Transparent in its agency-wide audit initiative, Defense Logistics Agency is pioneering the way for other agencies to be auditable.
In September 2015, DLA was one of the first defense agencies and military departments to assert Audit Readiness of the DLA transaction fund, working capital fund, and general fund financial statements. The Independent Public Accountant Ernst & Young arrived in August 2016 to serve as the primary auditor for DLA’s first focused fiscal year 2017 financial statement audit. In November 2018, the second year of DLA’s audit effort, the Department of Defense Office of Inspector General completed its first full financial statement audit of the DoD’s financial statements for FY18. According to the DoD Chief Financial Officer, this was one of the largest financial statement audits in history.
The DLA FY17 and FY18 audit reports provided 353 Notice of Findings and Recommendations with DLA required to assemble corrective action plans for 273 NFRs in FY17 and 80 in FY18. The audit identified specific deficiencies surrounding internal controls, financial reports and regulatory compliance and DLA is making progress in remediating those deficiencies/material weaknesses. DLA developed Corrective Action Plans to address the areas noted in the EY reports.
DLA Director Army Lt. Gen. Darrell Williams affirmed a clean audit improves efficiency and support to the Warfighter, as well as upholds DLA’s goal to be accountable to the American taxpayer, Congress and the DoD. He referred to the fact that DLA has been undergoing its audit initiative longer than any other agency in the DoD.
“In being the audit leader, there is both pleasure and pain,” he said. “There is pain in being on the leading edge because we’re taking all the headwinds. But there is pleasure in our role because other agencies who are not as far into their audit journeys look to DLA for guidance and lessons learned.”
DLA must move full steam ahead and not slide back, Williams said. We are setting the audit standards and are a model for other agencies in the future.
AUDIT OPINIONS
An auditor’s opinion is the outcome of an auditor’s review of an agency’s financial statements. In a government audit, an auditor determines whether the financial statements of an entity are presented fairly in all material respects and in accordance with accounting standards by reviewing the underlying information and processes that went into preparing the financial statements. Audit reports include an opinion as to whether there is a reasonable assurance that the financial statements are free from material misstatements.
The goal is to achieve an unmodified (clean) opinion which represents the highest level of the auditor’s confidence. A modified opinion is when an auditor has identified one/few material weaknesses or came across scope limitations that prevented the auditor from executing all planned objectives. Yet with minimal material weaknesses and scope limitations, the auditor was able to satisfy the fundamental requirements of their audit to allow a basis of reasonable assurance of the client’s financial statements.
A disclaimer of opinion is when auditors are unable to completely perform their work because they are unable to obtain sufficient appropriate audit evidence needed to execute their audit, impeding their ability to reach an audit opinion.
“A disclaimer of opinion does not represent failure, particularly in a first-year audit,” said Navy Rear Adm. Deborah Haven, DLA Audit Task Force Lead. “Rather, it provides focus for future improvement efforts.”
An adverse opinion is a negative response. The auditor finds the Agency to pose significant material weaknesses that have led to material misstatements/reporting of current financial statements.
In June 2017, after DLA’s first financial audit, EY announced its intent to issue a disclaimer of opinion on DLA’s FY17 working capital fund, general fund and transaction fund financial statements, a result not unexpected for agencies undergoing a first-year audit.
“Financial stewardship will always be a priority for DLA,” Haven said. “Each audit report will help DLA build a better financial reporting foundation and act as a steppingstone toward achieving a clean audit opinion.”
AUDIT PROCESS
Audits are important for several reasons, but for the DoD they provide Congress and the public an accurate assessment of where DoD spends its money and provides transparency of DoD resources.
According to the IG January 2019 report, Understanding the Results of the Audit of the DoD FY 2018 Financial Statements, audits can help assist in detecting and deterring waste, fraud, and abuse by providing a starting point for the costs and spending of operations. Having a baseline allows management to detect anomalies that could help identify wrongful or inappropriate acts.
“DLA’s audit is a never-ending cycle,” said Khalid Hamidi, chief of DLA Energy Audibility and Sustainment Office, process health lead and direct liaison between DLA Energy and the Ernst & Young auditors. “Even once DLA successfully obtains an unmodified opinion and EY departs, an effective internal control program is essential to continuously test our business processes for the purpose of audit sustainment.”
There are four phases of a Financial Statement Audit: planning/risk assessment, internal control assessment, substantive testing and reporting. The audit phases last several months each, may overlap, and are continuous year after year.
Phase I, the planning and risk assessment phase, is about obtaining an understanding of the organization’s business processes, structure and nuances to develop a scope for testing.
Phase I lasts between one to three months and includes EY’s understanding of any corrective action plan packages they may receive (that address prior year findings) to determine if they can assess/validate within the fiscal year of testing, Hamidi explained.
“We attempt to coordinate as much as possible with the IPA during the risk assessment phase to assist with their upcoming fiscal year planning,” he said. “Such input would assist with their scoping for internal control walk throughs/testing, addressing Provided By Clients, testing DLA CAP validation packages, substantive testing, fiscal year-end inventory assessment and more.”
Phase II of a financial statement audit focuses on preparing for the auditor’s walkthrough of selected internal controls and business processes where the IPA assesses if they can base reliance on the evidential matter/output (whether manual driven or automated) in support of their fieldwork. During this phase, DLA employees play a significant role and are expected to identify specific policies/narratives that fundamentally validate their daily execution requirements in the selected control or process being tested.
“DLA Energy will schedule ‘dry-run’ sessions before walkthroughs are conducted with the IPA,” Hamidi said. “The IPA has selected eight locations, to include Defense Fuel Support Points and regions, in FY19 for these walkthroughs in addition to the walkthroughs of internal controls that will be conducted at DLA Energy headquarters.”
Phase III of the audit cycle is the substantive testing phase. It requires the IPA to randomly select potentially thousands of DLA financial transactions and ask for the specific evidential matter to support the transactions. In addition, the fiscal year-end inventory assessment falls under this category.
“This can be time consuming,” Hamidi said. “Last year EY went to 66 DLA Energy sites where they performed physical inventories and we had to provide evidential matter for all transactions from the date of the visit to the end of the fiscal year.”
The purpose of the fiscal year-end inventory assessment site visits is to assess whether the IPA can assert an ending inventory balance/beginning balance. The focus will be to gauge tanks and try to come to an agreed upon balance of total DLA Energy inventory as of the end of the fiscal year.
“This is essential for the auditor because if you are unable to validate a beginning balance, an IPA would refrain from executing a full examination which would allow an opinion,” he explained.
In addition, during the second and/or third phase, the IPA will attempt to test any submitted DLA CAP remediation packages related to prior EY identified deficiencies and/or material weaknesses. The potential for having outstanding NFRs, yet still have the IPA reach an opinion, is possible, Hamidi said. The question an auditor will ask is whether those NFRs/material weaknesses that are outstanding prevent them from assessing reasonable assurance that the financial statements are fair/free from material misstatement.
Phase IV is the reporting phase of the audit cycle. The IPA summarizes the results of the audit conclusions and assertions based on the fieldwork.
“The end goal in this phase is to reach a determination of an opinion,” Hamidi said. “This is based on a number of variables assessed by the auditor to include identified issues, gaps, unresolved deficiencies, unresolved material weaknesses and scope limitations.”
After the completion of Phase IV, the agency begins taking correction actions and fixing identified problems before the phases begin all over again in the next fiscal year.
“It can take several years for an agency the size of DLA to obtain a clean audit opinion,” Hamidi said. “But, the DLA director has set a clear goals to achieve unmodified opinions.”