Navy Financial Management: Improved Management of Operating Materials and
Supplies Could Yield Significant Savings (Letter Report, 08/16/96,
GAO/AIMD-96-94).

In March 1996, GAO reported that the Navy's fiscal year 1994
consolidated financial statements did not include $14 billion worth of
operating materials and supplies, $5.7 billion of which are located on
vessels and at 17 distribution sites throughout the Atlantic and Pacific
fleets. (See consumables that were bought from the Defense Business
Operations Fund (DBOF), a revolving fund that finances the purchase of
inventory items for the military. This report provides a detailed
assessment of the Navy's financial reporting on, and management of,
operating materials and supplies that are not part of DBOF inventories.
GAO discusses (1) the adequacy of the Navy's accountability and
visibility over its $5.7 billion in operating materials and supplies on
board vessels and at distribution sites, (2) the Navy's management of
excess items of this type, and (3) the accuracy of operating unit
records for operating materials and supplies that GAO tested.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  AIMD-96-94
     TITLE:  Navy Financial Management: Improved Management of Operating 
             Materials and Supplies Could Yield Significant
             Savings
      DATE:  08/16/96
   SUBJECT:  Naval supplies
             Military inventories
             Surplus federal property
             Inventory control systems
             Management information systems
             Military vessels
             Warehouse facilities
             Financial management systems
             Spare parts
             Reporting requirements
IDENTIFIER:  Defense Business Operations Fund
             Navy Force Inventory Management Analysis Reporting System
             Navy Consolidated Residual Asset Management Screening 
             Information System
             Navy Residual Asset Screening Program
             Navy Residual Asset Management Program
             DOD Joint Defense Total Asset Visibility Program
             
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Cover
================================================================ COVER


Report to the Secretary of the Navy

August 1996

NAVY FINANCIAL MANAGEMENT -
IMPROVED MANAGEMENT OF OPERATING
MATERIALS AND SUPPLIES COULD YIELD
SIGNIFICANT SAVINGS

GAO/AIMD-96-94

Navy Financial Management

(918843)


Abbreviations
=============================================================== ABBREV

  GMRA - Government Management Reform Act
  CFO - Chief Financial Officer
  DBOF - Defense Business Operations Fund
  DOD - Department of Defense
  FASAB - Federal Accounting Standards Advisory Board
  DLA - Defense Logistics Agency
  O&M - Operations & Maintenance

Letter
=============================================================== LETTER


B-271909

August 16, 1996

The Honorable John H.  Dalton
The Secretary of the Navy

Dear Mr.  Secretary: 

As part of our broad-based review of various aspects of the
Department of the Navy's financial management operations and its
ability to meet the management and reporting requirements of the
Chief Financial Officers Act of 1990, as amended by the Government
Management Reform Act (GMRA) of 1994, we examined the Navy's
reporting on and management of operating materials and supplies.  The
act specifically requires that each agency Chief Financial Officer
(CFO) develop an integrated agency accounting and financial
management system that complies with applicable principles and
standards and provides for complete, reliable, consistent, and timely
information that is responsive to the agency's financial information
needs.  The act also specifies that the CFO should direct, manage,
and provide policy guidance and oversight of asset management
systems, including inventory management and control. 

In a March 1996 report,\1 we pointed out that the Navy's fiscal year
1994 consolidated financial reports did not include approximately $14
billion of operating materials and supplies, $5.7 billion of which
are located on vessels and at 17 redistribution sites throughout the
Atlantic and Pacific fleets.  These operating materials and supplies
include repair parts (repairables) and consumables that were
purchased from the Defense Business Operations Fund (DBOF).  DBOF is
a revolving fund that, among other activities, finances the purchase
of inventory items for the military services.\2

Operating materials and supplies are separate and apart from the
reported $17.5 billion of inventory held for sale by Navy DBOF
activities as of September 30, 1994. 

Generally, the Navy and the Defense Logistics Agency (DLA) manage
such items at two levels--the consumer level and the wholesale level
(often referred to as DBOF activities).  The consumer level operating
materials and supplies are purchased from DBOF by operating units
such as Naval air stations and ships--including aircraft carriers,
cruisers, frigates, destroyers, and submarines--with Operations and
Maintenance (O&M) appropriations.  Supply officers at these operating
units are responsible for procuring items from DBOF and storing them
for subsequent issue or consumption.\3 At the wholesale level,
inventory item managers are responsible for making Navy budget,
purchase, redistribution, and other inventory management decisions. 
To effectively execute these responsibilities, item managers need
visibility over--knowledge of and specific data on--operating
materials and supplies held at the consumer level. 

This report provides the results of our detailed assessment of the
Navy's financial reporting on and management of operating materials
and supplies that are not part of DBOF inventories.  Specifically, it
provides the results of our assessment of (1) the adequacy of the
Navy's accountability and visibility over its approximately $5.7
billion in operating materials and supplies on board vessels and at
the redistribution sites, (2) the Navy's management of excess items
of this type, and (3) the accuracy of operating unit records for
operating materials and supplies that we tested.  This report also
contains recommendations that are directed at improving financial
reporting and inventory management. 

Our scope and methodology are described in appendix I.  We requested
comments on a draft of this report from the Secretary of Defense or
his designee.  On July 24, 1996, the DOD Deputy Chief Financial
Officer provided us with written comments, which are discussed in the
"Agency Comments and Our Evaluation" section and reprinted in
appendix II. 


--------------------
\1 CFO Act Financial Audits:  Increased Attention Must Be Given To
Preparing Navy's Financial Reports (GAO/AIMD-96-7, March 27, 1996). 

\2 DBOF consists of business areas that are managed by DOD components
for providing goods and services, on a reimbursable basis, to other
activities within DOD.  For the Navy, the supply business area
activities include the Naval Inventory Control Point and the Defense
Distribution Depots managed by the Defense Logistics Agency. 

\3 Federal Accounting Standards Advisory Board (FASAB) Statement no
3, Accounting for Inventory and Related Property, defines operating
materials and supplies as property to be consumed in normal
operations and specifies that any component that maintains or stocks
operating materials and supplies for future issuance shall account
for and report such items.  OMB's financial reporting guidance
requires agencies to disclose the amount of operating materials and
supplies on hand. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

We found that the Navy's item managers did not have adequate
visibility over the $5.7 billion in operating materials and supplies
on board ships and at 17 redistribution sites.  Because of the lack
of visibility, we had to analyze data from individual ships to
identify items valued at approximately $883 million, or about 15
percent of the $5.7 billion, that were excess to current operating
allowances or needs.  The item managers' lack of adequate visibility
over these operating materials and supplies, particularly excess
items, substantially increases the risk that millions of dollars will
be spent unnecessarily as they execute their budget and spending
plans for items that are already in excess at the operating unit
level.  For example, we determined that for the first half of fiscal
year 1995, item managers had ordered or purchased items in excess at
the operating level that will result in the Navy incurring
unnecessary costs of approximately $27 million.  Further, a review of
item managers' forecasted spending plans for the second half of
fiscal year 1995 and fiscal years 1996 and 1997 found planned
purchases of items considered excess at the operating level that
could result in the Navy incurring approximately $38 million of
unnecessary costs. 

The Atlantic and Pacific Fleets and other Navy components are
pursuing their own separate nonintegrated systems projects in
attempts to improve visibility and thus management of their operating
materials and supplies.  While these efforts represent positive steps
by individual Navy components involved, they are not directed at
ensuring that item managers have all the necessary data they need or
CFO Act financial system and reporting requirements are satisfied. 
Also, these efforts are not comprehensive in that some do not capture
all necessary data, such as demand data, or include all operating
units needed for effective management of operating materials and
supplies. 

While providing item managers with visibility over excess items at
the operating level can save tens of millions of dollars, the Navy
could achieve further savings by eliminating redundant or unnecessary
warehousing activities.  These consumer-level warehousing activities
are conducted at 17 redistribution sites and manage about $455
million or half of the excess items we identified.  These sites are
often located in the same general areas as DBOF supply activities. 
Thus, these redistribution sites not only duplicate DBOF
wholesale-level activities and contribute to the lack of visibility
and wasteful spending by item managers, but result in the Navy
incurring other unnecessary costs.  For example, based on Navy
information, it is incurring approximately $2 million annually for
contractor costs--including routine operating costs, such as
utilities--to run 11 of the 17 redistribution sites.  The other
sites' operating costs and data processing support costs for all
sites were not readily available. 

A critical element in support of readiness and consolidated financial
reporting is the accuracy of the underlying unit-level records. 
While all operating units should always strive to exceed the
established minimum accuracy goal, we found that 22 out of the 27
sites tested met the Navy's minimum inventory record accuracy goal of
95 percent.  Those not meeting these accuracy goals can adversely
affect redistribution decisions and, thus, operational readiness as
well as result in poor financial management decisions. 


   BACKGROUND
------------------------------------------------------------ Letter :2

Because of its longstanding inventory management problems, DOD's
inventory management is on GAO's list of high-risk federal program
areas especially vulnerable to waste, fraud, and mismanagement.  For
the last 3 fiscal years, the Naval Audit Service reported inventory
management weaknesses in its audits of DBOF activities' financial
statements.  In terms of Navy inventory management weaknesses, we
also have reported on excess inventory at Naval aviation depots and
shipyards,\4

which are part of DBOF operations. 

At the consumer level, Navy supply officers store the operating
materials and supplies purchased from DBOF on ships and at shore
locations, such as air stations, for subsequent issuance or
consumption.  In addition to items stored that are needed to meet
operating requirements, these sites often have excess items stored. 
Also, over the past 6 years, excess items have been stored at
redistribution sites as ships were decommissioned or overhauled.  The
fleets have been redistributing these excess items free of charge
from these redistribution sites. 

At the wholesale level, the Navy Supply Systems Command, through its
inventory control points--the Ships Part Control Center and the
Aviation Supply Office--is responsible for providing supply support
to the Navy.\5 The Ships Part Control Center is primarily responsible
for the ship and submarine spare and repair parts, and Aviation
Supply Office is primarily responsible for the aircraft spare and
repair parts.  The item managers at these inventory control points
use DBOF funds to purchase items for resale.  These items are stored
at the Defense Distribution Depots which are part of DBOF operations
and managed by the DLA.  DLA also manages most common consumables. 
Navy and DLA item managers make decisions on (1) budgeting and buying
items to support Navy operations and sales to foreign governments,
(2) redistributing items among Navy units, and (3) disposing of
excess items. 

Item managers use a process called stratification to forecast
requirements and determine if enough inventory will be available to
satisfy them as a primary basis for budgeting.  Basically,
stratification reports display anticipated demand, quantities on
hand, and items forecasted to be purchased during the current year
and the following 2 fiscal years.  These stratification reports are
updated quarterly to reflect changes in purchases and requirements. 


--------------------
\4 Navy Supply:  Excess Inventory Held at the Naval Aviation Depots
(GAO/NSIAD-92-216, July 22, 1992) and Navy Supply:  Improved Material
Management Can Reduce Shipyard Costs (GAO/NSIAD-94-181, July 27,
1994). 

\5 Effective October 1, 1995, the Aviation Supply Office and the Ship
Parts Control Center became a consolidated Naval Inventory Control
Point with two sites--Philadelphia and Mechanicsburg, Pa. 


   INADEQUATE VISIBILITY OVER
   EXCESS ITEMS FOR NAVY'S DBOF
   BUDGET AND BUY DECISIONS
------------------------------------------------------------ Letter :3

The Navy's item managers do not have complete information on hundreds
of millions of dollars of operating materials and supplies on ships
and at redistribution sites that is needed for budget and purchase
decisions.  This occurs because the inventory systems on ships and at
the redistribution sites do not provide the item managers complete
and accurate data on operating level excess items.  Out of the $5.7
billion of operating materials and supplies covered in our analysis,
we identified items valued at approximately $883 million that were
excess to current operating allowances or needs.  Approximately $428
million worth of these excess items, as of July 1995, were stored on
board 261 Navy vessels, aircraft carriers, frigates, destroyers, and
some submarines.\6 In addition, the Navy had 17 redistribution sites
storing a total of $455 million worth of items, all of which were
excess. 

Operating materials and supplies are consumed during the normal
operating cycles, and Navy vessels attempt to maintain sufficient
stock on hand to meet their operating allowances and anticipated
demand.  The allowances are developed by the inventory control points
based on technical and supply support information.  Excesses will
occur due to changes in demand and allowances for items after the
fleets have purchased and stored them on ships.  The Navy's
downsizing also has resulted in items that had been stored on
decommissioned ships becoming excess. 

Excess items need to be visible for operational and budgetary
purposes, otherwise readiness and spending plans can be adversely
affected.  Thus, to effectively manage items and reduce the risk of
buying unneeded items, item managers must have complete information
on what items are in excess of requirements at the Navy's operating
unit level.  DOD 4140.1-R, "DOD Materiel Management Regulation,"
requires item managers to have visibility of inventories to improve
utilization and to limit buys and repairs in meeting requirements. 
The regulation further specifies that activities are to provide the
item managers asset-level data and requirements information needed to
make economical and readiness-based decisions on lateral
redistribution, procurement, and repair. 

To determine the effectiveness of the Navy's management of operating
units' excess items, we analyzed the first half of fiscal year 1995
purchase decisions and the forecasts for the second half of fiscal
year 1995 and for fiscal years 1996 and 1997 planned purchases.  We
used (1) the March 1995 stratification reports which supported the
development of the fiscal year 1996 and 1997 forecasted requirements
for the Ships Part Control Center and the Aviation Supply Office and
(2) inventory data that we consolidated from 261 ships and 12 of the
17 redistribution sites.\7

Our analysis determined that the Navy's item managers in the first
half of fiscal year 1995 had ordered or purchased items in excess at
the operating level that will result in the Navy incurring
unnecessary costs of over $27 million.\8 For example, the cost to the
Navy will be (1) $2,477,320 for the purchase of four new stabilized
turrets and (2) $532,900 for the purchase of five new displacement
gyroscopes.  Further, the item managers' forecasted spending plans
for the remainder of fiscal year 1995 and fiscal years 1996 and 1997
showed that the Navy's item managers could incur unnecessary costs of
approximately $38 million for purchases earmarked for items already
in excess at the operating level.  Two examples of planned purchases
were (1) five cryogenic coolers with a total cost of about $1,811,800
and (2) one main coolant pump with a price of $2,741,590.  Until item
managers have full visibility over these excess items that are
available to meet demand, they will not be in a position to adjust
their purchase decisions to reflect such items.  Thus, the fiscal
year 1995 spending pattern will be repeated. 

Further, the lack of visibility over excess items that are free
issued has resulted in the operating unit's Operations and
Maintenance budget requests being overstated.  For example, many of
these excess items are redistributed among the fleets to meet demand
and without any charge to the gaining operating unit.  Because these
redistributed items are meeting annual operating unit demand, the
fleets should fully consider the availability and use of these
resources in developing their annual O&M budgets. 

The Atlantic and Pacific Fleets, which account for about 40 percent
of the Navy's O&M appropriation, prepare annual O&M budget requests
based on projected needs for operating materials and supplies and
maintenance.  However, in developing their O&M budgets, they have not
been adequately reducing their budgets for items received free from
redistribution sites.  We reported in September of 1995 that the
Navy's fiscal year 1996 O&M budget could be potentially reduced by
$60 million for the items redistributed as free issue during the
current period.\9 The Navy was able to demonstrate that $21.6 million
of the $60 million had been taken as a budget reduction, leaving
$38.4 million in potential savings. 


--------------------
\6 As of July 1995, the Navy had approximately 324 vessels in the
active fleet.  For determining the amount of excess items on board
vessels, the Navy could readily provide data on only 261 vessels,
largely due to the difficulty of getting timely information from
submarines. 

\7 Only 12 of the 17 redistribution sites were included in the
consolidated data base at the time we obtained the data.  A complete
data base, which was not readily available, would likely have
resulted in additional estimated savings. 

\8 In our analysis, we used the standard prices for items in order to
determine the total costs to the Navy.  Standard prices include a
cost recovery element that is added to the acquisition cost of items. 
The cost recovery element includes operating costs for supply
operations support, shipping and transportation, and inventory
expenses, such as those for losses and obsolescence.  After adjusting
the standard prices for this cost recovery element, the amount
ordered or purchased for the first half of fiscal year 1995 would be
over $17 million.  The potential savings based on acquisition costs
for the last half of fiscal year 1995 and fiscal years 1996 and 1997
would be $24 million. 

\9 1996 DOD Budget:  Potential Reductions to Operation and
Maintenance Program (GAO/NSIAD-95-200BR, September 26, 1995). 


   NAVY LACKS AN INTEGRATED AND
   COMPREHENSIVE APPROACH TO
   REPORTING ON OPERATING
   MATERIALS AND SUPPLIES
------------------------------------------------------------ Letter :4

The Navy has various initiatives underway to improve management and
reporting of operating materials and supplies.  These initiatives can
enhance the Navy's ability to meet its CFO act consolidated financial
reporting needs for operating materials and supplies and provide
greater asset visibility for item managers' decision-making. 
However, some of these efforts are more directed at and concerned
with providing visibility for redistribution of excesses among the
operating activities sponsoring the initiative than providing item
managers with all the data needed to perform their responsibilities
from a Navy-wide perspective.  Thus, unless a more integrated and
coordinated approach is taken, item managers will continue to lack
the necessary information needed to make the best redistribution,
budget, and purchase decisions possible and the Navy's consolidated
financial reporting needs will not benefit fully from these present
efforts. 

The CFO Act of 1990, as amended by the GMRA of 1994, requires DOD, as
one of 24 agencies, to improve its financial management and reporting
operations.  The CFO act specifically requires that each agency's
Chief Financial Officer develop an integrated agency accounting and
financial management system that complies with applicable principles
and standards and provides for complete, reliable, consistent, and
timely information that is responsive to the agency's financial
information needs.  The act also specifies that the CFO should
direct, manage, and provide policy guidance and oversight of asset
management systems, including inventory management and control. 
Also, new accounting standards for federal agencies and OMB's
financial reporting guidance requires agencies to report on operating
materials and supplies as a major line item on their financial
statements.  Further, OMB's guidance requires that agencies disclose
specific information on these operating materials and supplies, such
as their general composition, the balance for items held for use, and
the amount of excess, obsolete and unserviceable items. 

As previously mentioned, the Navy has an estimated $14 billion of
operating materials and supplies at air stations, Defense
Distribution Depots, Trident Refit Facilities, redistribution sites,
and on board all types of vessels.  Of this amount, approximately 49
percent of the items are at the air stations, Defense Distribution
Depots, and the Trident Refit Facilities; about 47 percent of the
items are on board Navy vessels, including submarines; and about 4
percent are at redistribution sites.  Numerous systems are used to
account for the operating materials and supplies at these various
activities.  Nevertheless, most of the data on operating materials
and supplies at the shore-based locations is available for financial
reporting purposes and, to some limited extent, item managers have
data on excess items for decision-making.  However, this is not the
case for those operating materials and supplies on board ships and
submarines. 

For example, the Atlantic Fleet has developed and implemented the
Force Inventory Management Analysis Reporting System to consolidate
data from ships for fleetwide visibility and redistribution among the
fleet.  The Pacific Fleet has tested the system and is implementing
it.  Yet, according to Atlantic Fleet officials, they are not
planning to provide the item managers information on excesses from
the system for use in their budget and buy decisions.  However, the
information is available for supporting consolidated financial
reporting requirements, and according to Atlantic Fleet officials,
they have provided such information for the Navy's fiscal year 1995
financial reports. 

At the same time, the Aviation Supply Office is planning to turn over
some operating materials and supplies to DBOF, such as repairables at
air stations and on board about 25 ships with aircraft and
helicopters--such as aircraft carriers and amphibious assault
ships--which then become DBOF inventories held for sale.  These DBOF
inventories will remain at the operational level and accounted for by
the units' own asset management system.  One aim of this change is to
improve financial management and reporting, which includes improving
item managers' visibility over these items.  However, the Ships Part
Control Center is not planning a similar change to turn over
repairables to DBOF on the fleets' remaining ships and submarines. 

The Aviation Supply Office's plan considered 41 Naval and Marine
Corps air stations as implementation sites for this program. 
Twenty-four air stations will begin a phased implementation around
mid-1996, and a few ships may have their first prototype system
around April 1997.  However, no specific implementation milestone has
been set for the majority of the 25 ships and the remaining 17 air
stations.  According to the official responsible for the ship portion
of this effort, implementation will depend on available resources,
installation of upgraded automated data processing capabilities, and
the fleets requesting the changes be made. 

Since 1990, the Navy has developed three separate systems or programs
to improve the item managers' visibility over items specifically at
redistribution sites and to provide item managers demand data (on
reissues and returns) which are essential for determining
requirements.  However, progress has been slow and the Navy has not
fully achieved these objectives.  For example: 

  -- The first system was the Consolidated Residual Asset Management
     Screening Information System and has been in use for over 6
     years.  However, it has not adequately met item managers' needs
     because access to the system is manual and labor intensive,
     limiting their ability to obtain timely information, and the
     system does not incorporate demand data. 

  -- The second initiative--the Residual Asset Screening Program
     (RASP)--enhances automated screening capabilities for
     identifying excess items at redistribution sites and other Navy
     activities, and became operational in November 1994.  However,
     RASP only matches item managers' back orders against excess
     items at the redistribution sites.  It does not provide item
     managers on-line visibility over excess items or the capability
     to manage current customer demand. 

  -- The third effort--the Residual Asset Management Program--is
     intended to provide item managers on-line visibility over excess
     items and allow them to manage these assets.  However, as of
     February 1996, it had been implemented at only 2 out of 17
     sites. 

Until the Residual Asset Management Program is fully implemented, the
item managers will still lack complete decision-making information on
item demand at redistribution sites.  Incomplete information will be
further affected by any backlog of items not entered into the
system's data base.  For example, three of the six sites we visited
were not recording receipts of material into their inventory systems
within the 30 days required by informal Chief of Naval Operations
business rules, which limits the completeness of the data base and,
thus, their ability to respond to demand for redistribution.  At one
of the six redistribution sites we visited, its reports showed 457
pallets of material had not been entered into the system, some of
which had been backlogged for over 9 months. 


   REDISTRIBUTION WAREHOUSING
   OPERATION IS REDUNDANT AND
   UNNECESSARY
------------------------------------------------------------ Letter :5

For at least 6 years, the Atlantic and Pacific Fleets, with the
assistance of the Naval Sea Systems Command, have been operating
redistribution sites to store excess items.  During fiscal years 1994
and 1995, they had 17 major redistribution sites with approximately
$455 million of excess items (repairables and consumables) stored in
them that could have been returned to the wholesale supply system. 
These redistribution sites are consumer-level storage facilities
located in the same general geographical areas as the wholesale
supply activities, such as DBOF's Defense Distribution Depots,
illustrated in figure 1.  The three depots at Navy's home
ports--Norfolk, VA, San Diego, CA, and Puget Sound, WA--are
geographically positioned to redistribute items and serve the fleets. 
The geographically dispersed redistribution sites are generally
further away from the home ports.  Thus, given the number of
redistribution sites and their proximity to the home ports, the Navy
could be incurring unnecessary transportation costs.  In addition to
contributing to the visibility problem and poorly informed budget and
buy decisions by item managers as previously discussed, the Navy
incurs unnecessary costs of approximately $2 million annually to
operate and manage 11 of the 17 redistribution sites.  These are
contractor costs that include routine operating costs such as
utilities and personnel.  Operating costs for the other sites and
data processing support costs for all sites were not readily
available.  Most of these costs could be avoided if excess items were
promptly returned to the wholesale supply system. 

   Figure 1:  Locations of Defense
   Distribution Depots Compared to
   Navy's Redistribution Sites as
   of April 1995

   (See figure in printed
   edition.)

Further, if these items were simply returned to the wholesale supply
activities and included in their systems or sent directly to disposal
if appropriate, the need for the numerous system efforts to track and
report on only about 4 percent of operating materials and supplies
discussed in the previous section would be eliminated.  Prolonging
the storage of excess items and not disposing of them can result in
the Navy incurring unnecessary storage and other costs.  For example,
four of the six sites we visited were holding items for more than a
year.  In fact, one site had been holding some items for at least 5
years. 

According to DOD Directive 4100.37, "Retention and Transfer of
Materiel Assets," all serviceable or economically repairable assets
that are excess to retention limits should be reported to the item
manager, who advises on the disposition of the assets and whether
credit will be provided for returning them to the wholesale supply
system.  NAVSUP Publication 500, "Navy Policy and Standards for
Supply Management," specifically requires that (1) repairables in
excess of allowances and (2) consumables that are excess to retention
limits be returned to the wholesale supply system.  Further, as
previously mentioned, "DOD Materiel Management Regulation," requires
item managers to have visibility over assets to help maximize their
redistribution.  It also specifies that items returned to the supply
system are to be considered in determining future requirements and
that demand data, which are a factor used in determining
requirements, be adjusted for these returns. 

According to Navy officials, they have not promptly returned these
items to the supply system because they do not routinely receive
credit for them and may need them in the near future.  Navy officials
further explained that if they returned them promptly but found that
they needed them later, they would then have to purchase them again,
in essence paying twice for an item.  In following up on this point,
we held discussions with logistics officials at DLA and the Office of
Under Secretary for Defense (Acquisition and Technology).  These
officials commented that financial incentives probably need to be
reevaluated to help ensure that all excess items are returned to the
supply system. 

Under 10 U.S.C.  2208(g) and the DOD and Navy policies which
implement it, activities generally will be given credit for returns
when the item managers have immediate needs for the items, are
purchasing the items, or have included them in the budget.  However,
since the fleets do not automatically receive credit and they wish to
avoid paying twice for the same item, the Navy retains these items
either at the operating unit or at the redistribution sites, counter
to DOD's stated policy.  We noted that it was the fleets' surface
ship and submarine operations that were primarily storing excess ship
parts and consumables at redistribution sites.  According to
officials who manage the Atlantic Fleet's air operations, they return
excess items as required by policy and do not operate redistribution
sites. 

The Naval Audit Service also has been critical of the fleets'
operating these redistribution sites.  In a January 1992 report,\10
the Naval Audit Service stated that retaining "off-line" excess
inventories (1) was contrary to supply policy, (2) reduced assurance
that Navy-wide priorities are met and maximum redistribution is
achieved, and (3) is not efficient. 

In September 1992, we reported on a similar situation with Army
redistribution activities for excesses in Europe.\11 We recommended
that the Army transfer ownership of the special redistribution
inventories to the wholesale inventory managers to facilitate
redistribution Army-wide.  The Army concurred with our recommendation
and, on October 26, 1992, directed this program to be discontinued. 


--------------------
\10 Naval Audit Service, 011-S-92, January 15, 1992, Material Held By
Type Commanders. 

\11 Army Inventory:  Problems Managing Excess Supplies as the Army
Draws Down in Europe.  (GAO/NSIAD-92-273, September 22, 1992). 


   ACTIVITIES GENERALLY MEETING
   THE NAVY'S MINIMUM RECORD
   ACCURACY GOAL WITH SOME
   EXCEPTIONS
------------------------------------------------------------ Letter :6

Effectively meeting item manager and consolidated financial reporting
needs is dependent on the adequacy of Navy financial systems
including the accuracy of the underlying unit records.  Thus,
accurate unit records on operating materials and supplies are crucial
to properly support readiness, ensure proper decision-making for
budgets and purchases, and provide reliable financial reporting at
all levels.  At the 15 shore activities--air stations, redistribution
sites, and Trident Refit Facilities--and 12 ships we visited to
assess the accuracy of Navy's records on its operating materials and
supplies, we found that 22 out of 27 met the Navy's minimum inventory
record accuracy rate goal of 95 percent.  We believe that to ensure
reliable financial reporting and maximum operational efficiency, all
units should strive to exceed the minimum goal.  The accuracy rates
we computed were comparable to those being reported by the activities
and ships as a result of their own physical counts. 

Of the 2,619 items valued at $101.3 million in our sample, we found
100 items with quantity and location errors.  The dollar value of
these errors was approximately $5.1 million.  For each location, we
computed accuracy rates based on the number of items with an error
and the dollar value of the errors.  For the locations we visited,
our results showed that: 

  -- Of eight shore activities and seven ships in the Atlantic Fleet,
     only two ships had item accuracy rates below 95 percent--one was
     88 percent, and the other 94 percent.  However, for one of these
     ships, the dollar accuracy rate exceeded 95 percent.  For the
     other ship, the dollar accuracy rate could not be determined
     because insufficient data were provided. 

  -- Of six shore activities and five ships in the Pacific Fleet, one
     air station and one ship had item accuracy rates below 95
     percent--86 percent and 88 percent, respectively.  However, that
     ship's dollar accuracy rate exceeded 95 percent.  The air
     station's dollar accuracy rate was only 78 percent. 

  -- The only air station we visited under the command of the Naval
     Reserve had an item accuracy rate of 91 percent, and its dollar
     accuracy rate was 77 percent. 

For the two air stations that did not meet minimum accuracy rates,
errors primarily were due to the use of the wrong location identifier
or we could not determine the reason.  For the three ships with
errors--two aircraft carriers and a frigate--our results were similar
to those found in the past by the Naval Audit Service.\12 Our testing
revealed that approximately half of the discrepancies were due either
to unprocessed transactions or the use of the wrong location
identifier; the remaining discrepancies could not be readily
explained.  The Naval Audit Service had found that most adjustments
due to discrepancies resulted from unrecorded receipts or issues and
erroneously processed transactions. 

In its 1986 and 1992 reports, the Naval Audit Service recommended
that the Navy develop and issue comprehensive reconciliation
guidelines, improve receiving procedures on ships, enhance automation
and training, and establish a focal point at the Chief of Naval
Operations level to ensure that progress is made.  In addition, as
part of its current audit of Navy's financial reports, the Naval
Audit Service is (1) testing the accuracy of unit records for
operating material and supplies and (2) assessing the effectiveness
of the Navy's actions in response to Naval Audit Service
recommendations.  We believe the Naval Audit Service's current audit
of the Navy's financial reports should determine whether the Navy's
actions adequately address concerns raised by our findings on unit
record accuracy. 


--------------------
\12 Naval Audit Service, S10555, September 30, 1986, Aviation Supply
Management Aboard Aircraft Carriers and Naval Audit Service,
005-W-92, January 27, 1992, Followup On Aviation Supply Management
Aboard Aircraft Carriers. 


   CONCLUSION
------------------------------------------------------------ Letter :7

Item managers need to have visibility over all operating material and
supplies in order to effectively support the Navy's mission and
readiness goals as well as to make the most efficient use of limited
resources.  The present efforts to gain visibility over such items
will not fully address item managers' needs and effectively meet the
CFO Act financial reporting requirements.  Also, the duplicative
supply activities of the 17 redistribution sites are inconsistent
with the central supply functions which DBOF's Defense Distribution
Depots offer, and contribute significantly to the problems associated
with the lack of visibility over excess operating material and
supplies.  By eliminating the duplication of supply activities and
taking a more integrated and coordinated approach to the various
asset visibility program or system efforts, the Navy is in the
position to improve its ability to achieve its mission and readiness
goals, substantially reduce unnecessary annual spending, and meet
consolidated financial reporting requirements. 


   RECOMMENDATIONS
------------------------------------------------------------ Letter :8

We recommend that the Secretary of the Navy direct the Chief of Naval
Operations to take the following actions: 

  -- Direct the fleets to eliminate redistribution sites.  Until the
     redistribution sites are eliminated, we further recommend that
     the Assistant Secretary for Financial Management direct the
     fleets to continue reducing their O&M budget estimates by the
     value of the items annually issued free from these
     redistribution sites. 

  -- Ensure that the various asset visibility efforts are properly
     coordinated and integrated to fully meet the information needs
     of item managers for data on operating materials and supplies. 

  -- In conjunction with the Navy Assistant Secretary for Financial
     Management, ensure that the asset visibility efforts facilitate
     complete, reliable, and prompt consolidated financial reporting
     of operating materials and supplies in accordance with the FASAB
     Statement no.  3 and OMB's financial reporting guidance. 

  -- Report on a quarterly basis to the Secretary of the Navy, the
     progress made on eliminating the unnecessary redistribution
     sites and the asset visibility efforts in meeting item managers
     and consolidated financial reporting needs. 


   AGENCY COMMENTS AND OUR
   EVALUATION
------------------------------------------------------------ Letter :9

DOD generally concurred with the audit findings and most of the
recommendations.  However, DOD strongly disagreed with our
recommendation to disestablish the redistribution sites. 

DOD asserted that the redistribution centers are a sound business
practice because they encourage customers to (1) move excess material
to centralized sites without giving up ownership and (2) aggressively
redistribute assets internally to offset requirements.  Further, DOD
claimed that the use of redistribution sites limits the number of
sites requiring upgraded automation and training as Total Asset
Visibility initiatives progress.  DOD also asserted that elimination
of the redistribution sites with immediate turn-in requirements would
apparently optimize the wholesale level at the expense of the
consumer level and potentially drive excesses underground, resulting
in reduced, rather than enhanced, inventory management at both
levels.  DOD suggested that an alternative to this recommendation
could be to have the Chief of Naval Operations direct accelerated
implementation of the Residual Asset Management program to achieve
complete consideration of all assets at these sites to the Navy
Inventory Control Point requirement determination programs. 

While the Residual Asset Management program is intended to address
our major concern (that is, item manager visibility), we believe the
Navy is not pursuing this objective in the most cost-effective
manner.  Specifically, the Defense Distribution Depots that are
colocated with the three home ports are more centralized locations
than the 17 geograhically dispersed redistribution sites.  Since DBOF
has the capacity and systems in place to give item managers
appropriate visibility and oversight of excess items, the initial
establishment and the continuing operation of the redistribution
sites duplicates existing capabilities and is inefficient.  If the
Navy made redistribution decisions at the point of decommissioning
and overhaul and sent items directly to the appropriate supply and
repair activity at the ships' home ports to satisfy anticipated
short-term future needs, then the redistribution of items might be
accomplished with less transportation, handling, and storage costs. 
Further, disposal decisions would not be prolonged, reducing storage
and other costs.  With total asset visibility down to the operating
unit level, redistribution sites should not be needed to encourage
redistribution of Navy-owned assets and, in fact, add another
operating layer requiring additional systems, people, and controls
and the associated costs to properly manage them.  Accordingly, we
disagree with DOD that the redistribution sites represent centralized
locations and limit the number of locations needing automation
upgrade and training. 

Without adequate financial incentives to ensure that excess items are
returned to DBOF, we understand the potential for "underground"
excesses and recognize this as a legitimate management concern. 
However, an effective and efficient supply system requires adequate
financial incentives and properly designed controls.  It is
management's responsibility to establish proper discipline and
incentives to ensure that policies and procedures are followed.  As
we and the Naval Audit Service have pointed out, operating these
redistribution sites is contrary to supply policies.  DOD's position
is also inconsistent with that taken for Army's redistribution center
in Europe, as discussed in this report.  It is our intent that the
Navy optimize operating material and supplies management from a total
Navy-wide perspective, not at the expense of the consumer level over
the wholesale level.  Effective Navy-wide management and oversight of
operating materials and supplies should help preclude "underground"
excesses. 


---------------------------------------------------------- Letter :9.1

We are sending copies of this report to the Chairmen and the Ranking
Minority Members of the Senate and House Committees on
Appropriations, and their Subcommittees on Defense; the Senate
Committee on Armed Services and its Subcommittee on Readiness; the
Senate Committee on Governmental Affairs; the House Committee on
Government Reform and Oversight as well as its Subcommittee on
Government Management, Information, and Technology; and the House
Committee on National Security.  We are also sending copies to the
Secretary of Defense, Director of the Defense Finance and Accounting
Service, and Director of the Office of Management and Budget.  We
will make copies available to others upon request. 

The head of a federal agency is required by 31 U.S.C.  720 to submit
a written statement on actions taken on our recommendations.  You
must send your statement to the Senate Committee on Governmental
Affairs and the House Committee on Government Reform and Oversight
within 60 days of the date of this report.  You must also send a
written statement to the House and Senate Committees on
Appropriations with the agency's first request for appropriations
made over 60 days after the date of this report. 

If you have questions regarding this report, please call me at (202)
512-9542, or Linda Garrison, Assistant Director, Defense Financial
Audits, at (404) 679-1902.  Major contributors to this report are
listed in appendix III. 

Sincerely yours,

Lisa G.  Jacobson
Director, Defense Financial Audits


SCOPE AND METHODOLOGY
=========================================================== Appendix I

To assess the adequacy of the Navy's accountability and visibility
over its operating materials and supplies, we identified the
inventory management systems used throughout the fleets, at depots,
and at the inventory control points.  We interviewed Navy personnel
at the Ship Parts Control Center, the Aviation Supply Office, Navy
Supply Command Headquarters, and the Atlantic and Pacific Fleets to
help determine what operating material and supplies the item managers
have visibility over, or needed visibility over, for decision-making. 
Our discussions with these Navy personnel included the status of the
Navy's principle efforts to improve asset visibility, particularly
over operating materials and supplies throughout the Navy.  We also
reviewed DOD and Navy accounting and supply policies, accounting
standards recommended by the Federal Accounting Standards Advisory
Board, and OMB guidance on financial reporting. 

To evaluate the Navy's management of excess operating materials and
supplies, we focused our work on operating material and supplies on
ships and at redistribution facilities.  The data we used was as of
July 1995, the most current data files available at the time of our
work, which covered 261 out of 324 active vessels--aircraft carriers,
frigates, cruisers, destroyers, other ships, and some submarines.  We
compared the on-hand quantities to the ships' allowance for each item
to identify potential excesses.  Using the March 1995 item managers'
stratification data (from the final stratification reports used in
the development of fiscal year 1996 and 1997 forecasted
requirements), we determined the extent to which excess items we had
identified could have altered the mix of items that DBOF item
managers were either purchasing or planning to purchase during fiscal
years 1995 through 1997.  For determining the potential dollar
savings, we used the Navy's standard pricing catalog. 

We used a similar methodology for evaluating other excess items using
consolidated data from 12 of 17 redistribution sites as of January
1996.  In addition, at 6 of the 17 redistribution sites, we examined
internal controls over receipt processing, compliance with "business
rules" established by the Chief of Naval Operations, costs of
operations, and accuracy of unit records.  We also discussed the
operation of these redistribution warehouses with Navy, DLA, and
Office of the Secretary of Defense supply officials. 

To assess the accuracy of operating material and supplies records at
the unit level, we performed physical counts at 15 shore locations
and on 12 ships.  These locations accounted for about 26 percent, or
$3.7 billion out of the estimated $14 billion of operating materials
and supplies.  These sites visited represented air stations, Trident
Refit Facilities, redistribution warehouses, and Navy
vessels--aircraft carriers, cruisers, frigates, destroyers, and other
ships. 

From a list of 51 naval air stations provided by the Aviation Supply
Office, we selected all Naval air stations with reported operating
material and supplies valued at $200 million or greater, a total of 4
air stations.  For the remaining air stations we randomly selected
from those that had reported operating materials and supplies.  The
air stations selected had about $1.7 billion, or 57 percent, of the
approximate $3 billion in operating material and supplies reported by
the 51 Naval air stations.  We selected both Trident Refit Facilities
which reported $1.5 billion of operating materials and supplies. 
Also, based on the highest dollar value of items stored, we selected
three redistribution sites of the Atlantic Fleet and three of the
Pacific Fleet.  These sites constituted 61 percent of the total
reported value of items held by redistribution sites--about $455
million as of April 1995.  We selected aircraft carriers, cruisers,
frigates, destroyers, and other ships to visit based on their
availability at home ports. 

To perform our counts, we selected a random sample of 45 items from
operating material and supplies records at each location for
record-to-floor counts and selected an additional 45 items in the
storage areas for floor-to-record counts.  For each error identified,
we worked with Navy supply personnel to determine the cause for it
and attempted to reconcile the variance.  From our results, we
computed accuracy rates for each location based on quantity and
location errors and the dollar value of those errors using the unit
prices from the activity's or ship's records.  We compared our rates
with the Navy's accuracy rate goal of 95 percent and the accuracy
rates determined from the units' own physical inventory programs.  In
addition, we reviewed Navy supply policies and procedures and results
of supply management assessments at the activities we visited. 

We did not assess the reliability of the automated systems from which
we obtained data for our analyses. 

We performed our work from January 1995 through March 1996 in
accordance with generally accepted government auditing standards. 

We performed work at the following locations: 

Naval Supply Systems Command, Arlington, VA
Ship Parts Control Center, Mechanicsburg, PA
Aviation Supply Office, Philadelphia, PA
Commander-in-Chief U.S.  Atlantic Fleet, Norfolk, VA
Commander-in-Chief U.S.  Pacific Fleet, Pearl Harbor, HI
Commander Naval Surface Force, U.S.  Atlantic Fleet, Norfolk, VA
Commander Naval Surface Force, U.S.  Pacific Fleet, San Diego, CA
Commander Naval Air Force, U.S.  Atlantic Fleet, Norfolk, VA
Commander Naval Air Force, U.S.  Pacific Fleet, San Diego, CA
Commander Naval Submarine Force, U.S.  Atlantic Fleet, Norfolk, VA
Commander Naval Submarine Force, U.S.  Pacific Fleet, Pearl Harbor,
HI
Naval Station Mayport, Mayport, FL
Naval Air Station, Cecil Field, Jacksonville, FL
Naval Air Station, Whidbey Island, Oak Harbour,WA
Naval Air Station - Oceana, Virginia Beach,VA
Naval Air Station, Norfolk, Norfolk,VA
Naval Air Station, North Island, San Diego,CA
Naval Air Station, Dallas, Dallas,TX
Trident Refit Facility Bangor, Bangor, WA
Trident Refit Facility Kings Bay, Kings Bay, GA
Defense Distribution Depot, Norfolk, VA
Defense Distribution Depot, San Diego, CA
Fleet Industrial Supply Center, Norfolk, VA
Fleet Industrial Supply Center, San Diego, CA
East Redistributable Material Management System, Portsmouth, VA
West Redistributable Material Management System, Bell, CA
East Ready Resource Materials Program, Chesapeake, VA
West Ready Resource Materials Program, Auburn, WA
Shipbuilding and Conversion, Navy Consolidated Residual Asset
 Management Program, St.  Juliens Creek, VA
Submarine Program for Excess Redistribution, Auburn, WA
USS George Washington
USS Kitty Hawk
USS Trenton
USS Barry
USS Guam
USS Gettysburg
USS Boone
USS Shiloh
USS Tarawa
USS Ft.  Fisher
USS Callaghan
USS Supply




(See figure in printed edition.)Appendix II
COMMENTS FROM THE DEPARTMENT OF
DEFENSE
=========================================================== Appendix I



(See figure in printed edition.)

1 and 2. 



(See figure in printed edition.)



(See figure in printed edition.)


The following are GAO's comments on the Department of Defense letter
dated July 24, 1996. 

GAO COMMENTS

1.  Discussed in "Agency Comments and Our Evaluation" section. 

2.  We question DOD's assertions that (1) the redistribution sites
are a controllable collection and distribution point, and (2)
mandatory turn-in of items to the wholesale system actually occurs
after 12 months.  During our review, we assessed some of the controls
at six of the redistribution sites that held over 61 percent of the
$455 million, as of April 1995, in excess items held at the 17
redistribution sites.  We found that some of the sites were not
following operating rules established by the Chief of Naval
Operations.  As pointed out in the report, 3 of the 6 sites were not
recording receipts of materiel into their inventory systems within
the required 30 days.  In addition, officials at 2 sites told us that
they offer items for return only if they have not had demand for a
year.  Further, we found that 4 of the 6 sites we visited were
holding items for more than a year--1 site had been holding some
items for at least 5 years.  A full discussion of our control testing
at the redistribution sites was not included because it is our
opinion that these sites should not exist. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix III

ACCOUNTING AND INFORMATION
MANAGEMENT DIVISION, WASHINGTON,
D.C. 

William D.  Grindstaff
Alan A.  Steiner

ATLANTA REGIONAL OFFICE

Linda P.  Garrison
Paul D.  Shoemaker
William J.  Cordrey
Christopher T.  Brannon
Marshall L.  Hamlett
Carolyn L.  McClary
Patrick H.  Sevon

SEATTLE REGIONAL OFFICE

Richard L.  Harada
Kelly Campbell


*** End of document. ***