD’s  core financial reporting system to Missile Defense Agency accounting  systems in the second quarter of fiscal year 2019, and has set the stage  for 19 other components using the same accounting system as the  agency to follow suit. Although this initiative may not reduce the overall  number of accounting adjustments that DOD records, it will reduce the  need for data call adjustments to be recorded at the consolidated level.  OUSD (Comptroller) expects this initiative will also enhance the quality of  the supporting documentation maintained for these types of adjustments  because the underlying transaction-level detail for the adjustments will be  available in the components’ accounting systems.

Individual DFAS sites have also undertaken their own initiatives that  eliminate the need for some accounting adjustments. For example, in  fiscal year 2018, DFAS Indianapolis found that some financial information  from the Army’s accounting systems was improperly recorded, requiring  adjustments to correct the errors when the financial information  transferred into the DOD’s core financial reporting system. DFAS  Indianapolis staff worked with the Army to resolve the issue. As a result,  adjustments are no longer needed at the consolidated level when the  information transfers from Army’s system into DFAS’s system. According  to DFAS Indianapolis officials, this initiative resulted in a significant  decrease in accounting adjustments at the consolidated level for fiscal  year 2019.

DOD and DFAS Lack Procedures for Implementing a Department-Wide Strategy to Reduce the Need for Accounting Adjustments

Developing and implementing a DOD department-wide strategy to reduce  the need for recording accounting adjustments at the consolidated level  requires DOD to identify the underlying root causes and risks associated  with accounting adjustments and to prioritize efforts to address them. This  involves clearly defining what is to be done, who is to do it, how it will be  done, and the time frames for achievement. To address DOD’s many  financial management issues, including reducing accounting adjustments,  OUSD (Comptroller) and DFAS have developed different strategies and  business plans. However, these strategies and business plans do not  include clearly defined expected outcomes or procedures for achieving  stated goals.

OUSD (Comptroller) issued the DOD Financial Management Strategy  Fiscal Years 2016–2020 (Strategy) to help achieve a simplified, standard, affordable, auditable, and secure financial environment, which includes  the reduction of accounting adjustments. The Strategy’s JV initiative  states that “The purpose of this initiative is to determine why unsupported  JVs occur and resolve them.” However, we found that the Strategy did not  provide clear direction to staff on how to achieve the JV initiative and did  not call for a department-wide effort to address accounting adjustments  recorded at the consolidated level. The Strategy also acknowledged that  excessive adjustments can indicate underlying problems, such as weak  internal controls, and may indicate that transactions are not captured,  reported, or summarized correctly. However, we found that the focus of  the Strategy was on reducing the number of accounting adjustments  recorded without adequate supporting documentation rather than on  reducing the overall need for recording accounting adjustments  department-wide.

In addition to following the OUSD’s (Comptroller) Strategy, DFAS  management has also developed the Fiscal Years 2017—2021Strategic  Plan (Strategic Plan) and Fiscal Year 2018 Annual Business Plan  (Business Plan), which include goals for reducing accounting  adjustments, supplemented by bimonthly Strategy Updates. For  example, DFAS’s November 2017 Strategy Update outlined the Business  Plan goals for fiscal year 2018 with regard to internal controls and  business processes. In that update, DFAS set broad goals, such as  executing plans to support or reduce system-generated and manual  adjustments. However, we found that similar to the OUSD (Comptroller)  Strategy, neither DFAS’s Strategic Plan nor Business Plan included  defined outcomes or clear procedures for accomplishing the stated goals.

The primary focus of these goals was also to reduce the number of  accounting adjustments recorded without adequate supporting  documentation. We found that this lack of clear procedures led each  DFAS site and DFAS headquarters to focus their initiatives on accounting  adjustments that impacted their responsible work areas instead of  reducing the need for recording accounting adjustments overall.  According to DFAS site officials, in some instances, reducing the number  of accounting adjustments recorded without adequate supporting  documentation at their individual sites could have an impact on the need  to record adjustments at the consolidated level; however, the effect at the  consolidated level was not their primary focus.

Standards for Internal Control in the Federal Government requires that  management implement control activities through policies. To do this,  management documents in its policies the internal control responsibilities  of the organization. In addition, management periodically reviews policies,  procedures, and related control activities for continued relevance and  effectiveness in achieving the entity’s objectives or addressing related  risks. Without detailed documented policies and procedures for  implementing its initiatives, and a complete understanding of the issues  contributing to the recording of accounting adjustments (both supported  and unsupported) across DOD, there is an increased risk that  management efforts to reduce accounting adjustments at the  consolidated level will be ineffective.

In the routine course of business, organizations often record accounting  adjustments on a monthly, quarterly, and annual basis. Some  adjustments are necessary so that financial information is presented  meaningfully and accurately. However, an extensive use of accounting  adjustments may indicate significant underlying problems.

In order to produce reliable financial information that DOD management  and Congress can use for decision-making, DOD needs to develop  policies and procedures for recording accounting adjustments that are  consistently implemented across the department and reflect the current  DOD financial reporting environment. DOD also needs to address the  issues that contribute to its need to extensively record accounting  adjustments by implementing policies and procedures for the consistent  identification of the causes for recording adjustments and the  development, implementation, and monitoring of action plans to address  the identified causes. If DOD does not address these issues, there is an  increased risk that its financial information will be misstated and DOD will  continue to be unable to prepare reliable and auditable consolidated  financial statements.

We are making the following eight recommendations to DOD:

The Director of DFAS should, in accordance with the FMR, implement  procedures to help ensure that FBWT reconciliations are consistently  performed and that all DFAS sites review and document research  conducted on the causes of any differences arising from these  reconciliations. (Recommendation 1)

The Under Secretary of Defense (Comptroller) should update the  FMR to clearly define the required supporting documentation for  system-generated accounting adjustments, including the required  documentation of business rules driving the recording of these  adjustments, such as documentation of the programming logic.  (Recommendation 2)

The Under Secretary of Defense (Comptroller) should perform and  document a comprehensive review of the FMR accounting adjustment  category codes to determine their ongoing applicability or the need for  additional codes to reflect the current financial reporting environment.  (Recommendation 3)

The Under Secretary of Defense (Comptroller) should establish  procedures to help ensure the consistent implementation of the  requirements of DFAS Form 9339. (Recommendation 4)

The Under Secretary of Defense (Comptroller) should update policies  and procedures to identify the causes of out-of-balance accounting  adjustments and resolve the causes in a timely manner.  (Recommendation 5)

The Under Secretary of Defense (Comptroller), in conjunction with the  Director of DFAS, should develop and implement policies and  procedures to help ensure that root cause analyses for accounting  adjustments are consistently performed and documented across  DOD. (Recommendation 6)

The Under Secretary of Defense (Comptroller), in conjunction with the  Director of DFAS, should develop and implement policies and  procedures to help ensure consistent development, implementation,  monitoring, and documentation of action plans across DOD that  address accounting adjustment causes that staff identified internally.  (Recommendation 7)

The Under Secretary of Defense (Comptroller), in conjunction with the  Director of DFAS, should develop and implement procedures across  DOD that include clearly defined outcomes focused on reducing  accounting adjustments (supported and unsupported) with specific  actionable steps and procedures for achieving stated goals.  (Recommendation 8)

We provided a draft of this report to DOD for review and comment. In  written comments, DOD concurred with all eight of our recommendations  and cited actions to address them. DOD’s comments are reproduced in  appendix II.

As agreed with your office, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 11 days from the  report date.  At that time, we will send copies of this report to the  appropriate congressional committees, the Secretary of Defense, the  Under Secretary of Defense (Comptroller), the Director of the Defense  Finance and Accounting Service and other interested parties. In addition,  the report is available at no charge on the GAO website at  http://www.gao.gov.

If you or your staff have any questions about this report, please contact  me at (202) 512-2989 or kociolekk@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. GAO staff who made key contributions to this  report are listed in appendix III.

Appendix I: Objectives, Scope, and Methodology

This report examines (1) accounting adjustments and their effect on the  reliability of the Department of Defense’s (DOD) financial information,  (2) the extent to which DOD has established and implemented policies  and procedures for recording accounting adjustments, and (3) the extent  to which DOD has taken actions to reduce accounting adjustments  recorded at the consolidated level.

To determine the accounting adjustments recorded and their effect on the  reliability of DOD’s financial information, we focused our review on the  categories of accounting adjustments that DOD recorded at the  consolidated level. We reviewed prior audit reports issued by GAO,  DOD’s Office of Inspector General (OIG), and independent public  accountants for fiscal years 2015 through 2019 to gain an understanding  of the types and categories of accounting adjustments. We also reviewed  related policies and procedures, such as DOD’s Financial Management  Regulation (FMR); performed walk-throughs of the Defense Finance and  Accounting Service’s (DFAS) processing of accounting adjustments; and  interviewed DOD officials to gain an understanding of the types of  accounting adjustments. Additionally, we obtained and analyzed  summary information on the adjustments affecting fiscal years 2017 and  2018 by quantity, dollar value, whether they were manual versus system- generated, and unsupported versus supported.

To evaluate the extent to which DOD has established and implemented  policies and procedures for recording accounting adjustments, we  reviewed relevant notices of finding and recommendation that the  independent public accountants and DOD OIG issued related to  accounting adjustments for fiscal year 2018. We also reviewed DOD and  DFAS policies and procedures and interviewed officials from DFAS and  the Office of the Under Secretary of Defense (OUSD) (Comptroller) to  identify issues surrounding accounting adjustments and the procedures  used to process, review, and approve these adjustments in DOD  systems. We also inquired about the procedures used to determine the  underlying causes of accounting adjustments, if action plans to address  the causes had been developed, and the status of these plans. In  addition, we assessed DFAS’s efforts to monitor the effectiveness of its  action plans.

To determine the specific internal controls DOD had in place over its  accounting adjustment processes, we interviewed DFAS officials  knowledgeable about the accounting adjustment processes and  performed walk-throughs of these processes at DFAS. We evaluated the  procedures observed during our walk-throughs and those that DOD  officials described to determine whether DFAS recorded adjustments in  accordance with established policies and procedures. For issues  identified, we interviewed DOD officials to confirm our understanding and  determined the reasons for the issues identified.

To determine if DOD had designed and implemented internal controls  over its accounting adjustment processes, we analyzed the information  we obtained through the interviews and walk-throughs using relevant  criteria, including the DOD FMR, the Treasury Financial Manual, and our  Standards for Internal Control in the Federal Government. We also  performed tests of controls on a random sample of 242 accounting  adjustments from a population of 200,468 adjustments that DFAS  recorded at the consolidated level that impacted the financial statements  for the fourth quarter of fiscal year 2018. The selected adjustments were  recorded in the Defense Departmental Reporting System (DDRS)— Budgetary (DDRS-B), DDRS—Audited Financial Statements (DDRS- AFS), and DDRS-AFS Beginning Balance Adjustment modules. From the  DDRS-B and DDRS-AFS modules, we selected a random sample of 225  accounting adjustments, and from the DDRS-AFS Beginning Balance  Adjustment module we selected all 17 accounting adjustments. From the  three different sets of data, we stratified the selected accounting  adjustments into six strata (see table 1).

Of the total 242 adjustments, we selected all 17 adjustments in stratum 1,  and 45 adjustments each from strata 2 through 6 for testing. We designed  the sample to support estimation for all supported accounting adjustments  with a margin of error no greater than plus or minus 11.7 percentage  points at the 95 percent level of confidence, estimation for all unsupported  accounting adjustments with a margin of error no greater than plus or  minus 11.8 percentage points at the 95 percent level of confidence, and  estimation overall for all accounting adjustments with a margin of error no  greater than plus or minus 8.4 percentage points at the 95 percent level  of confidence.

Because we followed a probability procedure based on random  selections, our sample is only one of a large number of samples that we  might have drawn. Since each sample could have provided different  estimates, we express our confidence in the precision of our particular  sample’s results as a 95 percent confidence interval (e.g., plus or minus 8  percentage points). This is the interval that would contain the actual  population value for 95 percent of the samples we could have drawn.

For the accounting adjustments in our sample that DOD considered  supported, we reviewed underlying documentation to determine whether  the adjustments were properly supported and contained all critical  elements required by DOD policy. We then shared the results of testing  with DOD and incorporated any applicable additional information DOD  officials provided into our analysis, as appropriate. As part of our testing,  we also reviewed documentation related to unsupported accounting  adjustments selected in our sample and interviewed DFAS officials to  determine if DOD had performed root cause analyses, developed action  plans to address the identified causes, and taken any actions in  response. We then shared the results of testing with DOD and  incorporated any applicable additional information DOD officials provided  into our analysis, as appropriate.

To assess the reliability of the accounting adjustment information we  received from DOD, we conducted interviews with relevant agency  officials, compared summary-level dollar amounts and quantities to  another DOD information source, performed electronic testing of the  financial information, and reviewed related internal controls. On the basis  of this work, we found the financial information to be sufficiently reliable to  project results of our random sample testing to the population of  accounting adjustments for the fourth quarter of fiscal year 2018. Margins  of error varied depending on the specific stratum being projected and are  disclosed with all estimates contained within the report.

To determine the extent to which DOD has taken actions to reduce  accounting adjustments recorded at the consolidated level that may affect  the reliability of its financial information, we interviewed officials from  DFAS and the OUSD (Comptroller) to identify initiatives aimed at  reducing accounting adjustments. We further inquired about what tools  DFAS used to measure its progress and analyzed summary metrics  provided from fiscal years 2017 to 2018 to determine the effect of these  efforts on the number of accounting adjustments recorded during these  periods.

We conducted this performance audit from November 2018 to January  2020 in accordance with generally accepted government auditing  standards. Those standards require that we plan and perform the audit to  obtain sufficient, appropriate evidence to provide a reasonable basis for  our findings and conclusions based on our audit objectives. We believe  that the evidence obtained provides a reasonable basis for our findings  and conclusions based on our audit objectives.

Appendix II: Comments from the Department of Defense

Appendix III: GAO Contact and Staff Acknowledgments

In addition to the contact named above, Kimberley McGatlin (Assistant  Director), Carl Barden, Rathi Bose, Veronica Cadiz-Rodriguez, Virginia  Chanley, Benjamin Durfee, Patrick Frey, Maxine Hattery, Jason Kelly,  Jason Kirwan, Zhen Li, John Lopez, Samuel Sawhook, Dacia Stewart,  and Anne Thomas made key contributions to this report.

DOD uses accounting adjustments to record corrections or changes in its financial systems. Such adjustments should be accompanied by documentation showing why the change was needed. Some accounting adjustments that DOD frequently makes—including “forced-balance” adjustments to make its financial systems agree with Treasury balances—don’t have adequate supporting documentation.

We recommended that DOD reduce the use of accounting adjustments to ensure they have reliable and accurate financial information. The agency’s financial management has been on our High Risk list since 1995.