Foreign Military Sales: Navy's Accounting for Sales to Foreign Customers
Needs Improvement (Letter Report, 08/24/1999, GAO/AIMD-99-213).

The Navy did not always charge customer trust fund accounts when goods
and services were delivered under the foreign military sales program.
Moreover, the Navy did not always maintain accurate and reliable
information on trust fund charges. The Navy's accounting records
indicate that, as of October 1998, it had not charged FMS customers'
trust fund accounts for $582 million of delivered goods and services.
According to GAO's review of $75 million of this amount, FMS customers'
accounts had not been charged for $11.3 million for goods and services
provided between April 1987 and December 1997. Without ensuring that
accounts are promptly charged and that the Management Information System
International Logistics System accurately reflects changes, the Navy
cannot be certain that FMS customers are paying the full cost of goods
and services. Moreover, because GAO's review focused on only 13 percent
of the $582 million reported as not charged to FMS customer trust fund
accounts, it is important that the remaining balances be reviewed and
that amounts still owed be promptly collected.

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

 REPORTNUM:  AIMD-99-213
     TITLE:  Foreign Military Sales: Navy's Accounting for Sales to
	     Foreign Customers Needs Improvement
      DATE:  08/24/1999
   SUBJECT:  Trust funds
	     Foreign military sales policies
	     Foreign military sales
	     Military cost control
	     Federal agency accounting systems
	     Foreign governments
	     Reporting requirements
IDENTIFIER:  Foreign Military Sales Program
	     Navy Management Information System International Logistics
	     F-18 Aircraft

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GAO/AIMD-99-213

Report to the Honorable
Charles E. Grassley,
U.S. Senate

August 1999

FOREIGN MILITARY SALES

Navy's Accounting for Sales to Foreign Customers Needs Improvement
Accounting and Information
Management Division

B-281171

August 24, 1999

The Honorable Charles E. Grassley
United States Senate

Dear Senator Grassley:

This report responds to your request that we review the Department of
Defense's (DOD) accounting for and reporting on the costs of the foreign
military sales (FMS) program.1 The report focuses specifically on whether
the Navy has properly charged its FMS customers for goods and services
already provided. As of September 30, 1998, Navy's open FMS sales cases
totaled a reported $60.1 billion. Of this amount, the Navy reported that it
had $25 billion of undelivered orders representing goods and services that
had not yet been delivered to FMS customers. As agreed with your office, we
will subsequently review and report on whether the Army and Air Force are
properly charging FMS customers for goods and services already provided.

The Navy did not always (1) charge FMS customer trust fund accounts when
goods and services were delivered under the FMS program or
(2) maintain accurate and reliable information on trust fund charges. As of
October 1998, Navy's FMS accounting records indicated that it had not
charged FMS customer trust fund accounts for $582 million of delivered goods
and services. According to our review of $75 million of this amount, FMS
customer accounts had not been charged for $11.3 million for goods and
services provided between April 1987 and December 1997.2

For example, in 1996, the Navy provided support services valued at
$1.1 million for Canada's Navy Patrol Frigate Harpoon Shipboard Command and
Launch System. Instead of charging Canada's trust fund account for the $1.1
million, the Navy incorrectly charged (1) $636,123 to its appropriations and
(2) $450,882 to the trust fund accounts of Greece and Japan. Further,
although the remaining $18,507 was charged to Canada's account, it was
recorded incorrectly in the Navy's system. Navy officials agreed with our
findings and told us that they plan to correct the erroneous charges to the
Greece and Japan accounts and will also charge Canada's account in order to
reimburse the Navy appropriation for the $636,123.

For the remaining $62 million of balances in our sample, we found that the
Navy's accounting records included inaccurate data on the status of charges
to FMS customer trust fund accounts, making it difficult for Navy managers
to accurately account for and report on the FMS program. For example, Navy's
accounting records showed that Kuwait's trust fund account had not been
charged $54 million for three F-18 aircraft it received in 1993. However, we
found that Kuwait's trust fund account had, in fact, been charged for the
full amount and that the Navy's accounting system did not reflect the
charges because erroneous data had been entered in the system.

We are recommending that the Navy (1) recover the amounts we identified as
owed by FMS customers and (2) correct errors in its accounting system. We
are also recommending that the Navy work with the DOD Comptroller to develop
and implement a plan to review the remaining $507 million of transactions
recorded in the Navy's system that were reportedly not charged to foreign
customer trust fund accounts and (1) charge FMS customer accounts for goods
and services already provided, (2) correct erroneous transactions, and (3)
address the problems causing these errors to occur.

In commenting on a draft of our report, the Defense Deputy Chief Financial
Officer generally concurred with our findings and recommendations. He stated
that the Navy and the Defense Finance and Accounting Service (DFAS) have
taken significant steps in correcting the situation we identified. For
example, he pointed out that they have taken steps to properly charge the
FMS trust fund accounts for $8.8 million of the
$11.3 million identified in this report as not properly charged to FMS
customer accounts. He said that the processing of the remaining
$2.5 million will be completed by October 1999. He also described several
other current or planned initiatives that will result in the implementation
of our recommendations.

The Arms Export Control Act gives the President authority to sell defense
articles and services to eligible foreign countries, generally at no cost to
the U.S. government. While the Defense Security Cooperation Agency (DSCA)
has overall responsibility for administering the FMS program, the Army,
Navy, and Air Force generally execute the sales agreements, which are
commonly referred to as sales cases.

Foreign military sales are made on an individual case basis. A foreign
country representative initiates a case by sending a letter of request to
DOD asking for information such as the price and availability of goods and
services, training, technical assistance, and follow-on support. Once the
customer decides to proceed with the purchase, DOD prepares a Letter of
Offer and Acceptance (LOA) stating the terms of the sale for the items and
services being provided. After the LOA is accepted, the FMS customer is
generally required to pay, in advance, amounts necessary to cover costs
associated with the services or items purchased from DOD. The Department of
the Treasury holds these advance payments in an FMS trust fund. DOD then
uses these funds to pay private contractors--commonly referred to as direct
cite payment transactions--and/or reimburse DOD activities for the costs of
goods and services provided and other costs related to executing and
administering the FMS sales agreement, commonly referred to as reimbursable
payment transactions. If for some reason DOD fails to process the
appropriate charges against the FMS trust fund accounts, amounts FMS
customers paid in advance to cover the costs of goods and services could
eventually be returned to them.

The objective of this review was to determine whether the Navy was charging
FMS customer trust fund accounts for goods and services already provided. To
determine the requirements and procedures for charging the FMS trust fund
for goods and services, we obtained and reviewed applicable laws,
regulations, policies, and procedures. During our visits to DOD locations,
we gathered and analyzed financial information from pertinent accounting
records and reports to identify data on deliveries of goods and services and
related charges to the FMS trust fund accounts.

To select transactions for detailed review, we obtained a database from the
Navy's Management Information System International Logistics (MISIL) which
included 25,993 delivery transactions totaling $582 million for which there
were no corresponding charges to the FMS customer trust fund accounts to
show that the customers had been charged for the goods and services
provided. Our analysis showed that there were 14,173 reimbursable and 11,820
direct cite transactions totaling $71,092,232 and $510,837,316,
respectively.3 We judgmentally selected 20 of the 25,993 transactions for
detailed review based primarily on (1) large dollar amounts and (2) the type
of financing involved to ensure that both reimbursable and direct cite
transactions were included. We did not independently verify the integrity of
the MISIL database. The 20 transactions are listed in appendix I.

To determine whether an FMS customer had received the goods and services and
its trust fund account had been charged, we contacted the staff responsible
for managing the FMS case and/or other officials knowledgeable about the
case to identify the (1) number, type, and value of goods and services the
FMS customer received, (2) date the FMS customer received the goods or
services, and (3) amount that the FMS customer's trust fund account had been
charged for the goods and services. We also asked the officials to
independently calculate how much the FMS customer should have been charged,
compared it with our calculated amounts, and resolved any differences. In
those instances where it was determined that the FMS customer's trust fund
account had not been charged, we asked responsible FMS program officials to
provide an explanation.

We performed our work at and obtained documents from headquarters of the
Defense Security Cooperation Agency, Office of the Under Secretary of
Defense (Comptroller), and the Naval Sea Systems Command, Arlington,
Virginia; Naval Air Systems Command, Patuxent River, Maryland; Naval
Inventory Control Point, Philadelphia, Pennsylvania; Naval Ordnance Command,
Indian Head, Maryland; and Defense Finance and Accounting Service locations
in Denver, Colorado; Columbus and Cleveland, Ohio; and Charleston, South
Carolina. We performed our work between September 1998 and June 1999 in
accordance with generally accepted government auditing standards.

We requested written comments on a draft of this report from the Secretary
of Defense or his designee. The Deputy Chief Financial Officer provided
written comments, which are discussed in the "Agency Comments and Our
Evaluation" section and are reprinted in appendix II.

Customers for Goods and Services

The Navy did not always promptly charge foreign customer trust fund accounts
when goods and services were delivered under the FMS program. In addition,
the Navy's accounting system contained inaccurate data on the status of
charges to the FMS customer trust fund accounts, making it difficult for
Navy managers to monitor the status of the FMS program. As of October 1998,
the Navy's MISIL accounting records indicated that FMS customer trust fund
accounts had not been charged for goods and services amounting to $582
million--79 percent of which had been reported as delivered over 3 years
ago. Table 1 provides additional details.

 Time period       Delivered dollar amount  Number of transactions

 Up to 1 year      $56,761,184              12,832

 1 to 2 years      31,812,557               1,865

 2 to 3 years      32,360,014               2,787

 More than 3 years 460,995,793              8,509

 Total
                   $581,929,548             25,993

Source: Navy's MISIL accounting records data as of October 1998.

Services

Volume 15 of DOD's Financial Management Regulation 7000.14-R, entitled
Security Assistance Policy and Procedures, states that implementing agencies
shall report accrued expenditures and physical deliveries to the DFAS Denver
Center within 30 days of date of shipment or performance. The regulation
also requires the Center to charge the FMS customer's trust fund account
within 20 days after receiving notification that the goods or services have
been delivered. The following describes what generally should be a typical
transaction flow to report the delivery of items and services and to charge
FMS customer trust fund accounts.

Navy program and logistical offices responsible for managing and reporting
on the delivery of items and services generally receive shipping documents

from those activities providing the items and services to FMS customers.4 As
expenditures against the trust fund accounts are accrued and the goods and
services are delivered, this information is to be recorded in MISIL. MISIL
then transmits the expenditure and delivery information to the DFAS Denver
Center, which maintains the records on each country's trust fund balance and
issues quarterly statements to FMS customers summarizing amounts charged to
their cases. If the goods and services were paid for using the reimbursable
method, the Center will process vouchers charging the FMS customer's trust
fund account and reimbursing the Navy's appropriation account. If the goods
and services were paid for using the direct cite method, which does not
require a reimbursement, the Center only has to record the charges against
the appropriate FMS customer's trust fund account.

Navy did not always promptly charge FMS customers for goods and services
already provided. We found that FMS customer trust fund accounts had not
been charged $11.3 million for the goods and services provided under all 14
of the reimbursable-type transactions in our sample and for 1 of the 6
direct cite transactions. The following are examples of transactions where
FMS customer trust fund accounts had not been charged for the goods and
services already provided.

Navy reported that one of its inventory stock points shipped a total of
280,000 rounds of 20 millimeter ammunition to Canada in 1997. Since this was
a reimbursable transaction, Canada's trust fund account should have been
charged $3,393,600 for the costs of the ammunition and the Navy's
appropriation account should have been reimbursed for the same amount.
However, our review disclosed that Canada's trust fund account had not been
charged for these items as of February 1999. While Navy program officials
agreed with our finding, they could not explain why Canada's trust fund
account had not been charged. They added that they were not aware of the
problem until we brought it to their attention and now plan to take the
necessary actions to charge Canada's trust fund account for the amount owed.

Navy's MISIL system indicated that seven helicopters from Navy's inventory
of excess defense articles had been shipped to New Zealand between January
1997 and December 1997. Our review of these seven reimbursable transactions
disclosed that the Navy should have charged New Zealand's trust fund account
a total of $4,184,733, or $597,819 for each helicopter. We found, however,
that New Zealand's trust fund had not been charged. The FMS case manager
acknowledged that New Zealand's account had not been charged for the seven
helicopters but could not tell us why. After we brought the situation to the
Navy's attention, Navy officials told us they plan to charge New Zealand's
trust fund account for the amount owed.

In 1996, the Navy provided support services valued at $1.1 million for
Canada's Navy Patrol Frigate Harpoon Shipboard Command and Launch System.
Our review of this direct cite transaction found a combination of errors
resulting in undercharges and incorrect postings to the MISIL accounting
records. For example, instead of charging Canada's trust fund account for
the $1.1 million of services, the Navy incorrectly charged $636,123 to its
appropriations and $450,882 to the trust fund accounts of Greece and Japan.
Further, although the remaining $18,507 was charged to Canada's trust fund,
it was recorded incorrectly in MISIL. According to the Navy program manager,
errors in entering two contract modifications affected the obligation and
expenditure balances in MISIL. As a result of these errors, actual charges
to Canada's trust fund account were reduced and the Navy, Greece, and Japan
accounts were charged by mistake. Navy officials agreed with our finding and
told us that they plan to correct the erroneous charges to the Greece and
Japan accounts. They also agreed to correct the erroneous charge to the Navy
appropriation account by correctly charging Canada and reimbursing the Navy
appropriation for $636,123.

The results of the 15 transactions where FMS customers' accounts were not
properly charged are summarized in table 2.

 Country and case code Goods and services          Amount not charged to
                       delivered to customers      FMS trust funds

 Canada-ANB            Ammunition                  $3,393,600

 Pakistan-ABU          Rocket motors               1,628,305

 Greece-GCV            Packing, crating, handling  414,781

 Greece-GCV            Transportation              444,408

 Egypt-ABN             Ammunition                  3,026

 New Zealand-SAA       Helicopter                  597,819

 New Zealand-SAA       Helicopter                  597,819

 New Zealand-SAA       Helicopter                  597,819

 New Zealand-SAA       Helicopter                  597,819

 New Zealand-SAA       Helicopter                  597,819

 New Zealand-SAA       Helicopter                  597,819

 New Zealand-SAA       Helicopter                  597,819

 Philippines-LBX       Ground handling equipment   336,000

 Turkey-AGJ            Projectiles 5 inch          243,936

 Canada-GKJ            Harpoon system services     636,123

 Total
                                                   $11,284,912a

aNavy's MISIL incorrectly reported that the 15 transactions totaled $12.9
million.

Our analysis and discussions with program officials for the remaining five
direct cite transactions in our sample totaling $62 million found that FMS
customer trust fund accounts had, in fact, been charged. However, because of
various accounting errors, the Navy's MISIL system did not accurately
reflect the charges. As a result, MISIL was not providing accurate and
reliable information for managers to use when monitoring delivery and
billing transactions. The following example involves three direct cite
transactions where the MISIL system did not accurately reflect a charge to
the customer's account.

MISIL showed that in 1993 Kuwait received three separate deliveries of F-18
aircraft, each valued at $18,127,142, for a total of over $54 million. While
we found that the Navy had in fact charged Kuwait's account for this amount,
the MISIL system did not reflect the charges as of October 1998. After we
brought this to the attention of Navy officials, they told us that their
research showed that the failure to record the charges to the trust fund
account occurred because the contractor submitted incorrect delivery reports
to the Navy that contained accounting errors and were rejected by the
accounting system. However, they could not tell us why the 5-year-old
rejected transactions had not been corrected. They told us that they now
plan to correct the information in MISIL.

The Navy is not always charging FMS customers in a timely manner to recover
its costs for delivered goods and services. Without ensuring that accounts
are promptly charged and that the MISIL system accurately reflects charges,
the Navy will not be able to effectively ensure that FMS customers are
paying the full cost for goods and services, as required by the Arms Export
Control Act. Furthermore, because our review focused on only 13 percent of
the $582 million reported as not charged to FMS customer trust fund
accounts, it is important that the remaining balances be reviewed and that
amounts still owed be promptly collected.

We recommend that the Secretary of Defense direct the Secretary of the Navy
to (1) collect from the FMS trust fund accounts the $11.3 million identified
in this report that has not been charged to FMS customer trust fund accounts
for goods and services already provided and (2) place increased management
emphasis on monitoring and follow-up efforts to ensure that foreign customer
trust fund accounts are promptly charged for all goods and services and
errors recorded in MISIL are promptly identified and corrected.

We also recommend that the Secretary of Defense direct the Secretary of the
Navy and the Under Secretary of Defense (Comptroller) to develop and
implement a plan to review the remaining $507 million of transactions
recorded in the Navy's MISIL system to (1) identify and collect amounts FMS
customers owe for goods and services already provided, (2) correct erroneous
transactions in MISIL, and (3) determine the causes for these type of errors
and take action to eliminate similar errors in the future.

With respect to the remaining $507 million of MISIL transactions, the review
could initially focus on the reimbursable transactions since we found that
100 percent of the reimbursable transactions in our limited sample
represented amounts where FMS customer accounts had not been charged for the
goods and services already provided.

In commenting on a draft of this report, the Defense Deputy Chief Financial
Officer (CFO) generally concurred with our findings and recommendations. He
stated that the Navy and DFAS have initiated actions to address our findings
and recommendations. For example, the Deputy CFO commented that Navy and
DFAS have already taken steps to charge the FMS trust fund accounts for $8.8
million of the $11.3 million this review found had not been properly
charged. He stated that the processing of the remaining $2.5 million to
properly charge the FMS trust fund accounts is expected to be completed by
October 1999. He also stated that the Navy and DFAS have made significant
progress in developing and implementing a plan to review the remaining $507
million of MISIL transactions. Finally, he stated that the Navy and DFAS
have already implemented several measures designed to ensure that foreign
customer trust fund accounts are promptly charged for goods and services
when received.

We are sending copies of this report to Senator Robert C. Byrd, Senator Carl
Levin, Senator Joseph I. Lieberman, Senator Ted Stevens, Senator
Fred Thompson, Senator John W. Warner, Representative Dan Burton,
Representative Benjamin A. Gilman, Representative Stephen Horn,
Representative David R. Obey, Representative Ike Skelton, Representative
Floyd D. Spence, Representative Jim Turner, Representative Henry A. Waxman,
and Representative C. W. Bill Young in their capacities as Chair or Ranking
Minority Member of Senate and House Committees and Subcommittees. We are
also sending copies of this report to the Honorable William S. Cohen,
Secretary of Defense; the Honorable Richard Danzig, Secretary of the Navy;
and the Honorable Jacob J. Lew, Director, Office of Management and Budget.
We will make copies available to others upon request.

If you have any questions regarding this report, please contact me at
(202) 512-6240 or Larry W. Logsdon at (703) 695-7510. Other key contributors
to this report were Harold P. Santarelli and John A. Spence.

Sincerely yours,

Jack L. Brock, Jr.
Director, Governmentwide and Defense
Information Systems Issues

14

15

Table 1: Aging Schedule for Delivered Goods and Services
Reportedly Not Charged to FMS Customer Trust Fund
Accounts 5

Table 2: Amounts Not Properly Charged to FMS Customer
Trust Fund Accounts 8

CFO chief financial officer

DFAS Defense Finance and Accounting Service

DOD Department of Defense

DSCA Defense Security Cooperation Agency

FMS foreign military sales

LOA Letter of Offer and Acceptance

MISIL Management Information System International Logistics

List of Selected Transactions

 Country and case code Type of transaction  Estimated item value recorded
                                            in MISIL

 Canada-ANB            Reimbursable         $3,337,600

 Pakistan-ABU          Reimbursable         1,628,305

 Greece-GCV            Reimbursable         693,311

 Greece-GCV            Reimbursable         742,829

 Egypt-ABN             Reimbursable         605,200

 New Zealand-SAA       Reimbursable         597,820

 New Zealand-SAA       Reimbursable         597,820

 New Zealand-SAA       Reimbursable         597,820

 New Zealand-SAA       Reimbursable         597,820

 New Zealand-SAA       Reimbursable         597,820

 New Zealand-SAA       Reimbursable         597,820

 New Zealand-SAA       Reimbursable         597,820

 Philippines-LBX       Reimbursable         336,000

 Turkey-AGJ            Reimbursable         268,330

 Finland-SAA           Direct cite          1,000,000

 Canada-GKJ            Direct cite          1,105,512

 Kuwait-SAO            Direct cite          6,630,000

 Kuwait-SAO            Direct cite          18,127,142

 Kuwait-SAO            Direct cite          18,127,142

 Kuwait-SAO            Direct cite          18,127,142

 Total
                                            $74,913,253

Comments From the Department of Defense

The following is GAO's comment on the Department of Defense's letter dated
July 29, 1999.

In many of the transactions we reviewed, we found that the Navy was not
aware that funds had not been transferred from the FMS customer trust fund
accounts to the Navy accounts to pay for the goods and services they had
received. This oversight represents poor financial management practices that
resulted in long periods of time when the Navy used its own funds to finance
sales to foreign customers. It also significantly increased the risk that
amounts will never be charged to the FMS trust fund accounts and that the
earlier collections, deposited in advance into the FMS trust fund for the
purpose of paying for goods and services, will be erroneously returned to
foreign customers.

Aging Schedule for Delivered Goods and Services Reportedly Not Charged to
FMS Customer Trust Fund Accounts 5

Amounts Not Properly Charged to FMS Customer Trust Fund Accounts. 8
  

1. In response to this request, we have also issued two reports that
identified a total of over $335 million of nonrecurring research,
development, and production costs for major defense equipment that had not
been charged to FMS customer trust fund accounts. See Foreign Military
Sales: Millions of Dollars of Nonrecurring Research and Development Costs
Have Not Been Recovered (GAO/AIMD-99-11, October 20, 1998) and Foreign
Military Sales: Recovery of Nonrecurring Research, Development, and
Production Costs (GAO/AIMD-99-148R, May 19, 1999).

2. The Navy's accounting system inaccurately reported this amount as $12.9
million.

3. Under the reimbursable method, the Navy uses its own appropriation to
initially purchase the goods or services being provided. Upon sale to an FMS
customer, the FMS customer's trust fund account is charged for the value of
the goods and services and the Navy appropriation is reimbursed. Conversely,
under the direct cite method, reimbursement is not required because the FMS
customer's trust fund account is used as the source of funding to pay the
vendor who provided the goods and services.

4. Activities providing items and services can consist of Army, Navy, and
Air Force locations, or other DOD locations, as well as private sector
contractors doing business in the FMS program.
*** End of document. ***