Defense Primer: FY2018 Department of Defense Audit Results

Updated January 9, 2019

Defense Primer: FY2018 Department of Defense Audit Results

The Chief Financial Officers Act of 1990 (CFO Act, P.L.

101-576) requires annual audits of financial statements for

federal agencies. Under the CFO Act, audits of federal

agencies are the responsibility of the agency’s inspector

general (IG), but the IG may contract with one or more

external auditors to perform the audit.

The Department of Defense’s (DOD) IG conducted the

first-ever agency-wide financial audit of DOD in FY2018.

A number of DOD components have previously undergone

annual audits (e.g., the U.S. Army Corps of Engineers,

Defense Contract Audit Agency, and National

Reconnaissance Office). The agency-wide audit was

conducted by nine Independent Public Accounting (IPA)

firms contracted by DOD IG. The IPAs conducted 24

separate audits within DOD.

The DOD released the results of the FY2018 audit on

November 15, 2018. DOD received a disclaimer of

opinion—meaning auditors could not express an opinion on

the financial statements because the financial information

was not sufficiently reliable. DOD is expected to submit a

full report to Congress on this effort by March 31, 2019.

Going forward, DOD has stated that it will be audited

annually, with audit results expected to be issued in

November for the prior fiscal year.

DOD spent $413 million to conduct the FY2018 audit:

$192 million on audit fees for the IPAs and $221 million on

government costs to support the audit. DOD spent an

additional $406 million on audit remediation and $153

million on financial system fixes.

Generally, the process and standards used to audit DOD are

the same as those used to audit other federal agencies.

Understanding why and how the DOD audit was conducted

can help Congress evaluate the first agency-wide audit

results and usefulness of the audit.

Why an Audit?

Government entities, including the United States

government as a unitary entity, issue annual reports that

present their current financial position and condition, and

discuss key financial topics and trends. An audit of the

government’s financial information provides accountability

over government agencies’ use of public resources to

Congress, oversight bodies, and the public.

Financial audits aim to provide reasonable assurance that

the audited firm’s financial statements are free of material

misstatements whether caused by error or fraud. DOD

audits can provide critical insight into (1) the reliability of

its financial data; (2) the efficiency and effectiveness of

internal operations; and (3) its compliance with statutes and

financial regulations. With such information, DOD and

Congress could take steps to improve DOD’s performance

in these areas.

DOD’s financial management has been on the Government

Accountability Office’s (GAO’s) High-Risk list since 1995.

Those on the High-Risk list are considered more vulnerable

to fraud, waste, abuse, and mismanagement.

How Are Audits Done?

For each line item on a financial statement and notes to the

financial statement, an auditor is to examine a sample of

underlying economic events to determine the accuracy of

the information reported. The auditor is expected to give an

unbiased opinion on whether the financial statements and

related disclosures are fairly stated in all material respects

for a given period of time in accordance with Generally

Accepted Accounting Principles (GAAP). While the

Federal Accounting Standards Advisory Board (FASAB)

sets the financial reporting and accounting standards for the

federal government, GAO is responsible for establishing

auditing standards for federal agencies, including for

federal grant recipients in state and local governments.

Material misstatement in financial reporting can be

defined as information on a financial statement that

could potentially affect the reader’s decision or the

conclusions drawn by a reader about the financial

status of an agency

Auditing Standards

GAO issues the Generally Accepted Government Auditing

Standards (GAGAS), also commonly known as the “Yellow

Book,” which provides a framework for conducting federal

government audits. The Yellow Book requires auditors to

consider the visibility and sensitivity of government

programs in determining the materiality threshold. Similar

to the requirements in the private sector, GAGAS requires

federal financial reporting to disclose compliance with

laws, regulations, contracts, and grant agreements that have

a material effect on the entities’ financial statements.

Some organizations within the federal government use a

hybrid of external and internal auditors. Whether external

or internal auditors perform the function, they are required

to adhere to the standards established under GAGAS.

In addition to examining financial information, an audit

evaluates management’s assertion of internal control over

financial reporting. Audit of internal control includes audit

of computer systems at the entity-wide, system, and

application levels. GAGAS recommends using specific

frameworks for internal control policies and procedures,

including certain evaluation tools created specifically for

federal government entities.

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Defense Primer: FY2018 Department of Defense Audit Results

Types of Audit Opinions

Auditors form opinions by examining the types of risks an

organization might face and the types of controls that exist

to mitigate those risks. Once the risks and controls to

mitigate those risks have been determined, the auditors will

examine supporting evidence to determine if management

is presenting the financial statements fairly in all material

respects. Although many entities in the federal government

usually receive unmodified opinions, auditors may express

other types of opinions based on the circumstances. There

are four types of audit opinions:

Unmodified Opinion. An unmodified opinion (clean

opinion) states that the financial statements present fairly,

in all material respects, the consolidated balance sheets,

related consolidated statements of net cost and changes in

net position, combined statements of budgetary resources,

and related notes to the consolidated financial statements in

accordance with GAAP. This opinion is expressed in a

standard report. In certain circumstances, explanatory

language might be added to the auditor's standard report,

which does not affect the unmodified opinion.

Modified Opinion. A modified opinion states that, except

for the effects of the matter(s) identified in the opinion, the

financial statements present fairly in all material respects in

conformity with GAAP.

Adverse Opinion. An adverse opinion states that the

financial statement(s) do not present fairly in accordance

with GAAP.

Disclaimer of Opinion. A disclaimer of opinion states that

the auditor does not express an opinion on the financial

statements. The auditor’s report should give all of the

substantive reasons for the disclaimer. Some of the reasons

for a disclaimer of opinion include financial statements not

conforming to GAAP and financial management systems

that are unable to provide sufficient evidence for the auditor

to express an opinion.

DOD receiving a disclaimer of opinion on its first-ever,

agency-wide audit in FY2018 was not unexpected; many

organizations do not receive an unmodified audit opinion

during the initial audit. It is estimated that it could take

DOD up to 10 years to receive an unmodified audit opinion.

The November 2018 audit report identified areas for

corrective action and revealed needed process

improvements.

“The Department's assets total more than $2 trillion,

making this likely the largest financial audit ever

undertaken. Along with sheer size, there exists

significant complexity. However, these are not reasons

to delay the audit; they are reasons to begin. Where

we find problems, we will also find opportunities.

Remediating audit findings is at the center of our

financial improvement strategy.”

David L. Norquist, Under Secretary of Defense

Comptroller/CFO

Congress may consider reviewing the results of the FY2018

DOD audit and using the findings to enhance oversight of

DOD’s remediation of issues identified in it. Possible

policy responses could include implementation of process

improvements, investments in information technology

systems, and changes in accounting practices.

CRS Resources

CRS Seminar, Understanding the DOD Audit, by Moshe

Schwartz and Raj Gnanarajah, January 11, 2019

CRS Report R44894, Accounting and Auditing Regulatory

Structure: U.S. and International, by Raj Gnanarajah

CRS In Focus IF10701, Introduction to Financial Services:

Accounting and Auditing Regulatory Structure, U.S. and

International, by Raj Gnanarajah

Limitation of Audits

Independent audit opinions provide reasonable assurance,

but for the following reasons do not fully guarantee, that

financial statements present fairly in all material respects:

 Auditors use statistical methods for random sampling

and look at only a fraction of economic events or

documents during an audit. It is cost—and time—

prohibitive to recreate or sample all economic events;

Other Resources

Office of the Under Secretary of Defense (Comptroller)/

Chief Financial Officer, Department of Defense Agency Financial

Report FY 2018, November 2018

 Some line items on the financial statements involve

Office of the Under Secretary of Defense (Comptroller)/

Chief Financial Officer, Defense Budget Overview, Fiscal Year

2019 Budget Request, February 13, 2018

subjective decisions or a degree of uncertainty as a

result of using estimates; and

U.S. Government Accountability Office, High-Risk Series, GAO17-317, February 15, 2017, p. 282

 Audit procedures cannot eliminate potential fraud,

though it is possible that an auditor may find fraud

during the audit process.

Department of Defense Office of Inspector General,

Understanding the Results of the Audit of the DoD FY2018

Financial Statements, January 8, 2019

Considerations for Congress

The federal government is unable to receive an unmodified

opinion on its Financial Report of the entire United States

Government because agencies with significant assets and

budgetary costs such as DOD, Department of Housing and

Urban Development, and Railroad Retirement Board have

each received a disclaimer of opinion in recent fiscal years.

Moshe Schwartz, Specialist in Defense Acquisition

Raj Gnanarajah, Analyst in Financial Economics

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Defense Primer: FY2018 Department of Defense Audit Results

Disclaimer

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