To the baseline and beyond: military equipment valuation sets sights on a clean audit: a clean audit: the avenue to securing the trust of the Congress and the American taxpayer in the DoD's stewardship its assets.

The Department's financial managers deserve praise. For more than three years, they have worked with the personnel in the Property & Equipment (P&E) Policy Office in the Office of the Under Secretary of Defense for Acquisition, Technology and Logistics and in the acquisition community to establish the initial value of every item of military equipment in the Department of Defense (DoD) inventory. Approximately 1,100 individual weapon system programs were assessed for a computed net book value of about $300 billion.

To its credit, the DoD financial management community assisted in developing the policy guidance (business rules) and processes that were used to complete the valuations for the military equipment programs. DoD financial managers also helped to ensure the accuracy of the specific program information needed to complete the valuations.

Establishing the initial values is the first of many significant objectives laid out by the Department as it implements Military Equipment Valuation (MEV), an initiative to value, capitalize, depreciate, properly account for, and report military equipment on financial statements. MEV was created in response to Statement of Federal Financial Accounting Standard (SFFAS) No. 23, "Eliminating the Category National Defense Property, Plant and Equipment," and it makes good business sense.

Prior to SFFAS No. 23, military equipment simply was expensed when it was acquired. Now, knowing the value of each item of military equipment gives senior decision makers the information they need to make better, more timely investment decisions on behalf of our warfighters. Additionally, MEV moves the Department closer to its goal of obtaining a clean audit opinion for military equipment on DoD financial statements. While not an end in itself, an unqualified audit opinion demonstrates to the Congress and U.S. taxpayers that the Department is a good steward of the resources entrusted to it, and enhances confidence in DoD business operations.

Establishing the Military Equipment Baseline

Building on the success of the initial valuations, efforts now are under way to establish the military equipment baseline for year-end financial reporting in fiscal year 2006. As part of this effort, the Department must update information that was used to complete the initial valuations, including program data (such as budgeted cost and useful life), asset status (that is, additions, transfers, and disposals), and program expenditures. Completion of these actions will bring the military equipment program information current as of September 30, 2006.

Updates to Program Data

Representatives of the P&E Policy Office have been working closely with DoD component acquisition personnel to identify changes needed in the program data. P&E Policy Office personnel are responsible for ensuring that this updated information, which likely will include changes to program funding and updated linkages to the accounting system, is considered as the military equipment baseline is developed.

Updates to Asset Status

By October 5, 2006, designated DoD component points of contact (POCs)--that is, program managers, item managers, or other individuals in the logistics chain who have the most reliable information concerning asset quantity--will be primarily responsible for updating the asset status information. These updates will identify changes in asset quantities, by specific asset, through a Web portal.

The asset status update process is no small task, but it's necessary because of the limitations of the component accountability systems. Until these systems are capable of capturing and reporting accurate, real-time asset status information, the Department will have to rely on these data calls.

To make the update process manageable, training for POCs was offered at 12 locations across the country in April and May 2006. Now the training is being offered online through the P&E Policy Office Web site at http.//www.acq.osd.mil/me.

Updates to Program Expenditures

The update of expenditure information will be accomplished through an automated interface to the supporting accounting transactions. As previously noted, during the program data update, program managers were asked to identify the accounting system linkages that relate to their program expenditures. For purposes of the MEV effort, these accounting linkages are referred to as financial account codes (FACs). The FAC is a combination of fields from the accounting line that can be used to associate expenditures with a program.

Data relating to military equipment expenditures is transmitted from each DoD component's accounting system into the Business Enterprise Information System (BEIS). The BEIS data then are transferred to and processed by the Capital Asset Management System-Military Equipment, a DoD enterprise system that well be used to compute the military equipment values that will be reported by the Department.

Validating the Military Equipment Baseline

Establishing the value is only the first part of the process. From there, the financial management, acquisition, and logistics communities must participate in a coordinated process to validate the data used in order to develop the military equipment baseline. This coordinated process supports the action known in the financial community as management assertion.

The outcome of the management assertion process is a formal representation, provided by the DoD component head or component senior financial manager, that the military equipment program values presented in the financial statements are ready for audit. Working closely with the components, the P&E Policy Office has developed a process whereby everyone who has provided direct input to the military equipment valuations will be required to attest that, to the best of his or her knowledge, the information provided is correct.

At the completion of the process--no later than December 31, 2006--the DoD components will be required to assert the following:

* Reported military equipment exists (existence)

* All military equipment that exists is reported (completeness)

* All military equipment is properly valued (valuation)

* The Department owns the military equipment that is reported (rights and obligations)

* The military equipment is reported in accordance with the accounting standards (presentation and disclosure)

Successful completion of the assertion process will assure the Department's senior leaders that the military equipment values reflected on the financial statements are accurate, complete, and ready for audit.

As with the asset update process, training on the assertion process was provided within the Department. This training still is offered online through the P&E Policy Office Web site at http.//www.acq.osd.mil/me.

Timeline for Achieving a Clean Audit Opinion

The Department has developed a milestone-based timeline to achieve a clean audit opinion. This is contained in the Financial Improvement and Audit Readiness (FIAR) Plan, the first edition of which the Department published in December 2005. The FIAR Plan, which has been reviewed by the Office of Management and Budget and delivered to the congressional Defense committees, is the cornerstone of the Department's efforts to improve its financial management--and MEV is part of that plan. Milestone accomplishments are reviewed monthly by DoD senior leaders, and failure to meet any milestone is brought to the direct attention of the Deputy Secretary of Defense.

Some of the key dates and milestones listed in the FIAR Plan for MEV follow:

September 30, 2006--Component Review of Computed Values. Internal auditors will conduct a limited scope validation to assess the work that has been completed and the documentation that has been compiled to support the MEVs.

December 31, 2006--Component Assertion. Based on input from their internal auditors, the senior financial manager of each DoD component will assert to the audit-readiness of the reported values.

March 31, 2007--Contract Awarded to Public Accounting Firm. Based on the assertions, the DoD Office of the Inspector General (OIG) will award a contract to an independent public accounting (IPA) firm to audit the military equipment baseline value.

June 30, 2007--DoD Inspector General Assessment of Audit Readiness. The IPA firm or the DoD OIG will issue an independent assessment regarding whether it appears likely that the component will receive an unqualified audit opinion on the military equipment balance. If so, the audit will be initiated. If not, a report will be prepared that describes what has prevented the conduct of an audit and what needs to be done to remedy those problems.

Improving Financial Management of Military Equipment in the Future

We have achieved many successes to date as we strive to fulfill the promise set forth in the President's Management Agenda "to secure the best performance and high measure of accountability for the American people."

However, we are only in the first phase of the MEV Initiative. In the second phase, the Department will begin using an automated process to maintain and update asset values using transactional data from DoD's receipt, acceptance, and payment systems.

These process improvements make good sense from financial and operational perspectives. The Department wants to take advantage of the data gathered, but knows that better, more discrete data will support better management decisions. In addition, SFFAS No. 6, "Accounting for Property, Plant and Equipment," which provides guidance on the valuation of all equipment (including military equipment), requires more granular valuation than can be supported by current accounting and accountability systems. For example, assets such as aircraft should be valued at their full cost exclusive of spare parts (since spare parts should be reported on a different line on the financial statements). Most systems currently in use cannot document separate valuations for the primary asset and the associated spare parts, the lack of which likely would create valuation issues during the audit.

Implementing the Process and Policy Changes

The P&E Office already has identified and is in the process of implementing the necessary process and policy changes. These changes will require substantial improvements both to financial systems and to acquisition business processes. These latter changes relate to the way contracts are written, individual items are identified, assets are associated with programs, items are classified, and expenditure information is captured.

A brief explanation of each of the five necessary changes follows.

Changes to Contract Structuring. Contract line items must be structured so that the cost for items that should be capitalized (for example, aircraft) can be easily segregated from the cost of items that should not be capitalized (for example, spare parts). The P&E Office soon will be conducting training on contract restructuring to ensure that those who are responsible for formulating and executing contracts clearly understand the objective of these changes and the related contract writing requirements.

Changes to Item Identification. The Department now requires the use of Item Unique Identifiers (IUIDs) for items that meet established criteria, such as those having a unit cost in excess of $5,000 and requiring serialized item management. This IUID, which associates a unique number with military equipment assets meeting these criteria, will make it easier to track and account for items as they move between programs and reporting organizations.

Changes to the Association of Assets with Programs. To associate assets and related expenditures with individual programs, the Department plans to establish individual Acquisition Program Unique Identifiers (APUIDs). These program identifiers already exist for major acquisition programs. Current plans call for extending this requirement to all acquisition programs, thereby improving the Department's ability to link assets and related expenditures with every acquisition program.

Changes to Item Classification. The Department plans to develop a new Demand Unique Identifier (DUID), which will be used to distinguish how an item will be classified for financial reporting purposes. Given that some contract expenditures should be capitalized as military equipment, some should be reported as operating material and supplies, and some should be expensed, this identifier will provide the visibility to distinguish the appropriate classification and accounting treatment in an automated way.

Changes to Capture of Expenditure Information. The Department is establishing an automated receipt, acceptance, and entitlement tracking system known as Wide Area Work Flow (WAWF). This capability will help the Department in associating expenditure information with programs.

Some of the preceding process changes, such as IUID and WAWF, already are being implemented. Others, such as the APUID and the DUID, should be in place within the next two years.

Once all of these process changes have been fully implemented, which is estimated to take from five to seven years, the Department will have the tools it needs to implement a fully automated military equipment valuation approach.

Your Participation--To the Baseline and Beyond

With excellent teamwork among the DoD financial management and other communities, the Department already has accomplished a great deal. Together, we've completed an initial valuation of all military equipment programs; developed a process for updating and asserting to these values; and mapped out a feasible, long-term plan to refine military equipment values in the future.

Now the P&E Office seeks your help in maintaining strong momentum for this initiative. Your commitment to securing accurate, consistent, and comparable data across programs and components will give decision makers the best possible information to support our warfighters. It also will move the Department forward in its effort to attain a clean audit opinion and thereby secure the trust of the Congress and the American taxpayer in DoD's stewardship over its assets.

Richard K. Sylvester is a member of the Senior Executive Service and Deputy Director, Acquisition Resources and Analysis for Property and Equipment Policy, Office of the Under Secretary of Defense (Acquisition, Technology and Logistics).