Background

1. Defence capability involves a combination of people, organisation, equipment, systems and facilities to achieve a desired operational effect. This audit covers the major capital equipment acquisition and logistics support aspects of Defence capability. The audit focuses on the Defence Materiel Organisation (DMO), which was established on 1 July 2000 as part of an ongoing reform of Australian Defence Force (ADF) material acquisition and logistics support. These reforms will enter a new phase from 1 July 2005, when DMO is expected to commence operations as a prescribed agency within the Defence portfolio.

2. DMO manages some 250 major capital equipment acquisition projects, which in 2003–04, had a total estimated cost of $52 billion. In 2003–04, DMO spent some $5.9 billion, of which $2.5 billion was on capital equipment acquisition, and $3.4 billion on logistics support. Expenditure for the top 30 acquisition projects represents nearly four-fifths the total planned expenditure on Major Capital Equipment in 2004–05.

3. During February to May 2004, DMO undertook a due diligence analysis of its business as part of preparations for becoming a prescribed agency. The aim was to identify the scope of the business undertaken by DMO, and to assess the risks to the successful achievement of planned outcomes in its core business areas – acquisition and logistic support. DMO considered this to be an essential precursor to the negotiation of agency agreements with Defence.

4. The diligence analysis was published in the June 2004 DMO Business Due Diligence Report, which reported that of 156 major acquisition projects, 30 per cent had already missed their agreed in-service date or had unrecoverable schedule slippage. A further 20 per cent, while not yet late, would require intensive management to achieve their in-service date, and the remaining 50 per cent should meet their in-service dates with normal management processes. It also reported that over the period 1981 to 2004, DMO's top 64 major acquisition projects incurred price increases totalling $11.8 billion. Some $10.5 billion, or
89 per cent, of the increases related to cost escalation associated with the price of labour and materials, and to currency exchange variations. The remaining 11 per cent, or $1.3 billion, related to real changes in the nature or scope of deliveries after the projects received initial Government approval.

5. DMO has 11 divisions, responsible for different aspects of ADF materiel acquisition, logistics support and disposal. This audit examines DMO through the operations of four of DMO's 46 Systems Program Offices (SPOs), which the ANAO selected from DMO's Maritime; Land; Aerospace; and Electronic and Weapon Systems Divisions. DMO's SPO tasks are, in the main, concerned with defining and monitoring contractor performance in meeting contractual obligations, regarding equipment acquisition and logistic support. Some SPOs also perform system integration tasks.

Technical regulation

6. The ADF's technical regulations have strengthened since the 1990s, mainly in response to its increasing reliance on the Defence Industry Sector to develop and logistically support its equipment. In June 2002, the regulations were placed within a Technical Regulatory Framework (TRF),¹ jointly authorised by the then Secretary of Defence and the then Chief of the Defence Force. The TRF's role is to monitor and control risks to safety, fitness for service and environmental compliance (collectively known as ‘technical integrity') of ADF materiel.

7. A core component of the ADF's TRF is Authorised Engineering Organisation (AEO) and Authorised Maintenance Organisation (AMO) certification, to be achieved by organisations that provide the ADF with equipment acquisition and support services. These certifications provide high-confidence by the Services' Technical Regulatory Authorities that the authorised organisations have: technical management systems appropriate to the type of work being performed; personnel having appropriate authority, training, qualifications, experience, demonstrated competence and integrity to undertake the activities required; processes that are documented, controlled and approved for all the organisation's engineering activities; and data applied to, and derived from, technical activities that are accessible, authoritative, accurate, appropriate and complete.

Audit approach

8. The audit focuses on DMO's equipment acquisition and support, at the system program management level. The objective of the audit was to assess the adequacy of Defence's capital equipment project definition, approval, acquisition and logistics support management.

9. The SPOs subject to audit are:

• Aerospace Systems Division's Tactical Fighter Systems Program Office (TFSPO), which is responsible for acquisition and logistics support management of the Air Force's F/A-18 and Hawk 127 fleets and associated equipment. TFSPO is located at Williamtown, NSW;
• Land Systems Division's Track Manoeuvre Systems Program Office (TMSPO), which is responsible for the acquisition and logistics support management of Army's Leopard Tanks and M113 Armed Personnel Carrier fleets. TMSPO is located in Melbourne;
• Electronic and Weapon Systems Division's
  Over-the-Horizon Radar Systems Program Office (OTHRSPO), which is responsible for acquisition and logistics support management of the Jindalee Operational Radar Network (JORN) and Jindalee OTHR systems. OTHRSPO is located within the Defence Science and Technology Organisation (DSTO) precinct at Edinburgh, South Australia; and
• Maritime Systems Division's Fast Frigate Guided System Program Office (FFGSPO), which is responsible for the support and upgrade of the Navy's FFG fleet. FFGSPO is located at Garden Island, Sydney.

10. In view of the significant role that DMO's SPOs play in managing major capital equipment acquisition projects, the audit includes a case study of the $1.448 billion Fast Frigate Guided (FFG) Upgrade Project. A high level of audit assurance is not able to be provided on the FFG Upgrade Project given deficiencies in the FFGSPO information management systems and deficiencies in the level of design and development disclosure provided to SPO personnel by the FFG Upgrade Prime Contractor. The ANAO was unable to access appropriate audit evidence on the financial expenditure associated with the FFG Upgrade Project, and the Project's approved Equipment Acquisition Strategy.

FFG Upgrade Project

11. The FFG Upgrade Project initially aimed to regain the original relative capability of six FFGs, and to ensure they remained effective and supportable through to the end of their life in 2013–21. How effective the Upgrade Project has been will not be known until acceptance of the Upgrade Software currently scheduled for May 2007.

12. In November 2003, the Minister for Defence announced changes to Defence capability. These changes included the acquisition of three air warfare destroyers and the strengthening of the FFGs' air warfare capability, by complementing the FFG Upgrade anti-ship missile defence system, with the long-range Standard Missile-2 (SM-2) missiles. Related offsets include the early retirement of the two oldest FFGs in 2005 and 2006, when the last of the new ANZAC class frigates are delivered. Defence assessed the savings attributable to the withdrawal of these two FFGs would be $678 million over ten years.² On a one-year basis, that represents less than two per cent of the estimated annual total operating expenses of the Navy, which in 2004–05 was reported to be $4.65 billion.

13. The retirement of the two FFGs requires a contract amendment covering the reduction of FFGs to be upgraded from six to four.³ This amendment had not been finalised by March 2005, despite being decided in November 2003. In 2002, DMO estimated that the unit cost of the upgraded FFGs to be $235 million each for six upgraded FFGs, or $353 million each if only four were upgraded. This indicates that upgrading only four FFGs would yield no savings in the FFG Upgrade Project. DMO records also state that unless FFG fleet tasking was reduced significantly, there would be marginal change in fleet operating costs if less than six FFGs were upgraded.

Key findings and conclusions

Capability development process

14. Defence's Capability Development Group (CDG) is responsible for assessing and defining current and future ADF capability needs, and for managing Defence's overall major capital equipment investment program. Responsibility for major capital equipment acquisition and logistics support rests with DMO through its SPOs. CDG bases its management processes on a ‘two pass' Government approval process, involving formal Government consideration of future Defence capability on three occasions. First, when Defence defines a capability gap and seeks to place a broadly defined solution into the Defence Capability Plan. Second, when Defence seeks the Government's approval to conduct further studies into defined capability options. The final occasion occurs when Defence seeks the Government's approval to acquire a preferred capability option. The process brings together CDG-DMO Integrated Project Teams (IPTs) with the aim of generating significantly more detailed and accurate qualitative data on cost, schedule and capability issues, than had occurred in previous ADF development processes.

SPO process management

15. In 2002, DMO commenced development of a standardised Business Process Model known as the Quality and Environmental Management System (QEMS). QEMS is to provide SPO personnel with up-to-date information on DMO's program management policies, processes and practices. The intention was to by 2005, have the model fully populated and having Information Technology (IT) design features that satisfy end user requirements. However by early 2005, this had not been achieved.

16. The ANAO found that the information in QEMS was difficult to access and lacked the necessary level of guidance for the users of QEMS to translate policy into practice. It was particularly deficient in financial policy on project approval and variations to approved project costs. QEMS implementation requires continued monitoring and evaluation to ensure it achieves its aims, and is fully accepted by SPO personnel.

17. In 2002, DMO commenced developing its Improve Project Scheduling and Status Reporting (IPSSR) system. IPSSR seeks to provide an improved method of planning, scheduling, budgeting, monitoring and controlling SPO tasks, through the increased use of earned value management techniques to produce accurate project cost and schedule data.

18. The ANAO found the development and implementation of IPSSR has taken DMO longer than expected. In order for IPSSR data to achieve the required degree of accuracy, each DMO project requires IPSSR to be established and maintained by adequately skilled project mangers, schedulers and earned value management personnel. Without that investment, the ANAO would have doubts as to IPSSR's value as an aid to overall project management and status reporting, given the complexity of project management, scheduling, Earned Value Management System (EVMS) techniques, and the coordination tasks associated with the management of Government provided materiel, and other fundamental inputs to ADF capability.

19. In early 1999, Defence selected the IT-based Defence Records Management System (DRMS) as its standard method of document and records management. The ANAO found that DRMS implementation within the SPOs audited ranged from fully effective in the TFSPO to non-existent in the FFGSPO. DMO recognises it has deficiencies in its documentation management systems supporting projects and general business, and that DRMS implementation in DMO has been slow partly due to the DRMS ‘user pays' cost model and limitations of its narrow functionality. In 2004, DMO commenced defining its documentation management system requirements and identifying possible solutions.

Integrity management

20. The ANAO found all nine SPOs within DMO's Aerospace Systems Division, and the Airborne Early Warning and Control organisation had achieved AEO certification, and commercial organisations that support these SPOs have AEO, AMO or interim AMO certification. Six of the eight Land Systems Division SPOs have AEO certification.

21. Three out of the 19 Electronic and Weapon Systems Division SPOs have AEO certification. Defence advised the ANAO that many of these SPOs perform systems integration work in conjunction with SPOs that have AEO certification and Chief Engineers authorised to monitor and approve their work. None of the 10 Maritime Systems Division SPOs have achieved AEO certification. However, eight have provisional AEO certification. The ANAO found that compliance with the ADF's TRF to be fully matured in the TFSPO, and mature in varying degrees in the other SPOs.

22. Given the risks involved, there is a strong case for DMO to increase the priority and assistance to Maritime Systems Division and Electronic and Weapon Systems Division to improve their compliance with the ADF's TRF. The ANAO considers that despite the considerable effort expended by Maritime Systems Division, the FFGSPO appears significantly behind the other SPOs audited, in terms of technical integrity policy, process and data maturity.

23. The audit found that TFSPO's F/A-18 Hornet and Hawk 127 logistics support arrangements are based on well-developed logistics support policy, plans and key performance indicators. Also, indications are that TFSPO is adequately maintaining the technical integrity of the Hornet and Hawk fleets. Hornet and Hawk fleet operations data indicate TFSPO is managing effectively its in-service support role.

24. TMSPO's Leopard and M113 fleet logistics support arrangements include DMO's Land Engineering Agency, fleet repair contracts managed by Joint Logistics Command, and fleet maintenance provided by Army. In 2003, DMO's Maintenance Advisory Service audited the Army's 1st Division logistic support and found that only four per cent of the vehicles sampled by the audit were considered fully functional, and only 22 per cent of all equipment sampled was regarded as fully functional. This indicates a need for DMO, Joint Logistics Command, and Army to continue working together to achieve improvements in Army vehicle and equipment logistics support arrangements. The Leopard and M113 fleet operations data indicate TMSPO is managing effectively, its logistics support role.

25. Operational availability data indicate the FFGSPO and OTHRSPO are managing effectively their logistics support roles, to the extent that the FFG Fleet and JORN and Jindalee OTHRs are achieving operational availability figures specified by the ADF.

Capital Investment Project - FFG Upgrade

26. In September 2003, the FFG Upgrade Prime Contractor commenced installing upgraded equipment into the first FFG to be upgraded, namely HMAS Sydney, at its Garden Island facility. Originally, the FFG Upgrade Contract schedule had the first ship fully upgraded and delivered by 4 August 2003. However, by September 2003, no ships been upgraded, and approximately 71 per cent of the total contract budget had been paid to the Contractor.

27. The ANAO found for the most part, the delays related to the design, development and integration of the upgraded combat systems. Progress to date casts doubt on the Contractor's ability to deliver upgraded FFGs, capable of meeting the contracted specifications, within the agreed price or schedule. In April 2005, the Contractor advised the ANAO that ‘it was not aware of any indication that it would not complete its current contracted scope of work within the agreed price.'

28. In November 2001, the Contractor submitted a draft excusable delay claim for an amount of $46 million (December 1998 prices), and an additional $14 million claim for loss of work and skills retention for the period the Project was delayed. In April 2004, the Contractor's claim was settled by DMO for $21.636 million (equivalent to $16 million in February 1998 prices). Other changes to the FFG Upgrade Project contract that flowed from that claim, included recasting the incentives to the Contractor's achievement of milestones, and allowing delivery schedule slippage ranging from 25 months, for the six FFGs to be upgraded, to 35 months for the FFG Warfare Systems Support Centre and Upgrade Software acceptance.

29. The Contract provides that the Defence may pay the Contractor Performance Incentive Fees capped at $18.7 million as additional incentive for the Contractor's due and proper performance of its contracted obligations. By May 2004, the Contractor had received six performance incentive fees totalling $3.323 million (excluding Goods and Services Tax (GST)). These incentive fees covered interim work done by the Contractor, rather than delivery of FFG upgrade outcomes.

30. A fundamental project management responsibility is to ensure that the contractor's cost and schedule progress data are sufficient and reliable enough to accurately track and review results being obtained. In November 2001, the Contractor's EVMS was certified by Defence as complying with the Defence EVMS standard. However, by then the Project was showing signs of extensive schedule slippage.

31. The EVMS contains a Contract Master Schedule (CMS), which establishes the Project's key dates. The CMS is required to be completely compatible and traceable to the Contract's Milestone Schedule, and be meaningful in terms of the Contract's technical requirements and key activities. FFGSPO records indicate that since 1999, SPO personnel lacked confidence in the validity of the Contractor's CMS. By August 2002, the Contractor had produced six revised CMSs.

32. FFGSPO is responsible for conducting recurring surveillance reviews of the Contractor's EVMS to ensure it remains compliant with the contracted standard, and continues to produce credible cost and schedule performance data. However, despite the FFGSPO's concerns, the Contractor's EVMS had not undergone a surveillance review by Defence personnel, until March 2005.

33. In August 2004, the Contractor advised DMO that it had undertaken an internal review of Tests and Trials for HMAS Sydney, and confirmed that 16 May 2005 was a high confidence date for the completion of the Sydney's Tests and Trials. This date represents a slippage of four-months from a schedule provided to DMO only one month before. The DMO advised the Contractor of its disappointment with schedule performance on the Project and the profound knock-on effects on national capability, reputation, fleet activity and Navy training and leave management. In September 2004, the Chief of Navy advised DMO's Chief Executive Officer that the situation had seriously undermined Navy's confidence in the Project.

34. By March 2005, further FFG Upgrade delays resulted in HMAS Sydney's sea trials being rescheduled for completion at the end of August 2005. Consequently, the Contractor exercised its contractual option to insert an eight-week postponement in the upgraded FFGs' provisional acceptance dates.

Technical certification

35. The FFG Upgrade project's Prime Contractor has accepted Total Contract Performance Responsibility for the design integrity and performance of the upgraded FFG systems, and for making certain that all inspections and acceptance test procedures are sufficient and performed in accordance with upgrade contract's Statement of Work and System Specifications. This makes the Contractor totally responsible for detecting and correcting inadequate design and construction.

36. FFGSPO records indicate that after some four years into the FFG Upgrade Project, the FFGSPO was not satisfied with the Contractor's implementation of the FFG upgrade Test Database, and that the system test procedures written against sub-system specifications were neither sufficiently rigorous nor complete. The ANAO found that the Contractor had not provided FFGSPO with the degree of design and development disclosure specified in the Contract, and that this had limited the effectiveness of the FFGSPO's technical review process. This includes FFGSPO Inspections, Tests and Trials personnel on-line access to the Contractor's Test Database, updated drawings and Requirements Database. This access is necessary to enable FFGSPO personnel to determine the extent to which the FFG Upgrade had satisfied the requirements specified in the Contract.⁴

37. From mid 2004 to March 2005, the Contractor was overdue in delivering some 160 contracted data items to the FFGSPO. These data items are used by the SPO as the basis of assessing the quality of the Contractor's work, and other data deliverables, such as equipment documentation supplied by sub-contractors.

38. The Upgraded FFG Combat System Software development, testing and certification process has not progressed as planned. In December 2003, FFGSPO in a Problem Identification Report advised the Contractor of its ‘great concern' with the safety and construction of the Combat System Software. The SPO advised that the Contractor had not allayed its concerns regarding safety aspects of the software, and had submitted Hazard Analysis Reports to the Contractor on this issue. The Contractor had not permitted FFGSPO personnel access to evidence of software safety and had rejected the SPO's Hazard Analysis Reports, citing that the reports were not sufficiently specific for the Contractor's Hazard Analysis techniques to be applied to them. By March 2005, the Combat System Software Safety Problem Identification Report raised by the SPO in December 2003 remained unresolved.

39. In light of these combat system safety and testing program problems, it appears likely that the FFG Upgrade technical and operational integrity certification process will experience further delays. In April 2005, the Contractor advised the ANAO that certification is not required under the Contract, other than on the delivery certificates (SG8s and SG1s) where the Contractor certifies that it has met the requirements as defined by the Contract for the nominated supplies.

Financial Management

40. In the period between May 2004 and February 2005, at the request of the ANAO, the FFGSPO attempted to assemble the financial records to support the payments made under the Project. For much of that period, the ANAO found that the FFGSPO's records for 1999 to mid-2003, did not provide a basis for orderly, efficient and accountable measurement of the use of Australian Government resources.

41. The ANAO is generally satisfied with the improved practices and procedures adopted by the FFGSPO to record and assess the basis of payments to the Contractor since mid-2003. During this period, payments amount to some $129 million, were validated by a complete set of invoices, completed authorised DMO sign off sheets and payments made in accordance with contractual terms. Since February 2004, the FFGSPO has incorporated a formal signoff process to approve Contractor payments.

42. Since December 1997, the Upgrade Project's price has increased by $328.94 million as a result of cost escalation associated with the price of labour and materiel, and foreign currency exchange adjustments. The increase includes cost escalation and foreign exchange adjustments associated with the FFG Upgrade Project's schedule slippage approved by contract changes. These increases were absorbed by automatic adjustments to Project budgets for the price and exchange variations.⁵

43. The Upgrade Contract's price has also increased by $98.87 million as a result of contract scope changes. FFGSPO records indicate SPO personnel moved funds between funding elements within the overall project approval, to absorb the Contract price increases associated with the scope changes.⁶ Automatic adjustments to project budgets, when combined with Project Managers' ability to move funds between project elements, may mask costs being incurred by the project that result from schedule slippages, and lessen the management incentives for effective schedule management.

44. The FFG Upgrade Contract provides that the first Earned Value Management Payment shall not be made until the Project Authority approves the project's EVMS Performance Measurement Baseline. The Performance Measurement Baseline was approved in mid 2000, with the payment of two milestones. However, during the period December 1999 to June 2000, the SPO approved $88.9 million in earned value payments to the Contractor.

45. The ANAO has not been provided with documentation from Defence that supports the basis of earlier value payments prior to the approval of the EVMS Performance Measurement Baseline. There is no evidence of a contract changes proposal being executed that would enable these earned value payments to be made. The Contractor's EVMS did not receive compliance certification until November 2001, by which time more than $200 million had been paid in earned value payments.

46. The FFG Upgrade Contract originally contained financial risk mitigation in the form of a Bank Guarantee Schedule covering the $125 million advanced payment Defence paid to the Contractor, and a Performance Security Schedule initially capped at $30 million. In September 2002, the Bank Guarantee and Performance Security amounts were reduced to nil, on the execution of a Deed of Substitution, whereby the Contractors' parent company became guarantor for the proper performance of the FFG Upgrade Contract.⁷

47. The ANAO also has concerns relating to GST claims that remain unresolved. By the time the GST came into effect on 1 July 2000, the Contractor had lodged a series of earned value claims and milestone payment claims amounting to $254.8 million. These claims contained some $133 million in advance (mobilisation) payments for future FFG Upgrade work. On 12 July 2000, the Contractor lodged an invoice for GST amounting to $8.38 million, to cover $83.8 million in pre-GST payments it had received, and which it claimed were ‘unamortised mobilisation'. On that basis, $83.8 million in payments were made available to the Contractor ahead of work performed, and the Contractor invoiced Defence for the GST payable on that amount. Defence approved payment of the $8.38 million GST claim, without apparently verifying the amount of work yet to be completed under the advanced payments arrangement.

48. The FFGSPO also pays GST on foreign currency price variation claims based on retail as apposed to wholesale foreign currency rates. The agreement to this appears to be based on implied understanding, as opposed to any written agreement between the parties.

49. Longstanding Defence policy is to pay its accounts on the due date, which is generally 30 days from acceptance of goods or services, and the receipt of a request for payment from the vendor. FFG Upgrade Project payment tracking records show the first earned value claim was received from the Contractor on 20 December 1999 for $34.44 million comprising $A 19.94 million and $US 9.65 million. The $US component was approved on the second working day and paid to the Contractor on 22 December 1999, and the $A component was paid on 24 December 1999. There is no evidence presented that indicates the FFGSPO validated the claim for payment of $US 9.65 million and $A 19.94 million, or that it reduced the claim by applying the correct contractual discounts for early payment. Payment before the due date occurred on a number of occasions up until mid 2000.

Overall audit conclusions

50. The DMO has implemented significant organisational change since 2000. The formation of CDG together with increased CDG-DMO IPT collaboration based on the two pass Government approval process, should in the future result in improved capital equipment acquisition contract work definitions, and more accurate project cost and schedule estimates.

51. DMO's SPO structure should enable accountability to be effectively aligned to system acquisition and logistics support management. It also exploits the system engineering synergies between product design, development and logistics support. However, here remains scope for further improvement in the areas of DMO's standardised Business Process Model, project scheduling and status-reporting system, and within the technical integrity management systems within DMO's Maritime and Electronic and Weapon Systems Divisions.

52. The FFG Upgrade Project is not proceeding satisfactorily and requires continued Defence Senior Executive attention, in order to prevent further loss of Navy capability. The FFG Upgrade Project has experienced extensive schedule slippage, and as of November 2004, 78 per cent of the contracted payments had been made without a satisfactory design and development disclosure process in place, nor agreement with important elements of the project's Tests and Trials program. ANAO considers that further slippage is likely on the lead ship, HMAS Sydney, which will have flow on effects for overall Navy capability.

53. The ANAO found that in the period 1999 to mid-2003, the FFGSPO financial records did not provide a reasonable level of assurance for the orderly, efficient and accountable measurement of the use of Australian Government resources. The ANAO is concerned that legislative and administrative requirements concerning the keeping of accounts and records may not have been met for a significant period, prior to mid-2003, in relation to this project. The ANAO plans to include a follow-up audit of the FFG Upgrade Project in our forward audit work program.

54. The audit highlights differences in relative management process maturity between the four SPOs audited. The ANAO found that TFSPO provides an example of better program management practice, in that it has a hierarchy of plans linked to key performance indicators and has a well-developed quality management systems integrated with the Services' technical regulatory framework. The TFSPO adherence to the Service's regulatory framework resulted in the early development of approved plans and procedures for effective introduction into service and logistic support of ADF aircraft and aircraft-related equipment. In contrast, the FFGSPO's plans, key performance indicators and the regulatory compliance system were either under review or in the early stages of implementation, despite the Upgrade Program being nearly six years old. This, when combined with problems related to the project's software safety and testing program, is likely to result in delays in the technical certification of the Upgraded FFGs and as a result delays in their acceptance into service.

55. The ANAO considers that specific management attention by Defence should focus on the following areas:

• ADF technical regulations require effective technical integrity management by Defence and contractor design approval organisations, and DMO design acceptance organisations. This requirement should be factored into equipment acquisition and logistics support contracts, prior to contact execution.
• SPOs should have a hierarchy of plans linked to key performance indicators, which are relevant to the introduction into service of the capability and its logistics support.
• SPOs should establish and maintain validated project cost and schedule data. Successful schedule and status monitoring and reporting requires accurate and reliable EVMS data from contractors, which is validated by adequately skilled DMO personnel through recurrent surveillance reviews.
• DMO project management business processes should accord with sound management practice for payment of claims and retention of appropriate records. Milestone payment strategies should align with high-value progress, rather than provide advanced payments for future work.
• DMO's standardised Business Process Model requires further development in terms of content, IT design, and alignment with SPO Quality Management Systems.
• Defence should improve the implementation of its Defence Records Management System.

56. The ANAO made eight recommendations to improve the management of ADF major capital equipment acquisition and logistic support, based largely on audit observations from the FFG Upgrade Project.

Agency response

57. Defence agreed with six recommendations, and agreed with qualifications and in principle to the remaining two recommendations. Defence advised the ANAO of its response to this audit as follows:

Defence welcomes this audit into a core part of our business. Overall Defence agrees with the outcomes provided and is heartened to have a finding that most of our System Program Offices have in place a good business structure supported by mature management processes.

Defence acknowledges that there is still work to be done, noting that the majority of this work is of a routine nature and does not represent a significant fundamental flaw.

The timing of this audit, coinciding with the commencement of the Kinnaird recommendations, makes this report a good performance benchmark against which the reform process can be assessed at a later date.

Footnotes

1 The TRF sets the criteria against which people, processes, products and organisations can be judged, and monitors and audits compliance with technical regulation policy and management guidelines. The framework's core principles are centred on the need for ADF materiel to be designed, constructed, maintained and operated to approved standards by competent and approved individuals, who are acting as members of an approved organisation, and whose work is certified as correct.

2 Senate Foreign Affairs, Defence and Trade Legislation Committee, Additional Estimates 2003-04, 18 February 2004.

3 Defence has already incurred the majority of expenditure on the contract, including the purchase of six ship sets of upgraded equipment.

4 In April 2005, the Contractor advised the ANAO that it had released the design information in accordance with the Contract, and that updates to that previously delivered are not contemplated in the current Contract scope of work. The Contractor also advised that on-line access to the Test Database was provided to the FFGSPO in March 2005, and that on-line access to the Project's Engineering Change Requests/Engineering Change Orders and updates to design documentation in progress, were only unavailable due to technical problems associated with [the Project's] Integrated Product Development Environment (IPDE) software.

5 These automatic adjustments to the project budgets are based purely on the unexpended funds remaining in the Project. DMO's standard fixed price contracting template does not allow compensation for inflation related to milestones, in the event that the contractor is late in meeting milestones.

6 DMO has flexibility to reallocate funds between project elements in the work breakdown structure. Project Managers do not have authority to vary the approved project scope. Where costs for specific project elements exceed the allocated funds and available contingency, a real cost increase or change in scope must be sought from the appropriate delegate. Depending on the size, this could be an internal Defence delegate, the Minister for Defence, the combined Ministers for Defence and Finance and Administration, or Cabinet.

7 The FFG Upgrade Contract also provided for liquidated damages, in the event of the Contractor's failure to achieve the contracted delivery schedule. The liquidated damages provisions represent about one percent of the Total Contract Price, and so are unlikely to provide an effective deterrent measure. As of March 2005, there had been no liquidated damages event.