How government policies prevent accurate financial reporting and result in huge costs


It would probably be surprising if many people learned that some of the accounting policies and standards designed to promote accurate financial reporting and “clean” audits in federal agencies in fact have almost exactly the opposite effect. This is especially true at the Department of Defense, which has long struggled to meet financial reporting requirements. In addition, these misguided policies often entail huge costs and hamper the efficiency of business operations.

To achieve real financial transparency and accurate reporting, Congress and the administration should work together to revise the requirements on agencies. Consider the following five areas ripe for reform:

1. Price changes after ordering for intra-government transactions

Imagine ordering something substantial from Amazon only to be charged 150% of the agreed price after the item has been shipped. This can happen with intra-government transactions with GSA and the various Defense Working Capital Funds serving as suppliers. Every day, government organizations order goods from these intermediary suppliers, who in turn contract with commercial sellers for their inventory; however, when government resellers do not have these items in stock, their policies require them to source the products and charge their customers the last commercial price, even if it differs from the price listed on the original order.

In contrast, business entities like Amazon or Grainger, having already closed the sale, would fulfill the order at the agreed price and adjust future sales to cope with fluctuations in supply costs. If this was not possible, companies would at a minimum inform customers of the price change and give them the option of canceling the order. Instead, government vendors are putting the blame on their customers, whether they like it or not. This transfer of responsibility in managing price changes from commercial suppliers places a huge burden on organizations to budget for unforeseen obligations. As a result, government entities annually amass tens of thousands of unrequited transactions for which the funds disbursed do not match the funds committed at the time of the order. When these obligations are covered by expiring restricted funds, the accounting headaches turn into blinding migraines.

A better approach would be to have GSA and Working Capital fulfill their orders at the agreed price and manage the gains and losses by adjusting future prices. While this will place the onus on government resellers to adjust their budgets, pricing, and business practices, it is far better than the current chaos.

2. Capitalization of equipment

To comply with federal accounting standards, agencies must value and depreciate hundreds of thousands of pieces of equipment. The appraisal should include all costs incurred in bringing the equipment to the form and location of its intended use, including transportation, storage, engineering labor, support, government-supplied equipment from other contracts, etc. to accommodate reconfiguration, recapitalization or even overhaul. This applies to military equipment such as tanks, aircraft, artillery, personnel carriers – anything that could be damaged or destroyed during their intended use.

While the purported purpose of these accounting standards is to develop cost information for decision making or to assess the condition of equipment or effective maintenance, it would be an exaggeration to suggest that depreciation expense or value of undepreciated assets on the balance sheet inform maintenance, decisions on condition or readiness.

Agencies spend tens of millions of dollars each year trying to estimate the value of their assets for esoteric purposes that cannot justify the resources required. Instead, the federal accounting committee should revert to previous rules that allowed federal agencies to spend on mission or military materiel and other mission support equipment.

3. Evaluation of mining materials

Another accounting standard requires agencies to measure their inventories of materials and operating supplies (OM&S). Unlike inventories held for resale, OM&S inventories are for the organization’s own use. The preferred practice is to use the “consumption method” to account for an expense, not at the time of receipt, but when the OM&S materials are ultimately used. In the meantime, standards require that these materials be valued using a cost stream methodology such as moving average cost. As with equipment valuation, the goal of OM&S inventory valuation is to recognize the full cost of these materials. What further complicates this requirement is that inventory returns must also be accounted for.

There is a mistaken presumption that this convoluted accounting regime will somehow provide more transparency about the locations, quantities and conditions of inventory, or that this is necessary for inventory cost analysis to inform resource allocation decisions, which is not true.

The methods and accuracy of valuation for everything from small arms cartridges to complex multi-component missiles require tortuous business rules and complex system designs that impose enormous costs on government agencies. Fortunately, accounting standards allow for a cost-benefit exception; however, this exception is rarely requested. The few advantages that may exist are hardly worth the considerable effort required to facilitate the accounting for the consumption of these materials. In contrast, the cost of establishing complex business rules, customizing information systems, and repeatedly revising system and process designs to accommodate ambiguous interpretations of what needs to be assessed is surprisingly high. .

A more pragmatic approach would be to spend OM&S inventory using the accounting ‘buy method’ and allocate a small portion of the budget otherwise needed to the much larger effort of instituting processes and systems that allow visibility and accurate physical inventory through the labeling of sensor materials and warehouse management systems, as well as the implementation of cost analysis algorithms, all of which are much better suited to inform decisions about resource allocation.

4. Capitalization of software for internal use

Another accounting standard requires federal agencies to capitalize their off-the-shelf or developed commercial software when those applications are to be used for internal agency business needs. The accounting standard provides guidance that is sure to confuse most software program managers. For example, costs incurred during the development phase of software should be capitalized, but these determinations should be based on “nature of costs incurred” rather than sequence. In addition, costs incurred during final acceptance testing must be capitalized and expensed thereafter. Unfortunately, this advice fundamentally includes how major business software is developed. For most of the major software used in federal agencies, the full operational capability of the system is unlikely to be developed for years after initial deployment. Subsequently, the major improvements will continue forever, apparently making it necessary to capitalize each independent major version of a new ability. Since most subsequent releases will be a mix of sustaining and improving, each activity will need to be evaluated to determine if its nature tends more toward an expense or a capital cost.

Additionally, like other valuation efforts, accounting standards require that all direct and indirect costs be incorporated into the depreciable basis of the software. There are so many questions about the business rules for capital software valuation that experts in the field often recommend something that resembles Judge Potter Stewart’s description of his obscenity threshold: “I know it when I do it.” see. ” This suggests either that programs take their best guess of what to capitalize, or that agencies hire an army of accountants dedicated solely to determining the value of assets. That doesn’t even take into account the premium their software contractors will charge for spending their time distinguishing between capital and non-capital costs.

All of this should make the casual observer wonder rightly what benefit all this effort will gain. It certainly does not serve to meet the needs of the citizens or to defend the nation. If the intention is to better understand IT spending, management cost accounting algorithms make more sense. They do not require determination of capital or expenditure, but allow systematic allocations of indirect and imputed costs. The simple prescription is to spend all the software for internal use and turn the page on this misguided practice.

5. Contract financing payments

When a federal contractor develops a major piece of equipment, the contractor may require additional payment before the first delivery. These payments provide an early funding reserve without which some entrepreneurs could not undertake engineering and production activities.

Unfortunately, the same federal and defense procurement and financial management policies that facilitate these payments ignore the implications for other processes. More precisely, they make it possible to finance the payments on the whole of a contract without any link with a specific contract line and the amount of the associated obligation. In addition, the policies allow for complex clawback arrangements when subsequent invoices from a supplier result in partial offsets with previous funding payments and new partial additional disbursements. The result is a complex tangle that is extremely difficult to disentangle. When there is an acquisition of fixed assets, it becomes almost impossible to reconcile the financial accounting of construction in progress with the new capitalization of the assets.

A more sensible approach would be to require that financing payments, deliverable invoices, and collections always refer to separate contract and obligation lines.

Al Baharmast, Ph.D. is an assistant professor in the School of Business at George Mason University and an operations management and information systems consultant specializing in business process management, enterprise applications and management. financial and supply chain. At the start of his career, he was a tangible asset auditor and expert witness in asset valuation.


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