Defense Inventory: Air Force Needs to Improve Control of Shipments to Repair Contractors

Defense Inventory: Air Force Needs to Improve Control of Shipments to Repair Contractors (07/01/2002, GAO-02-617}

-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-02-617
TITLE: Defense Inventory: Air Force Needs to Improve Control of Shipments to Repair Contractors
DATE: 07/01/2002

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United States General Accounting Office:
GAO:

Report to Congressional Requesters:

July 2002:

Defense Inventory:

Air Force Needs to Improve Control of Shipments to Repair Contractors:

GAO-02-617:

Contents:

Letter:

Results in Brief:

Background:

Procedures to Control Shipped Inventory Are Not Being Followed or Are
Ineffective:

Contractors Given Unrestricted Access to Government-Furnished Material:

Quarterly Shipment Reports Not Provided:

Contractors Not Posting Government-Furnished and Manager-Directed
Material Receipts:

Contractors Not Reporting Shipment Discrepancies:

Procedures for Following Up on Unconfirmed Material Receipts Are
Ineffective:

Air Force Has Not Established Integrated Financial Management System:

Air Force Program Oversight Is Insufficient:

Conclusions:

Recommendations for Executive Action:

Agency Comments and Our Evaluation:

Appendix I: Scope and Methodology:

Appendix II: Comments from the Department of Defense:

Appendix III: GAO Staff Acknowledgments:

Related GAO Products:

Tables:

Table 1: Fiscal Year 2000 Shipments by Number, Value, and Type:

Table 2: Types of Shipments in Fiscal Year 2000:

Table 3: Status of Material Receipt, from GAO Review of Shipments in
Fiscal Year 2000:

[End of section]

United States General Accounting Office:
Washington, DC 20548:

July 1, 2002:

The Honorable Richard J. Durbin:
The Honorable Tom Harkin:
United States Senate:

The Honorable Peter A. DeFazio:
The Honorable Carolyn B. Maloney:
House of Representatives:

This is one in a series of reports addressing defense inventory
vulnerabilities to fraud, waste, and abuse. (A list of related GAO
products appears at the end of this report.) Since at least 1990, our
office has considered Department of Defense inventory management to be
a high-risk area because inventory management systems and procedures are
ineffective. A lack of control over inventory shipments increases their
vulnerability to undetected loss and theft and substantially increases
the risk that millions of dollars will be spent unnecessarily. In
response to your request, this report evaluates the Air Force�s
inventory control procedures for material shipped to contractors for
repair or for use in repair. Specifically, we assess the Air Force�s
adherence to procedures designed to safeguard this material.

The Air Force contracts with private companies (i.e., repair and
production contractors) to produce, maintain, and repair its equipment.
In some cases, the Air Force furnishes from its inventories some or all
of the parts necessary to perform the contracts. Control responsibility
for this material is the shared responsibility of the Air Force
Materiel Command and its three inventory control points, the Defense
Logistics Agency, and repair contractors. The Air Force Materiel
Command administers the Air Force�s supply system and provides
management policies and procedures. Through its three inventory control
points, the command authorizes inventory movement from Defense Logistic
Agency storage depots Footnote 1] to repair contractors. The Defense
Logistics Agency�which operates and manages 24 storage depots�receives,
stores, and issues Air Force inventory and maintains Air Force
inventory records. In addition, the Defense Contract Management Agency,
through its property administrators, assesses the accuracy of repair
contractor records and determines whether all government property is
accounted for. Contractors are responsible for establishing and
maintaining systems to control, protect, preserve, and maintain all
government property.

To assess adherence to procedures, we examined shipments valued at
about $2.6 billion to the Air Force�s repair contractors in fiscal year
2000. These shipments included classified, sensitive, pilferable, and
unclassified items. [Footnote 2] We primarily focused our work at the
three Air Force inventory control points and 12 selected Air Force
repair contractors (associated with 14 repair contracts). More details
about our scope and methodology appear in appendix I.

Results in Brief:

The Air Force and contractor personnel have largely not complied with
Department of Defense and Air Force inventory control procedures
designed to safeguard material shipped to contractors, placing items
worth billions of dollars at risk of fraud, waste, and abuse. The
following items identify inadequate procedures and departures from
required procedures:

* The Air Force�s three inventory control points have not restricted
repair contractors� access to the specific items and quantities of
government-furnished material [Footnote 3] needed to accomplish the
contract. This practice could allow contractors to obtain unneeded and
unauthorized material.

* The inventory control points have not sent quarterly reports on the
status of shipped material to property administration officials at the
Defense Contract Management Agency. Without the quarterly reports, these
officials cannot independently verify that contractors have accounted
for government-furnished material.

* Contractors receiving shipped material have not (1) properly entered
the receipt of shipments into their records and into the inventory
control points� reporting systems or (2) routinely reported shipment
discrepancies. These failures impair the Air Force�s ability to account
for shipments worth millions of dollars. Unaccounted-for inventory
included items that warrant a high degree of protection and control,
such as circuit card assemblies and navigation set control units.

* Air Force procedures for following up on shipments that contractors
have not confirmed as received are ineffective, leaving the exact
status of the shipments uncertain.

* The Air Force has not provided adequate program oversight because it
does not request and analyze data on contractor shipment discrepancies
to identify the extent and cause of discrepancies so that corrective
action may be taken. This lack of oversight impedes the Air Force�s
ability to improve its supply operations and to determine which
activities are responsible for lost or misplaced items.

We are recommending that the Secretary of Defense direct the Secretary
of the Air Force to improve compliance with existing procedures for
controlling shipped inventory and to improve the procedures themselves.
In written comments on a draft of this report, the Department of Defense
concurred with six recommendations, non-concurred with one
recommendation, and partially concurred with three recommendations. The
main point the Department makes is that it has corrected problems with
an automated internal control system for loading stock numbers and
quantities and screening them against contractor requisitions.
Therefore, we modified our recommendations, stating that the
effectiveness of this automated internal system must be demonstrated.

Background:

Inventory shipped for repair or in support of repairs typically
involves the following types of material:

* Manager-directed material, which item managers direct to be shipped
to a contractor for repair, alteration, or modification.

* Government-furnished material, which contractors requisition in
support of repairs, alterations, or modifications. Generally, this
material is incorporated into or attached onto deliverable end items
(final products such as aircraft) or consumed or expended in performing
the contract.

For fiscal year 2000, Air Force logistics records for all inventory
control points showed the following number, value, and type of material
had been shipped to contractors (see table 1).

Table 1: Fiscal Year 2000 Shipments by Number, Value, and Type:

Manager-directed material:
Universe of shipments, Number of shipments: 12,222;
Universe of shipments, Value: $2,371,663,119.

Government-furnished material:
Universe of shipments, Number of shipments: 9,222;
Universe of shipments, Value: $252,406,484.

Total:
Universe of shipments, Number of shipments: 21,444;
Universe of shipments, Value: $2,624,069,603.

Source: Item Manager Wholesale Requisition Process System.

[End of table]

Table 2 shows a breakdown of all shipments to contractors in fiscal year
2000 by the security type, number of items, and dollar value of
shipments.

Table 2: Types of Shipments in Fiscal Year 2000:

Classified military items:
Number of shipments: 7,110;
Number of items: 57,920;
Value: $1,613,289,625.

Sensitive items:
Number of shipments: 1;
Number of items: 48;
Value: $50,884.

Pilferable items:
Number of shipments: 132;
Number of items: 440;
Value: 7,248,022.

Nonsensitive items:
Number of shipments: 13,491;
Number of items: 102,767
Value: $944,960,004.

Items with unknown security classification:
Number of shipments: 710;
Number of items: 1,305;
Value: $58,521,065.

Total:
Number of shipments: 21,444
Number of items: 162,480
Value: $2,624,069,603.

Source: GAO analysis.

[End of table]

Department of Defense (DOD) policy contains specific internal control
procedures to help ensure that shipped inventory is accounted for. When
an item is shipped, a shipping notification should be sent to the
receiving contractors. The intended recipient of the material is
responsible for notifying the inventory control point once the item has
been received or if a discrepancy exists (e.g., the item was not
received or the quantity received was less than expected). The
notification of receipt and discrepancy reporting processes are
internal controls designed to account for all shipped assets. If within
45 days of shipment the inventory control point has not been notified
that a shipment has arrived, it is required to follow up with the
intended recipient. The rationale behind this requirement is that until
receipt is confirmed, the exact status of the shipment is uncertain and
therefore vulnerable to fraud, waste, and abuse.

Procedures to Control Shipped Inventory Are Not Being Followed or Are
Ineffective:

As a result of departures from required procedures or ineffective
procedures, the Air Force�s shipped inventory is vulnerable to loss or
theft. First, the Air Force has allowed repair contractors access to
government-furnished material not needed to fulfill the repair
contract. Second, inventory control points have not provided property
administrators with the required government-furnished material status
reports to use in verifying contractor records of government-furnished
material received. Third, contractors have not adequately recorded
receipt of items and reported receipt to inventory control points.
Fourth, contractors have not routinely reported discrepant shipments to
the designated shipping activity. Fifth, Air Force procedures for
following up on shipments that contractors have not confirmed as
received are ineffective. Sixth, the Air Force has not provided
adequate oversight of shipments to contractors.

Contractors Given Unrestricted Access to Government-Furnished Material:

DOD requires inventory control points to establish one or more internal
control systems (i.e., management control activities) to restrict
contractor access to government-furnished material. Among other things
intended, the control systems are to screen all repair contractor
requisitions for validation and approval and to restrict contractor
access to government-furnished material to the specific items and
quantities listed in the repair contract. However, the inventory
control points� systems generally screen and restrict access to
government-furnished material by a federal stock class or stock group
rather than by stock number and quantity. [Footnote 4] Also, the
contracts we reviewed generally did not specify, as required, both the
items and the quantities of material that the inventory control points
had agreed to furnish to contractors. [Footnote 5] As long as
contractors requisition items within an authorized federal stock class
or stock group, government-furnished material is automatically provided
whether or not it is needed to fulfill the repair contract.

In a July 1997 memorandum, the Air Force Materiel Command reiterated
the requirement that the inventory control points screen all repair
contractor requisitions by stock number and quantity for validation and
approval, and it developed procedures for an automated method of loading
stock numbers and quantities into the control systems. Air Force
officials indicate that the major obstacle now is that the procedures
for the automated method of loading stock numbers do not work as
designed. For this reason, the Air Force Materiel Command waived the
requirement for screening by stock number and quantity and allowed
inventory control points to continue to screen contractor requisitions
for government-furnished material at the federal stock class or stock
group level.

The following example illustrates the weakness in the current screening
process. A contract we reviewed listed 14 specific, stock-numbered
parts�from seven different stock classes�that were required to repair
the end item (an electronic countermeasures system for the B-52H
aircraft). However, because the inventory control point�s system
screened and restricted the contractor�s access to government-furnished
material by federal stock class, the contractor could requisition any
item from the seven different stock classes in which the 14 parts are
grouped. The seven stock classes contain over 502,900 other stock-
numbered parts that are not needed to repair the end item. The
contractor could requisition any of these parts, in any quantity, and
the improper requisition could pass through the inventory control
point�s screening system and be approved.

We did not determine whether contractors had obtained unauthorized
material as a result of their access to material by federal stock class
or group. However, these control weaknesses are the same as those
identified in earlier reports as having allowed contractors to obtain
unneeded and unauthorized material. For example, in a 1998 report on the
adequacy of government oversight over government-furnished material to
a contractor, the Air Force Audit Agency reported 2,978 of the 5,569
validated requisitions were not needed to accomplish the contract. The
unneeded requisitions included 1,090 stock numbers valued at $17.4
million. Similarly, a 1995 DOD inspector general report on management
access to the DOD supply system concluded that granting contractors
access to government-furnished material in the DOD supply system by
federal stock class continued to be a material internal control weakness
that placed DOD material at undue risk.

Quarterly Shipment Reports Not Provided:

To independently verify that contractors have accounted for all
government-furnished material received, DOD policy requires inventory
control points to provide to property administrators at the Defense
Contract Management Agency quarterly status reports showing all
shipments of Air Force material to contractors. Inventory control point
officials responsible for distributing the reports to property
administrators told us that the reports have not been sent.

We found that existing Air Force procedures governing distribution of
the quarterly status reports do not assign responsibility for
distributing these reports to officials at inventory control points and
are outdated (e.g., the systems for generating the reports no longer
exist). Air Force officials acknowledge that the procedures are not
current and stated that they are in the process of updating them.

Proper distribution of government-furnished material status reports has
been a long-standing issue. For example, a 1995 Department of Defense
inspector general audit report on management access to the DOD supply
system stated that the Air Force should take the distribution of its
status report more seriously, ensuring that the report is issued each
quarter. The audit report asserts that property administrators are the
last line of defense in protecting material resources and, as such,
they need an independent record of the government-furnished material
shipped to contractors. The Air Force�s quarterly status report
provides such a record; without it, property administrators must rely
entirely on contractors� records.

Contractors Not Posting Government-Furnished and Manager-Directed
Material Receipts:

Department of Defense and Air Force policies contain specific procedures
governing the notifications that contractors should send to their
inventory control points when they receive shipped inventory. The
policies state that, upon receipt of an item, a receiving contractor
must enter the shipment into its inventory records and notify the
inventory control point of material receipt. To accomplish notification
of receipt, the Air Force requires contractors to enter receipts into a
reporting system at the appropriate inventory control point. The
notification of receipt is an internal control designed to account for
all shipped assets.

During fiscal year 2000, the Air Force shipped thousands of items with a
reported value at about $2.6 billion to contractors. As part of our
review, we sought to determine whether items reportedly shipped to
repair contractors had in fact been received and entered into both the
contractors� records and the inventory control points� reporting
systems.

Our review indicated that contractors are not following policies
governing receipt notification. Of the $2.6 billion of inventory
shipped to contractors in fiscal year 2000, we judgmentally selected
and reviewed 9,003 items valued at $814.2 million. We found that
contractors had not always properly posted material receipts for these
items into their records or into the inventory control points�
reporting systems. Specifically, 48 percent of these items had been
received and properly posted by contractors to the inventory control
points� reporting systems; 19 percent of the shipped items had been
received but were either improperly posted or not posted by contractors
to their records and/or the inventory control points� reporting
systems; and 33 percent of items reportedly had not been received by
contractors or lacked sufficient documentation to prove that they had
been accounted for by the contractors. The items unaccounted for
included those that warrant a high degree of protection and control
because of their high value and/or their security classification, such
as circuit card assemblies and navigation set control units. This lack
of documentation is in itself an internal control weakness. For
example, the federal acquisition regulation requires that contractors�
property control records provide a complete, current, and auditable
record of all transactions involving government property. Table 3
presents more detailed information on the items in our review.

Table 3: Status of Material Receipt, from GAO Review of Shipments in
Fiscal Year 2000:

Shipment properly posted to the reporting system: Contractor received
items and entered items into the reporting system using the correct
document number, stock number, and quantity:
Number of items: 4,315;
Value: $247,510,461.

Shipment properly posted to the reporting system: Subtotal:
Number of items: 4,315;
Value: $247,510,461.

Shipment improperly posted or not posted to reporting system but
accounted for: Contractor received items but entered items into the
reporting system using an incorrect document number, stock number,
and/or quantity:
Number of items: 543;
Value: $69,573,954.

Shipment improperly posted or not posted to reporting system but
accounted for: Contractor received item and entered item into inventory
record, but it is not reflected in the reporting system:
Number of items: 1,096;
Value: $436,277,575.

Shipment improperly posted or not posted to reporting system but
accounted for: Other:
Number of items: 71;
Value: $13,485,901.

Shipment improperly posted or not posted to reporting system but
accounted for: Subtotal:
Number of items: 1,710;
Value: $519,337,431.

Shipment not posted and not accounted for: Contractors did not retain
inventory records of shipment receipts or clearly document receipt
transactions:
Number of items: 1,145;
Value: $23,086,538.

Shipment not posted and not accounted for: Contractor reportedly did
not receive items:
Number of items: 1,829;
Value: $24,211,946.

Shipment not posted and not accounted for: Other:
Number of items: 4;
Value: $9,739.

Shipment not posted and not accounted for: Subtotal:
Number of items: 2,978;
Value: $47,308,224.

Total:
Number of items: 9,003;
Value: $814,156,116.

Source: GAO analysis.

[End of table]

No dominant cause for these failures to properly account for shipment
receipts emerged in our discussions with contractor officials. However,
in our interviews with contractor personnel, they identified a number of
factors:

* inadequate training/instruction on how to use and enter information
into the reporting system;

* lack of awareness of reporting procedures;

* data transmission problems (e.g., transactions entered by the
contractors did not show up in the reporting system);

* data input errors made while attempting to enter information into the
system, and;

* data deleted from the reporting system because of data storage
constraints.

In addition, two contracts in our review did not contain a reporting
requirement.

Because of these reporting problems, the inventory control points�
reporting systems contained inaccurate information on large numbers of
shipment receipt notifications, thus reducing the value of the
information as a means of accurately and adequately accounting for all
shipped assets. Inventory control point personnel indicated that they
are often forced to work around the reporting systems, and they expend
considerable time and effort to collect, maintain, and analyze receipt
information that should be readily available to them in these automated
systems. Visibility over shipped material depends in part on accurate
contractor reporting of material receipts; without adequate reporting,
the Air Force cannot readily account for shipped material, making it
vulnerable to theft or loss.

Contractors Not Reporting Shipment Discrepancies:

Air Force policy also requires contractors to notify the shipping
activity if a discrepancy exists between items shipped and items
received. The purpose of discrepancy reporting is to determine the
cause of discrepancies, effect corrective action, and prevent
recurrence. Such reports also provide (1) support for adjustment of
property and financial inventory accounting records, (2) information as
a basis for claims against contractors, and (3) information for
management evaluations.

As table 3 shows, 1,829 of the items (valued at about $24.2 million) we
reviewed had reportedly not been received, but only 8 of the items were
reported as discrepancies and resolved. For the remaining 1,821 items,
we found a number of problems in discrepancy reporting.

* Contractor personnel did not report the discrepancies. According to
most contractor personnel, this situation occurred primarily because the
shipping activity did not notify them of impending shipments, thus they
did not expect the shipment and could not monitor its status. Others
indicated that they simply never report any discrepancies.

* Contractor personnel reported the discrepancies, but they did not
route the discrepancy reports to the appropriate shipping activity
personnel who could investigate and resolve the discrepancies. Although
we found that contractor personnel did not properly route shipping
discrepancies to the appropriate shipping activity, they were under the
impression that they had.

* Contractor personnel reported the discrepancies, but did not follow up
when no response was received from the shipping activity. They did not
follow up because they planned to reorder the material that they had not
received.

* Contractor personnel reported the discrepancies, but when they later
determined that the materials had been received, they did not cancel the
discrepancy reports.

This failure to comply with Air Force procedures undermines the Air
Force�s ability to determine the cause of discrepancies, effect
corrective action, and prevent recurrence. This situation can also
result in loss of control over material, lost recovery rights, and
material remaining in a questionable status for long periods of time.

Procedures for Following Up on Unconfirmed Material Receipts Are
Ineffective:

To ensure proper reporting and accounting of material receipts, DOD
policy requires that inventory control points follow up with the
contractor within 45 days from the date of shipment if they have not
been notified that a shipment has arrived. The rationale behind this
requirement is that until receipt is confirmed, the exact status of the
shipment is uncertain and therefore vulnerable to fraud, waste, and
abuse.

At present, Air Force procedures do not ensure adequate follow-up on
unconfirmed receipts. According to Air Force officials, inventory
control points send electronic inquiries to contractors to follow up on
all shipments. However, the Air Force has not yet established a system
by which (1) the inventory control points can reconcile material
shipped to contractors with material received by contractors to
determine unconfirmed receipts and (2) contractors can respond to the
follow-up inquiries to confirm receipts or discrepancies. Consequently,
inventory control points assume that all material shipped to
contractors is received by them, and they close the record on the
shipments without contractor confirmation of material receipt. The
inventory control point does not become aware that material has not
been received unless the contractor inquires about the shipment. The
result is a situation in which unconfirmed receipts are officially
considered delivered, an assumption that, in turn, places this material
at risk of fraud, waste, abuse, and theft.

The following example illustrates how the lack of adequate follow-up on
unconfirmed receipts places this material at risk. In June 2000, the
Defense Distribution Depot in Warner Robins, Georgia, reportedly issued
and delivered 85 electron tubes to an Air Force repair contractor, but,
according to contractor personnel, the shipment was never received and
the contractor never reported the discrepancy to the inventory control
point. In January 2002, we requested proof of issuance and delivery from
the Warner Robins depot. The depot provided proof of issuance but could
not confirm delivery. According to depot personnel, a delivery signature
was not obtained from the contractor�s receiving personnel at the time
of delivery. Nevertheless, the inventory control point closed the
record on this $3.5 million shipment, assuming the electron tubes had
been received. The electron tubes remain unaccounted for.

To address its deficiencies relating to proper reporting and accounting
of material receipts, the Air Force plans to transition to the
Department of Defense Commercial Asset Visibility System (CAV II). This
will require a 2-year scheduled transition starting in fiscal year 2003
and ending in fiscal year 2004.

Air Force Has Not Established an Integrated Financial Management
System:

Another weakness preventing effective accountability over shipped
inventory relates to the Air Force�s financial management system. The
Chief Financial Officers Act of 1990 requires a plan for the
integration of agency financial management systems. The Federal
Financial Management Improvement Act of 1996 built upon the 1990 act
and required agencies to maintain an integrated system (i.e., an
integrated general ledger controlled system). With such a system,
accounting records and logistics records (i.e., records from the supply
and repair side of inventory control points) should be updated
automatically when inventory items are purchased and received. Any
differences between these two sets of records should be identified
periodically and research conducted to alert management at the
inventory control points to possible undetected loss or theft of shipped
items.

As part of the its latest efforts to reform its financial operations,
the Department of Defense has stated that it will develop Defense-wide
integrated systems. [Footnote 6] If effectively designed and
implemented, these systems will be integral to ensuring effective
accountability over the Air Force�s shipped inventories.

Air Force Program Oversight Is Insufficient:

To evaluate and improve supply operations and reporting performance,
Air Force policy requires shipping activities to record, summarize, and
report to Air Force headquarters the volume and dollar value of shipment
discrepancies, and headquarters is required to analyze this data to
identify the causes, sources, and magnitude of discrepancies so that
corrective actions can be taken. This policy is consistent with federal
government standards for internal controls that require ongoing
oversight to assess the quality of performance over time and to ensure
that findings of audits and other reviews are promptly resolved.

Air Force headquarters acknowledges that it has not requested nor
collected contractor shipment discrepancy data, and, as of February
2002, had not developed a definite plan of action or a target date for
full implementation. The lack of program oversight may represent
inadequate management emphasis. Even if the Air Force were collecting
the contractor shipment discrepancy data, it would not be meaningful
because, as shown earlier, contractors are not reporting discrepancies
accurately. The lack of this information impedes the Air Force�s
ability to evaluate and improve supply operations as well as its
ability to determine which activities are responsible for lost or
misplaced items.

Conclusions:

Inventory worth billions of dollars has been vulnerable to fraud, waste,
and abuse because the Air Force either did not adhere to control
procedures or did not establish effective procedures. Because of these
control weaknesses, repair contractors have access to items and
quantities of items not specified in their contracts, and the Defense
Contract Management Agency does not have the quarterly reports on
shipment status that it needs to independently verify that contractors
have accounted for shipments of government-furnished material. In
addition, contractor receipt posting and discrepancy reporting
practices produce incomplete and inaccurate information, impairing the
ability of the Air Force to monitor shipments. Even if contractor
records on shipment receipts were accurate, the Air Force�s system
cannot reconcile material shipped to contractors with material received
by contractors, so the Air Force cannot readily identify shipments with
unconfirmed receipts. Consequently, the Air Force cannot readily
account for these shipments, which include classified, sensitive, and
pilferable items. Finally, the Air Force has not exercised the required
extent of program oversight by collecting data on contractor shipment
discrepancies and using it to assess practices for safeguarding shipped
inventory; as a result, it cannot identify the extent and cause of
contractor shipment discrepancies or take corrective action.

Recommendations for Executive Action:

To improve the control of inventory being shipped, we recommend that
the Secretary of Defense direct the Secretary of the Air Force to
undertake the following:

* Improve processes for providing contractor access to government-
furnished material by:
- listing specific stock numbers and quantities of material in repair
contracts (as they are modified or newly written) that the inventory
control points have agreed to furnish to contractors;
- demonstrating that automated internal control systems for loading and
screening stock numbers and quantities against contractor requisitions
perform as designed;
- loading stock numbers and quantities that the inventory control points
have agreed to furnish to contractors into the control systems manually
until the automated systems have been shown to perform as designed;
and;
- requiring that waivers to loading stock numbers and quantities
manually are adequately justified and documented based on cost-effective
and/or mission-critical needs.

* Revise Air Force supply procedures to include explicit responsibility
and accountability for:
- generating quarterly reports of all shipments of Air Force material to
contractors; and;
- distributing the reports to Defense Contract Management Agency
property administrators.

* Determine, for the contractors in our review, what actions are needed
to correct problems in posting material receipts.

* Determine, for the contractors in our review, what actions are needed
to correct problems in reporting shipment discrepancies.

* Establish interim procedures to reconcile records of material shipped
to contractors with records of material received by them, until the Air
Force completes the transition to its Commercial Asset Visibility
system in fiscal year 2004.

* Comply with existing procedures to request, collect, and analyze
contractor shipment discrepancy data to reduce the vulnerability of
shipped inventory to undetected loss, misplacement, or theft.

Agency Comments and Our Evaluation:

In written comments on a draft of this report (see app. II), the
Department of Defense concurred with six of the recommendations, non-
concurred with one recommendation, and partially concurred with three
recommendations. DOD did not concur with our second recommendation�to
improve processes for controlling contractor access to government-
furnished material by developing automated internal control systems for
loading stock numbers and quantities and screening them against
contractor requisitions. DOD states that the Air Force Special Support
Stock Control system already has the recommended capability in place.
Although the Air Force Special Support Stock Control system may be
capable of loading stock numbers and quantities and screening them
against contractor requisitions, we found that in practice the system
was not able to carry out this function as designed. A January 2002
software change implemented to address the issue did not resolve it,
and Air Force officials acknowledged in April 2002 that this system was
still not working properly. To correct the weakness in its current
automated internal control systems, Air Force officials stated that in
April 2002 the Air Force Materiel Command planned to revise its
existing procedures for an automated method of loading stock numbers
into the current control systems. We believe that the Air Force�s
actions to correct its internal control systems deficiencies are a step
in the right direction, and, if the revised procedures do work as
designed, they will improve the process for controlling contractor
access to government-furnished material. Based on DOD�s comments, we
modified our recommendation to emphasize the need to demonstrate that
automated internal control systems for loading and screening stock
numbers and quantities against contractor requisitions perform as
designed.

DOD partially concurred with the recommendation to load stock numbers
and quantities for items requisitioned by contractors into the control
systems manually until the automated system is implemented. DOD again
stated that the Air Force Materiel Command�s current control systems
already provide the capability for loading and screening national stock
numbers and quantities against contractor requisitions. However, DOD
directed the Air Force to determine the feasibility of establishing an
interim capability until all repair contracts are written in compliance
with Air Force policies and procedures. We continue to believe our
recommendation will be valid until the previously discussed automated
internal control system for loading stock numbers and quantities and
screening them against contractor requisitions is proven to work as
designed.

DOD partially concurred with the recommendation to require that waivers
to loading stock numbers and quantities manually are adequately
justified and documented based on cost-effective and/or mission-
critical needs. DOD reiterated that the current Air Force control
systems already provide the capabilities for loading stock numbers and
quantities and screening them against contractor�s requisitions. DOD
further states that it will direct Headquarters, Air Force
Installations and Logistics, to ensure that future decisions affecting
validation of contractor orders involving government-furnished materiel
or equipment are based on cost-effectiveness and/or mission-critical
needs and that requests are processed in accordance with DOD policies
and procedures. We agree with DOD that any future waivers should be
justified and documented. However, we continue to believe our
recommendation will be valid until the waiver is rescinded, because the
waiver allows for the inventory control point to continue to load and
screen contractor requisitions at the federal stock class or stock
group levels rather than loading contracts at the required national
stock number level.

Finally, DOD partially concurred with the recommendation to comply with
existing procedures to request, collect, and analyze contractor shipment
discrepancy data to reduce the vulnerability of shipped inventory to
undetected loss, misplacement, or theft. DOD stated that in February
2001, Headquarters, Air Force Installations and Logistics, directed all
Air Force major commands to collect and analyze these types of supply
discrepancies for possible trends. DOD added that each major command
was tasked to provide Air Force Installations and Logistics a semi-
annual report of its findings (negative reports were not required). DOD
recently directed Headquarters, Air Force Installations and Logistics,
to reemphasize this requirement to all major commands and to require
that all major commands submit a report on their findings for the last
12 months. Moreover, a negative report will be required if no supply
discrepancies were received. While we believe this is a step in the
right direction, we also believe the DOD response to our recommendation
does not address the contractor discrepancy reporting issues raised in
this report. Although some Air Force major commands may actually be
collecting and analyzing shipment discrepancies at their Air Force
bases, we found that similar contractor shipment discrepancy data has
not been requested nor collected. As we stated in this report, Air
Force headquarters acknowledges that it has neither requested nor
collected these contractor discrepancy report data for shipments, and,
as of February 2002, had not developed a definite plan of action or a
target date for full implementation. We continue to believe the
conditions we reported on and our recommendation are still valid and
should be addressed by DOD. Based on DOD�s comments, we have made it
clear that the shipment discrepancy data referred to in this report and
in the related recommendation was provided by the contractors.

Appendix I contains the scope and methodology for this report. DOD�s
written comments on this report are reprinted in their entirety in
appendix II.

As arranged with your offices, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days
from its issue date. At that time, we will send copies of this report
to the appropriate congressional committees; the Secretary of Defense;
the Secretary of the Air Force; the Director, Office of Management and
Budget; and the Director, Defense Logistics Agency. We will also make
copies available to others upon request.

Please contact me at (202) 512-8412, or Lawson Gist, Jr. (202) 512-
4478, if you or your staff have any questions concerning this report.
Other GAO staff acknowledgments are listed in appendix III.

Signed by:

David R. Warren:
Director:
Defense Capabilities and Management:

[End of section]

Appendix I: Scope and Methodology:

To assess the Air Force�s and its repair contractors� adherence to
procedures for controlling shipped inventory, we took the following
steps:

* To identify criteria for controlling shipped inventory, we reviewed
Department of Defense and Air Force policies and procedures, obtained
other relevant documentation related to shipped inventory, and discussed
inventory management procedures with officials at the following
locations: Headquarters, Department of the Air Force, Washington, D.C.;
the Air Force Materiel Command, Wright-Patterson Air Force Base, Ohio;
the Oklahoma City Air Logistics Center, Tinker Air Force Base, Oklahoma;
the Ogden Air Logistics Center, Hill Air Force Base, Utah; the Warner
Robins Air Logistics Center, Robins Air Force Base, Georgia; the Defense
Contract Management Agency, Alexandria, Virginia; and the Defense
Logistics Management Standards Office, Fort Belvoir, Virginia.

* To identify the number, value, and types of shipped inventory, we
obtained computerized supply-side records of all government-furnished
material shipments and manager-directed material shipments between
October 1999 and September 2000 from the Air Force Materiel Command at
Wright-Patterson Air Force Base, Ohio. The records contained descriptive
information about each shipment, including the document number,
national stock number, and quantity shipped. We excluded broken items
shipped from end-user activities to contractor repair facilities and
repaired material returned from a contractor repair facility to a
storage activity or end user because the Air Force Materiel Command
could not readily identify and provide the descriptive information. To
determine the security type of selected shipments in fiscal year 2000,
we identified the national stock number for all shipments of government-
furnished material and manager-directed material. We then matched the
national stock number with security classification codes in the
Department of Defense Federal Logistics Information System.

* To select contractors and items shipped to them, we used computerized
shipment data obtained from the Air Force Materiel Command. To develop
our methodology, we conducted a preliminary review using three
judgmentally selected contractors; two contractors were chosen on the
basis of their proximity to the inventory control points, and the third
was selected because of the substantial volume of shipments between it
and all of the inventory control points. For these initial contractors,
we selected 214 government-furnished material items and 1,159 manager-
directed material items, based on such factors as the national stock
number of the items and the number of items and/or dollar value of the
shipments. Subsequently, we judgmentally selected an additional nine
repair contractors, three for each inventory control point, that had
either the largest dollar value or the largest number of government-
furnished and manager-directed items shipped to them. For these
contractors, we then selected 188 government-furnished material items
and 7,442 manager-directed material items based on the military
sensitivity of the items in the shipments and the unit price and/or
dollar value of the shipments. Because the number of selected
contractors and shipments was limited and judgmentally selected, the
results of our analysis cannot be projected to all Air Force repair
contractors and shipments.

* To assess whether shipments had been received and entered into the
inventory control points� repair-side reporting system, we obtained from
the inventory control points their computer-generated shipment receipt
histories. The receipt histories contained descriptive information about
each shipment, including the document number, national stock number,
and quantity reported as received.

* We did not independently verify the overall accuracy of the databases
for which we obtained data, but used them as a starting point for
selecting shipments that we then tracked back to records and documents
on individual transactions. Because our conclusions are based only on
those shipments for which we tracked back to documents, use of this
data is reasonable for our purposes.

* To determine whether contractors had accounted for our selected
shipments, we then matched the Air Force Materiel Command supply-side
records of shipments to inventory control points� repair-side receipt
histories. When we identified discrepancies, we followed up with the
repair contractors and inventory control points by tracking items back
to contractor inventory records and by holding discussions with
officials at the following locations: BAE Flight Systems, Mojave,
California; Boeing, San Antonio, Texas; Boeing Electronic Systems,
Heath, Ohio; Heroux, Inc., Quebec, Canada; ITT Avionics, Clifton, New
Jersey; Lockheed Martin, Marietta, Georgia; Lockheed Martin, San
Antonio, Texas; Lockheed Martin Lantirn, Warner Robins, Georgia;
Northrop Grumman, Baltimore, Maryland; Northrop Grumman, Warner Robins,
Georgia; PEMCO Aeroplex, Birmingham, Alabama; Teledyne Electronic
Technologies, Warner Robins, Georgia; and the Defense Distribution
Depots (located in Warner Robins, Georgia, and Oklahoma City,
Oklahoma).

* To determine what happened to selected items that had reportedly not
been received by contractors, our Office of Special Investigations
followed up with commercial carriers by obtaining proof of delivery
information and by holding discussions with officials at the following
locations: ABF Freight Systems, Inc., Fort Smith, Arkansas; Associated
Global Systems, Inc., New Hyde Park, New York; CorTrans Logistics, LLC,
Wooddale, Illinois; Emery Worldwide, Ontario, California; Federal
Express Corporation, Somerset, New Jersey; and United Parcel Service,
Washington, D.C.

* To learn whether issues associated with unaccounted-for shipments were
adequately resolved, we reviewed Department of Defense, Air Force, and
Air Force Materiel Command implementing guidance. Such information
provided the basis for conclusions regarding the adherence to procedures
for controlling shipped inventory.

* To determine whether the Air Force had emphasized shipped inventory as
part of its assessment of internal controls, we reviewed assessments
from the Department of the Air Force, the Oklahoma City Air Logistics
Center, the Ogden Air Logistics Center, and the Warner Robins Air
Logistics Center for fiscal years 1999 and 2000.

Our work was performed from May 2001 through April 2002 in accordance
with generally accepted government auditing standards. We conducted our
other investigative work during March 2002 and April 2002 in accordance
with investigative standards established by the President�s Council on
Integrity and Efficiency.

[End of section]

Appendix II: Comments from the Department of Defense:

Deputy Under Secretary Of Defense For Logistics And Materiel Readiness:
3500 Defense Pentagon:
Washington, DC 20301-3500:

June 17, 2002:

Mr. David R. Warren:
Director, Defense Capabilities Management:
U.S. General Accounting Office:
Washington, D.C. 20548:

Dear Mr. Warren:

This is the Department of Defense (DoD) response to the General
Accounting Office (GAO) draft report, "Defense Inventory: Air Force
Needs to Improve Control Over Shipments to Repair Contractors," May 7,
2002 (GAO Code 350079).

The Department concurs with the six of the recommendations in the draft
report, partially concurs with three of the recommendations and
nonconcurs with Recommendation 2, in which the Air Force already has
the recommended capability in place and operating. In fact, the Air
Force has taken immediate steps to improve compliance with controls
already in place over shipments to repair contractors.

The Department's detailed comments to the recommendations are enclosed.
The Department appreciates the opportunity to comment on the draft
report.

Sincerely,

Signed by:

Allen W. Beckett:
Principal Assistant:

Enclosure:

GAO Code 350079/GAO-02-617:

"Defense Inventory: Air Force Needs To Improve Control Over Shipments
To Repair Contractors"

Recommendation 1: The GAO recommended that the Secretary of Defense
direct the Secretary of the Air Force to improve processes for
providing contractor access to government-furnished material by listing
specific stock numbers and quantities of material in repair contracts
(as they are modified or newly written) that the inventory control
points have agreed to furnish to contractors. (p. 13/GAO Draft Report)

DoD Response: Concur.

a. DoD will direct Headquarters Air Force Materiel Command/Logistics
(HQ AFMC/LG) to:

(1) Establish management oversight to ensure that the Air Logistics
Centers comply with AFMCI 23-113, which already requires that repair
contracts authorizing Government Furnished Material and Equipment be
written at the stock number and quantity level.

(2) Develop a plan to modify existing contracts and provide a schedule
to ensure full compliance by 2004.

Estimated Completion Date (ECD): 14 Jun 02.

b. DoD will direct HQ AFMC/LG to change Section H, AFMAN 23-110, Volume
III, Part One, Chapter 9, to emphasize that appendix B of all contracts
authorizing Government Furnished Materiel and/or Equipment must be
written and validated at the stock number and quantity level.

ECD: 31 Jan 03.

Recommendation 2: The GAO recommended that the Secretary of Defense
direct the Secretary of the Air Force to improve processes for
providing contractor access to government-furnished material by
developing automated internal control systems for loading and screening
stock numbers and quantities against contractor requisitions. (p.
13/GAO Draft Report)

DoD Response: Non-concur. The Air Force Special Support Stock Control
(SSSC) D035D System already has this capability at both the contract
and DoD Activity Address Code level via user interface and a mass
contract upload feature. This enables an automated check between
requisitions and stock numbers.

Recommendation 3: The GAO recommended that the Secretary of Defense
direct the Secretary of the Mr Force to improve processes for providing
contractor access to government-furnished material by manually loading
stock numbers and quantities that the inventory central points have
agreed to furnish to contractors into the control systems until the
implementation of the automated systems is complete. (p. 13/GAO Draft
Report)

DoD RESPONSE: Partially concur. The Air Force Materiel Command Materiel
Control Activity process already provides user and mass contract stock
number/quantity upload capabilities for those contracts written IAW
AFMCI 23-113. DoD will direct Headquarters Air Force Installations and
Logistics (HQ AF/IL) to determine the feasibility of establishing an
interim maintenance interface capability until all repair contracts are
written in compliance with AFMCI 23-113.

ECD: 14 Jun 02.

Recommendation 4: The GAO recommended that the Secretary of Defense
direct the Secretary of the Air Force to improve processes for
providing contractor access to government-furnished material by
requiring that waivers to manually loading stock numbers and quantities
are adequately justified and documented based on cost-effective and/or
mission critical needs. (p. 13/GAO Draft Report)

DoD Response: Partially concur. The problem cited by the GAO was
specific to a software problem in 1999-2000 between the Air Force
Materiel Command's contract provisioning and materiel control activity
systems which has since been resolved. DoD will direct the HQ AF/IL to
ensure that future decisions affecting validation of contractor orders
involving Government Furnished Materiel or Equipment be based on cost
effectiveness and/or mission critical needs and requests processed IAW
DoD 4140.1-R and DoD 4000.25-1-M.

ECD: 14 Jun 02.

Recommendation 5: The GAO recommended that the Secretary of Defense
direct the Secretary of the Air Force to revise Air Force supply
procedures to include explicit responsibility and accountability for
generating quarterly reports of all shipments of Air Force material to
contractors. (p. 13/GAO Draft Report)

DoD Response: Concur.

a. DoD will direct HQ AF/IL to formalize responsibility and
accountability for the generation of required quarterly reports to the
applicable Defense Contract Management Agency (DCMA) office by updating
AFMAN 23-110, Volume III, Part 8, Chapter 15.

ECD: 14 Jun 02.

b. DoD will direct HQ AFMC/LG to publish interim policy and procedures.

ECD: 28 Jun 02.

Recommendation 6: The GAO recommended that the Secretary of
Defense direct the Secretary of the Air Force to revise Air Force
supply procedures to include explicit responsibility and accountability
for distributing the reports to DCMA property administrators. (p.
13/GAO Draft Report)

DoD Response: Concur.

a. DoD will direct AF/IL to formalize responsibility and accountability
for the distribution of required quarterly reports to the applicable
DCMAs by updating AFMAN 23-110, Volume III, Part 8, Chapter 15.

ECD: 14 Jun 02.

b. DoD will direct HQ AFMC/LG to publish interim policy and procedures.

ECD: 28 Jun 02.

Recommendation 7: The GAO recommended that the Secretary of Defense
direct the Secretary of the Air Force to determine, for the contractors
in the GAO review, what actions are needed to correct problems in
posting material receipts. (p. 14/GAO Draft Report)

DoD Response: Concur. DoD will direct HQ AF/IL to determine, for the
contractors in the GAO review, actions required to correct materiel
receipt posting problems.

ECD: 14 Jun 02.

Recommendation 8: The GAO recommended that the Secretary of Defense
direct the Secretary of the Air Force to determine, for the contractors
in the GAO review, what actions are needed to correct problems in
reporting shipment discrepancies. (p. 14/GAO Draft Report)

DoD Response: Concur. DoD will direct HQ AF/IL to determine, for the
contractors in the GAO review, actions required to ensure that
contractor personnel are aware of procedures in submitting supply and
transportation discrepancy reports.

ECD: 14 Jun 02.

Recommendation 9: The GAO recommended that the Secretary of Defense
direct the Secretary of the Air Force to establish interim procedures
to reconcile records of material shipped to contractors with records of
material received by them, until the Air Force completes the transition
to the Department of Defense Commercial Asset Visibility system in
fiscal year 2004. (p. 14/GAO Draft Report)

DoD Response: Concur. DoD will direct HQ AF/IL to establish interim
procedures to reconcile records of Government Furnished Materiel and
Equipment shipped to repair contractors and records of materiel
acknowledged received by them.

ECD: 14 Jun 02.

Recommendation 10: The GAO recommended that the Secretary of Defense
direct the Secretary of the Air Force to comply with existing
procedures to request, collect, and analyze shipment discrepancy data
to reduce the vulnerability of shipped inventory to undetected loss,
misplacement, or theft. (p. 14/GAO Draft Report)

DoD Response: Partially concur. In Feb 2001, HQ AF/IL directed all Air
Force major commands to collect and analyze these types of supply
discrepancies for possible trends. Each major command was tasked to
provide AF/IL a semi-annual report of their findings. Negative reports
were not required. DoD will direct HQ AF/IL to re-emphasize this
requirement to all major commands and require all major commands submit
a report on their findings for the last 12 months. A negative report
will be required if no supply discrepancies were received.

ECD: 31 Jul 02.

[End of enclosure]

[End of section]

Appendix III: GAO Staff Acknowledgments:

Acknowledgments:

Key contributors to this report include Sandra F. Bell, George Surosky,
Susan Woodward, Jay Willer, David Fisher, Norman M. Burrell, and John
Ryan.

[End of section]

Related GAO Products:

Performance and Accountability Series: Major Management Challenges
and Program Risks�Department of Defense. GAO-01-244. Washington,
D.C.: January 2001.

High-Risk Series: An Update. GAO-01-263. Washington, D.C.: January
2001.

Defense Inventory: Plan to Improve Management of Shipped Inventory
Should Be Strengthened. GAO/NSIAD-00-39. Washington, D.C.: February
22, 2000.

Department of the Navy: Breakdown of In-Transit Inventory Process
Leaves It Vulnerable to Fraud. GAO/OSI/NSIAD-00-61. Washington, D.C.:
February 2, 2000.

Defense Inventory: Property Being Shipped to Disposal Is Not Properly
Controlled. GAO/NSIAD-99-84. Washington, D.C.: July 1, 1999.

DOD Financial Management: More Reliable Information Key to Assuring
Accountability and Managing Defense Operations More Efficiently. GAO/T-
AIMD/NSIAD-99-145. Washington, D.C.: April 14, 1999.

Defense Inventory: DOD Could Improve Total Asset Visibility Initiative
With Results Act Framework. GAO/NSIAD-99-40. Washington, D.C.: April
12, 1999.

Defense Inventory: Navy Procedures for Controlling In-Transit Items Are
Not Being Followed. GAO/NSIAD-99-61. Washington, D.C.: March 31, 1999.

Performance and Accountability Series: Major Management Challenges and
Program Risks�Department of Defense. GAO/OCG-99-4. Washington, D.C.:
January 1999.

High-Risk Series: An Update. GAO/HR-99-1. Washington, D.C.: January
1999.

Department of Defense: Financial Audits Highlight Continuing Challenges
to Correct Serious Financial Management Problems. GAO/TAIMD/NSIAD-98-
158. Washington, D.C.: April 16, 1998.

Department of Defense: In-Transit Inventory. GAO/NSIAD-98-80R.
Washington, D.C.: February 27, 1998.

Inventory Management: Vulnerability of Sensitive Defense Material to
Theft. GAO/NSIAD-97-175. Washington, D.C.: September 19, 1997.

Defense Inventory Management: Problems, Progress, and Additional
Actions Needed. GAO/T-NSIAD-97-109. Washington, D.C.: March 20, 1997.

High-Risk Series: Defense Inventory Management. GAO/HR-97-5.
Washington, D.C.: February 1997.

High-Risk Series: Defense Financial Management. GAO/HR-97-3.
Washington, D.C.: February 1997.

[End of section]

Footnotes:

[1] Air Force inventory is also issued to contractors from warehouses
at Air Force bases.

[2] Classified items are those that require the highest degree of
protection in the interest of national security; sensitive items are
those that require a high degree of protection and control because of
their high value and/or hazardous or technical nature; and pilferable
items have a ready resale value or a civilian application and are
therefore especially subject to theft.

[3] Government-furnished material is that which contractors requisition
in support of repairs, alterations, and modifications. Generally, this
material is incorporated into or attached onto deliverable end items
(final products such as aircraft) or consumed or expended in performing
the contract.

[4] Only 12 of the 14 contracts we reviewed authorized the contractors
to requisition government-furnished material. Of those 12 contracts, 9
are screened by federal stock class or stock group rather than by stock
number and quantity.

[5] Only 12 of the 14 contracts in our review authorized the contractor
to requisition government-furnished material. Of those 12 contracts, 8
did not specify both the items and the quantities of material the
inventory control points had agreed to furnish to contractors.

[6] Under 10 U.S.C. 2222, the Department is to submit to the Congress
an annual strategic plan for improving financial management. The
Department�s plan was submitted in January 2001.

[End of section]

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