What’s Next for the DoD Audit

Office of the Under Secretary of Defense (Comptroller)

Mr. Mark Easton, Deputy Chief Financial Officer, OUSD(C)Ms. Alaleh Jenkins, Director, OUSD(C)/FIAR

Washington-ASMC NCR PDIMarch 3, 2015

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The Requirement: Why Financial Improvement and Audit Readiness (FIAR) Is Important

FIAR Strategy and Audit Strategy: How We Are Meeting the Deadline

Where Are We Now?

FIAR Guidance and Timeline: Less Than Two Years Remain

Your Role: How You Can Help

Final Thoughts

Agenda

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The Requirement:

Why FIAR is Important

The Chief Financial Officers Act of 1990: Created a CFO position within each cabinet-level agency, required all federal agencies to prepare timely and reliable financial statements for Congress and the Administration to use in managing and evaluating federal programs, and directed OMB to prepare a 5-year Federal Financial Management Improvement Plan

The Government Management Reform Act of 1994: Required annual auditable financial statements

Refined Guidance:

– Sec. 1003 NDAA FY 2012: Requires the plan to include the interim objectives and a schedule of milestones for each Military Department and Defense Agency to support the goal established by the Secretary of Defense that the SBR be validated for audit by not later than September 30, 2014

– Sec. 1003 NDAA FY 2010: requires the Department to develop and maintain a plan that ensures DoD financial statements are validated as ready for audit by not later than September 30, 2017

Continued interest from Congress, GAO, OMB, and the media

It’s the Law

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If DoD were a public company, would you invest?

Stewardship

– Reassures the American public and Congress that the Defense Department is a good steward of its funds

– Demonstrates accountability

– Helps to safeguard assets and is a tool for guarding against fraud, waste, and abuse

The DoD IG was unable to complete an audit and issued a Disclaimer of Opinion:

“… we could not obtain sufficient appropriate evidence to provide a basis for an audit opinion. Accordingly, we do not express an opinion on the DoD FY 2014 and FY 2013 Basic Financial Statements. Thus, the basic financial statements may have undetected misstatements that are both material and pervasive.”

Stewardship

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The Big Picture……and Challenge

FIAR Office Established

2005

1994

Initial Priorities Established

2009

2014

Pre-2009 Audit emphasis

largely within only the comptroller

organizations

Post-2009Audit efforts involve all functional areas

enterprise-wideInitial DoD Efforts Began

FY 2014 Statutory DirectionAchieve Audit Readiness

of General Fund Statement of Budgetary Resources (SBR)

2017 FY 2017 Statutory DirectionAchieve Full

Agency Financial Statement Audit Readiness

History of Audit Efforts to Date

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FIAR Strategy and Audit Strategy:

How We Are Meeting the Deadline

DoD has developed a strategy to move to full financial statement audit by FY 2018 in accordance with the NDAA for FY 2010

The audit strategy builds on audit readiness momentum and demonstrates interim progress toward the FY 2018 target using a phased approach

– Propose that audits of select reporting entities’ financial statements be accelerated

– Other reporting entities will undergo progressively more complex examinations

The phased approach will allow for continual growth and expansion of DoD’s audit infrastructure to support the increasing number of audits

Strategy assigns each of DoD’s reporting entities to one of four categories:

– Tier 1: Large Caps (OMB Designated Entity Audits)

– Tier 2: Mid Caps (DoD Designated Audits)

– Tier 3: Small Caps (DoD Designated Examinations)

– Tier 4: Micro Caps (Remaining Defense Agencies, Organizations, and Funds (Not Material for Audit))

The Resulting DoD Consolidated Financial Statement Audit Starting in FY 2018 Will Likely Be the Largest Financial Statement Audit Ever Performed

DoD Consolidated Audit Strategy Overview

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0.9 % Not Material for Audit Tier 43.6% DoD Designated ExaminationsTier 3

21.9% DoD Designated AuditsTier 2

73.6% OMB Designated Entity AuditsTier 1

Categories as Percentage of Total Budgetary Resources

• Department of the Army (GF and WCF)

• Department of the Navy (GF and WCF) (includes Marine Corps GF and WCF)

• Department of the Air Force (GF and WCF)

• Military Retirement Fund (MRF) Trust Fund

• U.S. Army Corps of Engineers (USACE)–Civil Works

• WHS (Pentagon admin)

• MDA (missile defense)

• DSCA (security cooperation)

• DoDEA (education)

• DARPA (R&D)

• Many others

• Defense Logistics Agency

• USTRANSCOM (transport)

• DISA (IT / communication)

• DHA (healthcare)

• USSOCOM (special ops)

• Others already under audit

Selected Activities

in the Fourth Estate are participating in

mock audits

Large Caps

Small Caps

Mid Caps

Micro Caps

The DoD Agency-Wide Audit Will InvolvePresenting Our Complete Portfolio

Entities in red are under audit 9

Fourth Estate reporting entities must be able to address a handful of “critical elements” or deal-breakers to support the proposed audit and examination schedule:

– Collect a universe of accounting transaction details reconciling the TI-97 accounting systems to the DoD financial statements

– Conduct reconciliations from source feeder systems where transactions occur and the DoD’s accounting systems and reconcile TI-97 Fund Balance with Treasury account to U.S. Treasury

– Complete IT controls discovery and corrective action for material financial systems

– Identify root causes for journal vouchers, eliminate unnecessary journal vouchers, and ensure all remaining journal vouchers are reviewed, approved, and supported by documentation

– Validate corrective action plans have been effectively implemented for critical internal controls processes

Much of the effort related to addressing these deal-breakers requires strong participation from DFAS for success.

Audit Readiness Deal-Breakers

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Where Are We Now?

Although the Department did not achieve the September 30, 2014, Statement of Budgetary Resources deadline, significant progress was made.

Military Departments asserted audit readiness on their services’ General Fund Schedules of Budgetary Activity

– Audit contracts awarded December 2-4, 2014

– Audits began in January 2015

– Audits will include financial transactions related to appropriation received in FY2015 and will not include financial transactions related to appropriations received in prior fiscal years

– DoD OIG oversees the IPA-conducted SBA audits

Other Defense Organizations (ODOs)

– By June 30, 2014, each of the other Defense organizations asserted audit readiness of their applicable assessable units or of specific SBR line-items

– In FY 2015, the ODOs material to the DoD Consolidated Financial Statements will undergo with SBA mock audits or IPA examinations

Over 90 percent of the Department’s FY 2015 General Funds will be under audit. Funds under audit represent most of the financial information

reported in the SBR.

Significant Progress Made

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Over 90 % Currently Planned for Audit, but Remainder Involves Fourth Estate Organizations

U.S. Army Corps of Engineers-Civil Works (TI-96)$30.28B (3.1%)Full Financial Statements

Military Retirement Fund (TI-97)$54.67B (5.6%)Full FinancialStatements

Marine Corps (TI-17)$29.81B (3.0%)GF (SBR)

Air Force (TI-57)$187.77B (19.3%)

GF (SBA)

Navy (TI-17)$181.86B (18.7%)

GF (SBA)

Army (TI-21)$266.48B (27.3%)

GF (SBA)

4th Estate (TI-97)$132.21B (13.6%)Full Financial Statements

4th Estate (TI-97)$91.15B (9.4%)Not Under Audit

• Payments to MRF

• DoD Component Level Accounts

• DHA, Contract Resource Management

• MERHCF (healthcare entitlement)

• Payment to MERHCF (healthcare)

• DCAA

• DeCA, General Fund

• Funds Provided by OSD to MilDeps– DHA– USSOCOM

• Foreign Allies Burden Sharing

• Defense Agencies(e.g., DLA, MDA, DCMA, DISA)

• DoD Field Activities(e.g., DHRA, DMA, DPMO, DTIC, DTSA, OEA)

• Other Defense Organizations(e.g., DAU, DOT&E, NDU, OIG)

• Military Housing Privatization Initiative

• Other Trust Funds

FY 2013 Total Budgetary Resources

FY 2015 General Funds Planned for Audit

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FIAR Guidance and Timeline:

Less than Two Years Remain

With less than three years remaining, the Department has expanded its priorities from budgetary data to all financial transactions including:

– Valuing and reporting over $1 trillion in assets

– Accurately reporting environmental and other liabilities

– Preparing Working Capital Fund financial statements for audit

Revised FIAR Guidance soon to be issued and will include:

– Requirements that apply to General Fund and Working Capital Fund statements

– Critical interim requirements, such as opening balances

– MilDeps and ODOs will update financial improvement plans accordingly

Leadership and Governance

– Former Secretary Hagel and recently confirmed Secretary Carter, who previously served as Deputy Secretary, have continued to stress accountability, sound business and management systems, and audit readiness

– Deputy Secretary Work launched the DEXCOM and addressed leaders of the Fourth Estate

– Mike McCord sworn in as USD(C) and CFO

Leadership is confident this expanded focus will keep the Department on the right path to full audit readiness.

Expanded Priorities and Guidance

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The five TI-97 reporting entities below will move towards stand-alone financial statement audits.

Tier 2: Mid CapReporting Entities

FY 2015 FY 2016 FY 2017 FY 2018FY 2019 Forward

DLAExamination – SBA (General Funds)

Annual Audits – Full Financial Statements

Defense Health Examination – SBA Annual Audits – Full Financial Statements

USSOCOM Examination – SBA Annual Audits – Full Financial Statements

DISAUndergoing Internal Validation

Annual Audits – Full Financial Statements

USTRANSCOMContinuing Audit Readiness Activities

Examination – Full Financial Statements

Annual Audits – Full Financial Statements

The Defense Agencies already under audit are not included in this list. The Defense Agencies already undergoing financial statement audit will

continue to receive annual full financial statement audits.

Timeline to Move to Stand-Alone Audit

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The 10 TI-97 reporting entities below will move towards stand-alone audit readiness examinations of their financial statements.

Tier 3: Small CapReporting Entities

FY 2015 FY 2016 FY 2017 FY 2018FY 2019 Forward

WHS Examination – SBA Annual Examinations – Full Financial Statements

MDA Examination – SBA Annual Examinations – Full Financial Statements

DSCA Mock Audit Annual Examinations – Full Financial Statements

DoDEA Mock Audit Annual Examinations – Full Financial Statements

Other TI-97 Funds Provided to the Army Mock Audit Annual Examinations – Full Financial Statements

DARPA Examination – SBA Annual Examinations – Full Financial Statements

ChemBio Examination – SBA Annual Examinations – Full Financial Statements

DTRA Examination – SBA Annual Examinations – Full Financial Statements

DCMA Mock Audit Annual Examinations – Full Financial Statements

JCS Mock Audit Annual Examinations – Full Financial Statements

Timeline to Move to Stand-Alone Examination

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Critical Path Audit Readiness Milestones– Present assertion strategy for critical financial statement line items to FIAR

Directorate (2/20/2015):o Critical Line Items: Fund Balance with Treasury; General Property, Plant, and

Equipment, including Real Property, General Equipment, and Internal Use Software; Inventory and Related Property, including Inventory and Operating Materials and Supplies; Environmental and Disposal Liabilities; and Other Line Items Material

– FIAR Directorate obtains DoD OIG/GAO approval on assertion strategy/methodology for critical line items (3/31/2015)

– Implement corrective action plans to address critical line items (4/30/2015)

– Undergo FIAR audit readiness validation (5/1/2015 – 5/31/2015)

– Implement corrective action plans to address deficiencies (6/30/2015)

– Undergo IPA financial statement audit (10/1/2015 – 11/15/2016)

DoD Designated Audits – Tier 2:Critical Path Audit Readiness Milestones

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Critical Path Audit Readiness Milestones– Present assertion strategy for critical financial statement line items to FIAR

Directorate (2/20/2015):o Critical Line Items: Fund Balance with Treasury; General Property, Plant, and

Equipment, including Real Property, General Equipment, and Internal Use Software; Inventory and Related Property, including Inventory and Operating Materials and Supplies; Environmental and Disposal Liabilities; and Other Line Items Material

– FIAR Directorate obtains DoD OIG/GAO approval on assertion strategy/methodology for critical line items (3/31/2015)

– Implement corrective action plans to address critical line items (9/30/2015)

– Undergo IPA examination (10/1/2015 – 3/31/2016)

– Implement corrective action plans to address deficiencies (9/30/2016)

– Undergo IPA examination (10/1/2016 – 3/31/2017)

– Implement corrective action plans to address deficiencies (6/30/2017)

DoD Designated Examinations – Tier 3:Critical Path Audit Readiness Milestones

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Five Working Groups for Critical Balance Sheet Line Items:

– Real Property

– General Equipment

– Internal Use Software

– Inventory and Related Property

– Environmental and Disposal Liabilities

The OSD Working Groups Were Established to:

– Address DoD-wide policy and process challenges to audit readiness

– Provide implementation guidance

– Review progress toward achieving audit readiness milestones

Expectations:

– Address issues quickly to expedite solutions, and elevate issues where needed

o Estimating beginning balances

o Developing systems and process agreements to sustain asset and liability valuations

– OSD will vet decisions with the DoD OIG and GAO over the next 3 months; decisions targeted for June to allow for implementation

Overview of Working Groups

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Your Role:

How You Can Help

Role Planning Phase Internal Control Phase

Test Phase Report Phase

Auditors Submit Document Requests to gain an understanding of operations and perform data analytics while planning the audit procedures

Assess control risk and determine the nature, timing, and extent of control, compliance, and substantive testing

Identify control weaknesses and, if appropriate, form an opinion and report on internal controls over financial reporting

Plan the nature, timing, and extent of procedures to be performed on budgetary transactions and effectiveness of controls

Perform substantive, control and compliance tests

Issue Notices of Findings and Recommendations (NFRs) to outline problem areas within accounting, internal controls, IT systems, and business processes

FM HQ Organizations

Provide strategic guidance and technical expertise to consolidate and coordinate the audit response and communication across the organization

Provide coordination and communication to facilitate a close working relationship between auditors, Commands, and functional owners

Direct, oversee, and provide quality control and quality assurance for all audit response activity before delivery to the Independent Public Accountant (IPA)

Communicate outcomes of the audit and coordinate NFR remediation and Corrective Action Plans (CAPs) implementation with assigned stakeholders

Financial and Functional Owners

Respond to Document requests – a function that will continue throughout the audit cycle

Facilitate the review of internal controls and processes to include MICP and system access & segregation of duties, etc.

Respond to sample data requests from the auditor in a timely manner and provide insight into the quality of line item supporting documentation

Assigned stakeholders develop CAPs

Roles and Responsibilities

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Tone from the Top

– Stress importance

– Emphasize deadlines

Strong Audit Infrastructure

– Well organized audit support team

– Continual and effective communication

Access to Supporting Documentation

– Correct, clear, and timely

– Auditor must be able to follow (plain English)

Critical Success Factors

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Be Prepared

– Auditor will interview personnel and observe operations

– Auditor will test account balances and trace to source

– All organizations, locations, processes, and systems may be subject to audit

– Assign point personnel for supporting documentation

– Expect large sample sizes for testing

Own Your Information

– Provide correct audit evidence in a timely manner

– Be able to respond to an auditor’s questions

Communicate

– Continually communicate with audit liaisons and your organizations

– Don’t assume auditors know your business…clear communication is key

– Embrace feedback

Setting Expectations

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Final Thoughts

This is a massive enterprise change management effort

– The scale of DoD’s consolidated financial statement audit is unprecedented

– DoD is much more like a country than a corporation

There is significant value in moving into an audit regimen

Until audit opinions become routine, sustained emphasis will be needed from:

– DoD senior leadership

– Congress

– Oversight organizations

Budget stability is critical to our success

This will be a multi-year effort

– Federal Government experience indicates this is a 3-5 year process once audits begin

– We plan to do better, but need to manage expectations

The Department is Fully Committed to Improving the Quality of Our Financial Information and Achieving Audit Readiness

Final Thoughts

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Visit the FIAR website– http://comptroller.defense.gov/FIAR.aspx

Read the FIAR Plan Status Report – http://comptroller.defense.gov/FIAR/plan.aspx

Subscribe to DCFO mailings by emailing– AuditReadiness@osd.mil

The Department is Fully Committed to Improving the Quality of Our Financial Information and Achieving Audit Readiness

Stay Connected

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Backup

Example Issues Solutions in Development

Policy Issue – Unclear Financial Reporting Responsibilities

The Department has struggled for years to develop a GAAP-compliant real property reporting policy that is also doable in a practical sense. Preponderance of use, operational control, and Title X have all been considered at various times.

The group looked at options from GAAP compliance, audit risk, and operational perspectives.

The pending solution focuses on the funding Component and Components that have exclusive use of a space.

Implementation Issue – Valuation of Existing RP Assets

Following significant Wave 3 (existence and completeness) work, a significant amount of the Department’s real property still lacks documentation to support historical costs.

Leveraging SFFAS 35 (Estimating the Cost of PP&E), a methodology was developed by the group to use a deflated plant replacement value for existing real property. The methodology uses information already included in property systems, and can be quickly and consistently deployed across the Department. The result will be an auditable value for approximately 65% of the Department’s real property assets.

Real PropertyExample Issues and Solutions in Development

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Example Issues Solutions in Development

Implementation Issue – Valuation of Existing Assets (Baseline)

The Department lacks an auditable valuation methodology that can consistently be deployed across all Components.

Using SFFAS 35, the group is developing an estimating methodology that includes the use of budget and contract documentation. The methodology will focus on identifying and allocating capitalized costs to end items using contract and budget data.

Policy Issue – Contracts Do Not Differentiate Capital vs. Expense

Major Defense Acquisition Programs include a significant percentage of DoD equipment value. Current program structures don’t isolate capital costs or associate them to specific end items.

Major Defense Acquisition Programs will likely require some estimates to value equipment but should be minimized to the extent possible. This includes differentiating between capital and expense costs and liquidating construction in progress accounts as end items are delivered. New CLIN structures are being embedded in future acquisition contracts to map capital costs to end items.

General EquipmentExample Issues and Solutions in Development

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Example Issues Solutions in Development

Policy Issue – Required Support for Cost Models

Cost models are used to estimate cost to complete. However, a recent audit of DLA E/L CTC highlighted the need for additional clarification to determine how models should be supported during an audit.

The Group is reviewing RACER and NORM to determine appropriate procedures for validating and documenting model data sources, inputs, table updates, and supporting documentation, as well as responsibilities for supporting the audit.

Implementation Issues – E&DL Completeness Challenge

Environmental liabilities can be associated with DoD assets but can also exist outside fence lines or even in locations where the Department has not operated in 100 years.

The group has developed a point of view on establishing a complete universe of E&DL that included several approaches. Establishing a complete universe may require more than one approach.1. Reconciling to APSRs2. Fence-to-fence survey3. Historical study4. Reconciling to other authoritative listings

(e.g. EPA listings)

Environmental and Disposal LiabilitiesExample Issues and Solutions in Development

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Example Issues Solutions in Development

Policy Issue – Terminology and Conceptual Gap Between FM and CIO

Component FM and CIO organizations interpret SFFAS 10 and FMR IUS definitions in a variety of ways. Further guidance is needed for consistent application of the standards and financial reporting.

The working group is collecting areas of misunderstanding or areas that lack clarity. For example, the SFFAS 10 IUS definition includes the term “operating system programs,” which CIO and FM personnel understand differently. This causes a significant disconnect in what IUS is reported and how. The group is also working with FASAB to help improve future guidance.

Implementation Issue – Lack of a Complete IUS Universe

IUS is dramatically underreported in many Components (e.g. Navy reports $5M in IUS on its GF balance sheet). To establish a baseline, a methodology is needed to identify the complete universe of IUS.

A methodology is being developed to identify a complete universe of software by reviewing multiple software record repositories, such as electronic discovery reports, APSRs, contracts, and budget documents. Following the accumulation of a potential IUS universe, functional and FM personnel, reduce the list to potentially capital IUS. Lessons learned from Components that have completed this milestone will be briefed at the WG meetings.

Internal Use SoftwareExample Issues and Solutions in Development

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Example Issues Solutions in Development

Policy Issue – Valuing existing OM&S

Much of the Department’s OM&S predates the requirement for historical cost supporting documentation. As a result, an initial moving average cost cannot be supported without significant manual effort to estimate values.

The group is working with the Federal Accounting Standards Advisory Board (FASAB) to consider other potential options. One option under consideration is the establishment of a baseline at latest acquisition cost (LAC) and using moving average cost (MAC) on a go-forward basis.

Implementation Issue – Defining the “End User” for OM&S

Components struggle to determine whether the purchases or consumption method is appropriate for OM&S. A significant contributor to this indecision is that there is no established criteria to define the “end user” of OM&S.

The group is developing more specific criteria to help Components evaluate whether OM&S stored in locations such as on ships or field units can be expensed because they are in the hands of the end user or must be capitalized.

Purchases Method “The purchases method provides that operating materials and supplies be expensed when purchased.” (i.e., no dollar amount reported on the Balance Sheet)

Consumption Method “The cost of goods shall be removed from operating materials and supplies (i.e., the asset account) and reported as an operating expense in the period they are issued to an end user for consumption in normal operations.” (i.e., dollar amount of items held for issue is reported on Balance Sheet)

Inventory and Related PropertyExample Issues and Solutions in Development

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