The military is about to do a major audit to figure out it huge budget problems.

The cost of the much-maligned F-35 fighter jet program has reached in excess of $1 trillion, far more than the Pentagon said it would cost.



The Pentagon tried to build and test-fly the jet at the same time, which added costs when parts had to be replaced. It also relies on accounting with a lot of wiggle room—keep that in mind when you hear how much a weapon will cost.

Defense Secretary James Mattis made some frank remarks about the Pentagon's budget woes last month. “I cannot right now look you in the eye and say that we can tell you that every penny in the past has been spent in a strategically sound manner,” he said during a speech to graduating Air Force cadets in Colorado Springs, CO. “And so this year, for the first time in 70 years, the Pentagon will perform an audit.”

A $2.4 billion gap is real money, even for the Pentagon.

The idea is simple, in theory: get some outsiders (1,200 accountants and some big-name firms) to scrutinize the books to identify where the money goes. But the process promises to be a painful exercise for the Pentagon, which has struggled to manage its $700 billion annual budget. Big-ticket items have the biggest cost overruns, most notably the F-35 Lightning II. But even well-run programs, like the effort to create the new B-61-12 nuclear bomb, have baseline discrepancies that run into the billions.

As we await the Defense Department’s big audit, here's what we know about why the Pentagon can't control it's spending.

We Don’t Know What Things Cost

Suppose you're making a grocery list and want to estimate your food expenses. You might list the cost of each item in a column and then add them up. But now imagine you are guessing at the prices of each item, taking into account fluctuating data like the cost of industrial supplies and the rate of monetary inflation. Plus, the recipe you’re shopping for may change, and the ingredients may require some extra test batches in the kitchen. Now you're starting to shop like the Pentagon.

“We also anticipate spending about $551 million in 2018 fixing problems identified by the auditors”

The Government Accountability Office released a report last month scrutinizing the cost of America's new nuclear bomb, the B-61-12. This is a modernization program by the Pentagon and National Nuclear Security Administration (NNSA) intended to consolidate four nuclear weapon variants into one bomb. The report mentions two estimates: a $7.6 billion price tag calculated by the Pentagon, and an independent NNSA estimate that adds up to $10 billion.

A $2.4 billion gap is real money, even for the Pentagon. Yet the GAO said both figures are correctly tabulated and gave the program high marks for using best accounting practices. How can that be? It turns out that professionals can count the costs in different ways, and both ways can be considered accurate.

“The (Defense Department) program developed its estimate by compiling cost and schedule estimates for activities at each of the NNSA contractor sites,” the GAO report explains. “In contrast, the independent office evaluated program activities completed to date and applied a historical model to estimate costs and durations for remaining activities.”

There’s even more room for error in the way people account for spent money. There is something called “data normalization” that is supposed to make comparisons and estimates more consistent so that budget projections are comparing apples to apples. “Cost data are adjusted in a process called normalization, stripping out the effect of certain external influences,” the report says.

In reality, not everyone normalizes the same way, leading to more gaps in the available estimates. An audit may try to rectify this disparate data and settle on one cost that everyone can agree on. This may lead to heartburn inside the Pentagon—especially if cost estimates soar by tens of millions with the stroke of a keyboard.

The Curse of Optimism

USMC

At $1.1 trillion, the F-35 Joint Strike Fighter is the most expensive weapons development program in U.S. history. While no one factor is solely responsible for that boondoggle, a big mistake was rosy thinking about how to build it. GAO researcher Mike Sullivan has written numerous reports of the warplane. “You know, the program was very ambitious to begin,” he said in a recent GAO podcast. “We reported early on, on this program, that their technologies weren't mature.”

The Pentagon and contractor Lockheed Martin tried to build the F-35 through a model called "concurrency," which means they were testing the warplane at the same time components were rolling off the assembly line. The idea is meant to speed up the development process compared to the old model, in which a contractor builds the item to spec only after the design has been proven during testing.

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The concurrency model could work if those new and innovative systems always checked out during flight testing, but the F-35's immature tech required hardware and software changes that led to delays and cost increases. “We saw the program extend by five, six, seven years at this point and almost double in cost in terms of development,” Sullivan said.

The Pentagon has tried to change its ways, but the F-35 program still holds to a schedule that ramps up production as flight tests continue. The program office is also plotting the stealth warplane’s modernization using optimistic predictions. “DOD is planning an incremental approach to F-35 modernization that requires the demonstration of key product knowledge at critical junctures in the acquisition process,” the GAO reported in late 2017. “However, some modernized F-35s may be purchased before the new capabilities are fully tested.”

This approach may not look so rosy under the bright glare of an independent audit.

Infrastructure Overlap

The Pentagon's audit won’t be counting just dollars and cents, but also buildings and equipment—a fact that may have far-reaching consequences.

Black Hawk helicopter U.S. Army

In testimony to Congress, Pentagon comptroller David Norquist disclosed that the Air Force identified 478 "structures and buildings" that are not listed in any Pentagon property tallies. Lest you think this is just a problem with buildings, an early Army audit found that 39 UH-60 Black Hawk helicopters were not recorded, either. These are not isolated cases, and the larger audit will uncover even more examples. There's already been a leak from the audit, which says that Ernst & Young found the Defense Logistics Agency failed to document more than $800 million in construction projects.

This information is vital to managing costs, but it might lead to ugly debates down the road. Tallying up military construction allows one to identify any overlap in infrastructure so that redundant buildings can be closed and sold. But the process of "Base Realignment and Closure" is one that makes regional Congressional delegations bare their fangs and attack like wolverines. Politicians love the money that comes in from military bases and do not want to see empty buildings and bases in their districts.

The audit should cost about $367 million in 2018. “We also anticipate spending about $551 million in 2018 fixing problems identified by the auditors,” Norquist told Congress. Of course, he is just guessing at how much the audit will find—making him a possible future ironic victim of hopeful accounting.

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