The U.S. Department of Defense (DoD) released its annual financial report in mid-November. The report included the fourth consecutive “disclaimer” (flunk) audit opinion from the DoD Office of Inspector General. The DoD, with more than $3 trillion in reported assets, is one of the main reasons that the U.S. Government Accountability Office (GAO) has delivered a disclaimer of opinion on the overall financial statements of the federal government of the United States – every year since 1997.
In recent years, the DoD Office of Inspector General (OIG) has delivered a valuable supplementary report, titled “Understanding the Results of the Audit of the DOD Financial Statements.” We use that report to develop our annual DoD Audit Report Card, which evaluates and ranks the Army, Navy, Air Force, Marines, and 14 other DoD component entities on their audit performance. We will do so again early next year.
This article sets the stage for that project. It reviews the latest overall audit opinion and provides a summary comparison to last year’s opinion to begin to assess the progress the DoD has made. Last year, when interviewed about the results from our DoD Audit Report Card, I summarized along the lines that “they are making progress in the sense that they’re finding more problems than they resolve.” This appears to be the case again.
By way of background, our federal government began issuing financial reports in their current format following the Chief Financial Officers Act of 1990 (CFO Act). That act required each executive branch department to prepare annual financial statements, which are then used to develop a single consolidated set of statements that are included in the annual overall Financial Report of the U.S. Government.
The CFO Act also required audits of the departmental financial statements, at least in theory. But the DOD failed to deliver audited statements for more than two decades. It committed to developing a comprehensive audit around 2010, but it took seven more years to finally include an audit opinion with its financial statements. And from 2017 to 2021, the DOD Office of Inspector General marked those statements with a “disclaimer” opinion – a grade of “F.”
There are several types of audit opinions. An auditor delivers an “unmodified” (clean) opinion if it determines that the financial statements are presented “fairly” and “in accordance with generally accepted accounting principles.” If the statements fail to meet that standard, the opinion is “modified,” with the auditor noting the shortfalls responsible. A “disclaimer” opinion is harsher than a “modified” opinion, as the auditor finds that it simply doesn’t have reliable evidence needed to express an overall opinion, period.
The DOD OIG’s latest “Independent Auditor’s Report” appears on pages 65-95 of the DoD Agency Financial Report for the September 2021 fiscal year. Last year, the OIG report was on pages 75-100 of the overall report, so the auditor’s report this year is five pages longer than it was last year. This year’s report is longer not because it discusses successes, except to the extent that identifying and reporting more issues constitutes a step in the right direction.
The OIG Report includes an introductory memo from the OIG, a “Report on the Basic Financial Statements,” a “Report on Internal Control Over Financial Reporting,” and a “Report on Compliance With Applicable Laws and Regulations, Contracts, and Grant Agreements.”
Report on the Basic Financial Statements
The Report on the Basic Financial Statements includes a paragraph with the overall audit opinion. The language for that paragraph is identical with last year, including a depressing concluding note that “Thus, the basic financial statements may contain undetected misstatements that are both material and pervasive.”
This section of the OIG Report identified 14 different DoD component entities that received a disclaimer opinion, the same number (and entities) as last year. The Army, Navy, and Air Force all received disclaimers for both their General Fund and Working Capital Fund Statements.
One element of this section of the report, titled “Emphasis of Matter,” deserves emphasis. It opens with a discussion of “Security Assistance Accounts” (SAAs), including “Foreign Military Sales” and “Foreign Military Financing.” The financial statements for the SAAs, which are consolidated in the overall financial statements in the Financial Report of the U.S. Government, are included in an appendix to the DoD Agency Financial Report. But the OIG emphasizes that those statements have not been scheduled for an audit until fiscal year 2022, undermining any claims that the DoD’s audits for the last four fiscal years have been either “full” or “complete.”
In this section, the OIG also stressed that the “audit ready” Agency Financial Report it received on November 10 was incomplete, and that the DoD provided five different versions of the report between November 10 and November 15. Another matter emphasized by the OIG was that the Agency Financial Report restated fiscal year 2020 statements to correct errors in 13 different areas, and that the OIG was unable to audit the restatements. Notably, the number of areas identified by the OIG for being restated due to errors went up, not down, from last year, when only six areas were called out on this score.
Report on Internal Control Over Financial Reporting
This section identifies “material weaknesses” and “significant deficiencies” in DoD internal controls for financial reporting. This year, the report had lengthy paragraphs discussing 28 different material weaknesses (up from 26 last year) and four “significant deficiencies” (the same number as last year). Twenty-five of the material weaknesses were repeats from last year. One material weakness identified last year, the “Military Housing Privatization Initiative,” was upgraded to a less-severe “significant deficiency.” But the OIG identified three new material weaknesses, including “Financial Statement Compilation,” “Contingent Legal Obligations,” and “Reconciliation of Net Cost of Operations to Outlays.”
Again, if identifying more problems than the ones that are resolved constitutes progress, the DoD is making progress on it’s audit performance.
Below is a list of the material weaknesses discussed in this section.
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In turn, below are the four “significant deficiencies” discussed in the report.
- Transition to Risk Management Framework
- Defense Agency Deposit Fund Accounts
- Accounts Receivable
- Military Housing Privatization Initiative
The “Transition to Risk Management Framework” and “Accounts Receivable” discussions were repeats from last year. The “Defense Agency Deposit Accounts” deficiency was a new arrival this year. The “Legal Contingencies” discussion in last year’s significant deficiencies was not repeated this year, but only because “Contingent Legal Liabilities” became a new, more serious material weakness. Likewise, the “Reconciliation of Net Cost of Operations to Outlays” discussion appeared as a material weakness this year, after appearing as a significant deficiency last year.
Report on Compliance With Applicable Laws, Regulations, Contracts, and Grant Agreements
This year’s report identified and discussed seven different Acts of Congress where the OIG determined that the DoD was not in compliance. In harsher terms, one could assert that the DoD is breaking the law. These laws included:
- The Antideficiency Act
- The Federal Financial Management Improvement Act of 1996
- The Federal Financial Managers’ Financial Integrity Act of 1982
- The Federal Information Security Modernization Act
- The Debt Collection Improvement Act
- The Prompt Payment Act
- The Coronavirus Aid, Relief, and Economic Security Act
Again, each of these areas were repeats from last year. Granted, it has only been a year. But four years ago, the OIG specifically identified only two laws – the Antideficiency Act and the Federal Financial Management Improvement Act – as areas with shortfalls. The noncompliance list has been growing , not shrinking.
Conclusion
In 1990, Congress directed executive branch departments, including the Defense Department, to produce audited financial statements. Thirty years and trillions of dollars later, the DoD has yet to secure a clean audit opinion. Granted, it has finally embarked on the audit process, and the auditors and auditees remain on a learning curve. But a review of the latest audit results reveals precious little evidence of positive progress.
Consider a case where a defense contractor had this kind of accounting and auditing history. The DoD may stop contracting with that organization. Might that imply that the Congress should stop contracting with the DoD?
We will be taking a deeper dive soon. The American people deserve better than this.