Reinventing the Audit: Why Now is the Time

Modernizing Auditing: The Pentagon’s Failed Financial Audit

The Department of Defense is the country’s largest employer, with 2.9 million people (1.3 million on active duty, 800,000 in the reserve components, and 770,000 civilians), and has 643,900 assets, from buildings to pipelines, roads, and fences located on over 4,860 sites, as well as 19,700 aircraft and over 290 battle force ships. By law, the department has to provide Congress and the public with an assessment of where it spends its money and to provide transparency of its operations. Auditing the Department of Defense is a massive undertaking that requires counting the location and condition of every piece of military equipment, property, inventory, and supplies.

The Annual Financial Statement Audit

Auditing the Department of Defense is no easy task, and it is required by law to undergo an annual financial statement audit to provide transparency of its operations and where its money is being spent. By doing this, the Department of Defense needs to count what it has and where it has it. The 2019 Department of Defense audit required 1,600 auditors. From that number, 1,450 auditors were from public accounting firms, and 150 auditors were from the Office of Inspector General. The audit cost $428 million in auditing costs ($186 million to the auditors along with $242 million to audit support) and required an additional $472 million to fix the issues the audit revealed.

The Failure of Audit

Unfortunately, the Department of Defense has failed its financial audit for the fifth year in a row. The audit failure comes with a higher price to pay, as the cost of auditing the Department of Defense reaches an estimated billion dollars a year. The reasons for the failed audit range from the Department of Defense’s 326 different and separate financial management systems, to their 4,700 data warehouses, and over 10,000 different and disconnected data management systems.

The Opportunity To Lead In Modernizing Auditing

The Defense of Department’s 40-plus advisory boards are staffed by outsiders who can provide independent perspectives and advice. Since defense spending on auditing is approaching a billion dollars a year, it was clear that it would take a decade or more to catch up to the audit standards of private companies. Instead of the department opting for more of the same, it had a chance to lead the way in modernizing auditing.

Audit 5.0 Initiative

The Defense Department had a chance to lead the way in modernizing auditing. By inventing future tools and techniques, the department could audit faster, cheaper, and more effectively. For this reason, it was proposed to start an initiative for the fifth generation of audit practices (the Audit 5.0 Initiative), with machine learning, predictive analytics, intelligent sampling and predictions.

Funding for the Audit 5.0 Initiative

The Audit 5.0 Initiative would not require more funds since the Department of Defense could allocate 10% of the $428M it was spending on auditors and fund SBIR (Small Business Innovation Research) programs in auditing/data management/finance to generate 5-10 new startups in this space each year. The Audit 5.0 Initiative would also fund academic research to incentivize research on machine learning as applied to Audit 5.0 challenges in finance, auditing, and data management.

Working Together

The Audit 5.0 Initiative could collaborate with civilian audit standard bodies (ASB (Auditing Standards Board) and PCAOB (Public Company Accounting Oversight Board). Furthermore, defense leaders could create the next generation of machine-driven and semi-automated standards, help the Independent Public Accounting firms (KPMG, EY, PwC, Deloitte, et al) create a new practice, and create a defense audit center of excellence that would fund academic centers for advanced audit research, create new startups each year, be the focal point for government and industry finance and audit standards, and create public-private partnerships rather than mandates.

Lessons Learned

The Department of Defense has failed its financial audit for the fifth year in a row, signaling that the department needs to innovate and modernize auditing to count what it has and where it has it. The opportunity to lead in modernizing auditing was there, but the department failed to take the initiative. Instead, the department relied on incremental improvements, and it was only through a revolutionary mindset that a breakthrough could have taken place. Defense leaders need to ask for transformational, contrarian, and disruptive advice, ensure that they have the will and organizations to act on it, and consider whether spending a billion dollars a year for an audit is causing the department to become appreciably more efficient or better managed.