Business Sense

David M. Walker has left the building, but his ideas for managing the Defense Department live on. As comptroller general and head of the Government Accountability Office, Walker regularly called for the appointment of a chief management officer to oversee Defense's business affairs. Now the fiscal 2008 National Defense Authorization Act has mandated the appointment of a deputy chief management officer for the department. Operating at the undersecretary level, the deputy CMO would advise the deputy secretary (the CMO) and other Defense leaders on ways to improve business operations.

Those operations include human resources, acquisition, real property and installations, logistics, and financial and information management. Reform efforts aimed at those activities began with the Defense Management Review in the 1980s, followed by acquisition reform and the Defense Reform Initiative in the 1990s, and continue today with the Business Transformation Agency effort that started in 2001. After almost 20 years, however, the major improvements long promised still have not been realized. Congress is unhappy with the rate of change and believes that establishing a full-time senior executive post accountable for results is the only way to achieve results.

Like the current legislation, the 1990 Chief Financial Officers Act and the 1996 Clinger-Cohen Act were enacted in response to GAO recommendations. Both laws called for the establishment of chief officers and required them to take specific steps to achieve business reforms. The chief financial officer would work toward auditable external financial statements and the chief information officer would set up an integrated information technology architecture to support the production of such statements at a reasonable cost.

The result has been the never-ending development of business enterprise architectures, which has done nothing to improve operations. To make matters worse, it never will-even if Defense were to achieve CFO Act compliance. Unlike profit-seeking businesses in a competitive marketplace whose ability to attract capital depends on their production of auditable financial statements, Defense's business activities are publicly funded, nonprofit government operations that rely on annual appropriations from Congress. And Congress' decisions about those activities never will depend on the kind of financial information that the CFO Act calls for.

The private-sector-style financial statements the CFO Act requires provide three kinds of information: what a business is worth, its income and its cash flow. None of that has anything to do with Defense's business activities because they aren't bought or sold, they don't exist to make profits, and they don't rely on cash to pay their bills (they use obligation authority from approved budgets to do that).

The one external financial report required by the CFO Act that does make sense is the annual statement of budgetary resources. That report tells Congress whether obligations were made in accordance with authorization legislation. But that kind of financial accountability is no different from the accountability called for almost 90 years ago by the 1921 Budget and Accounting Act. Thus, what is helpful in the CFO Act (the requirement for audited statements of budgetary resources) is not new, and what is new (the requirement for audited private-sector-style financial statements) is not helpful.

This is not to say Defense doesn't need better accounting. Textbooks make a clear distinction, however, between financial accounting-which serves external decision-makers such as stockholders, investors and creditors-and managerial cost accounting, which serves internal decision-makers such as managers. The Defense Department needs better managerial cost accounting, not financial accounting. Yet the comptroller's office, the Defense Finance and Accounting Service, and the department's new Business Transformation Agency have been unable to focus on managerial cost accounting because they've been required to build financial accounting systems.

But systems able to meet external reporting requirements are inadequate for "estimating the costs of activities and business processes" or for "providing useful feedback to improve business processes," writes Robert S. Kaplan of Harvard Business School in Cost and Effect (Harvard Business School Press, 1997). Choices have had to be made, therefore, between complying with the financial accounting demands of the CFO Act and developing managerial cost accounting. So far, managerial cost accounting is losing.

If the new deputy CMO is going to have any chance to succeed, he or she must find a way to work with Congress to mitigate the unproductive requirements in the CFO Act. Fortunately, language in the 2008 authorization bill does not explicitly require CFO-style financial accountability. Rather, it calls for the deputy CMO to work with Defense leaders to make business operations more effective and efficient-and that means there is hope.

Christopher Hanks is a mathematician and defense analyst. He can be contacted at chhanks@gmail.com.