Foreign Military Sales: Efforts to Improve Administration Hampered by
Insufficient Information (Letter Report, 11/22/1999, GAO/NSIAD-00-37).

Pursuant to a congressional request, GAO assessed the foreign military
sales program to determine the changes needed to improve the viability
of the program, focusing on: (1) whether the foreign military sales
program has achieved full recovery of its administrative costs; (2) the
Defense Security Cooperation Agency's (DSCA) basis for making
administrative account adjustments; and (3) the effectiveness of various
foreign military sales reinvention efforts in terms of cost recovery.

GAO noted that: (1) the Department of Defense (DOD) does not have
sufficient information to determine the administrative costs associated
with the foreign military sales program; (2) DOD is unable to use actual
cost as a basis to determine what charges should be applied to foreign
military sales, and does not know if the percentage charged to the
customer on individual sale's dollar value is appropriately recovering
foreign military sales program costs; (3) the allocation of
administrative funds to activities responsible for implementing the
foreign military sales program is based on past administrative budget
outlays and perceived needs; (4) the military services directly charge
customers for some administrative tasks on individual sales; (5) these
are referred to as program management charges; (6) under existing
guidelines, the services have discretion concerning when to apply
program management charges and which administrative activities
associated with foreign military sales should be funded through the
administrative budget and which should be funded as a direct charge
through program management charges; (7) DSCA uses estimated sales
projections and the balance of the administrative account to determine
whether program adjustments must be made; (8) sales projections are
judgmental estimates on the part of the agency's country desk officers
and are adjusted by DSCA's management; (9) when the administrative
account balance fell below zero, DSCA increased fees, sought and
obtained legislative relief that allowed program costs to be moved to
DOD appropriations accounts, and reduced administrative budgets provided
to the military services; (10) conversely, a recent decision to reduce
the administrative fee charged was justified, in part, by the large
balance held in the account; (11) having a positive balance in the
administrative account is important, since a certain level of funding is
needed to carry out work that has already been paid for by customers;
(12) however, too large an account balance may represent a mismatch
between fees and administrative account allocations to those activities
implementing the foreign military sales program; (13) reinvention
efforts to better identify costs lack a common approach and are managed
as independent efforts; and (14) as a result, these initiatives as
structured are unlikely to provide DSCA with complete and consistent
information about the costs of administering foreign military sales.

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

 REPORTNUM:  NSIAD-00-37
     TITLE:  Foreign Military Sales: Efforts to Improve Administration
	     Hampered by Insufficient Information
      DATE:  11/22/1999
   SUBJECT:  Foreign military arms sales
	     Defense cost control
	     Reengineering (management)
	     Administrative costs
	     Defense budgets
	     Foreign military sales costs
IDENTIFIER:  Foreign Military Sales Program
	     Foreign Military Sales Trust Fund

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Report to the Chairman, Committee on International Relations, House of
Representatives

November 1999

FOREIGN MILITARY SALES

Efforts to Improve Administration Hampered by Insufficient
Information
*****************

*****************

GAO/NSIAD-00-37

Letter                                                                     3

Appendixes

Appendix I:Breakdown of Foreign Military Sales Administrative Funding and
Organizations

                                                                         28

Appendix II:Comments From the Department of Defense

                                                                         31

Table 1:  Fiscal Year 1998 Program Management Spending and FMS
Administrative Budget Spending by Military Service10

Table 2:  Projections of Foreign Military Sales Versus Actual Sales 
Realized                                        13

Table 3:  Fiscal Year 1998 FMS Administrative Budget Allocation 
and Roles of Primary FMS Organizations          29

Figure 1:  Trend in the Value of Foreign Military Sales, Fiscal Years 1989-
19987

Figure 2:  Military Services' FMS Administrative Budgets, 1990-20029

Figure 3:  FMS Administrative Account Balance, Fiscal Years 1983-199814

Figure 4:  Projected Administrative Account Balance With 2.5-Percent
Administrative Charge at $7.5 Billion Sales and $10 Billion Sales, 1999-
200719

Figure 5:  DOD Organizations That Receive FMS Funding30

DOD     Department of Defense

DSCA    Defense Security Cooperation Agency

FMS     Foreign Military Sales

Defense Trade: Decision to Lower FMS Administrative Fee is Premature 
                                                     National Security and 
                                             International Affairs Division

B-283614

November 22, 1999

The Honorable Benjamin A. Gilman
Chairman, Committee on International Relations
House of Representatives

Dear Mr. Chairman:

Foreign military sales are an important component of the U.S. security
assistance program and also represent a key Department of Defense
acquisition strategy to help lower the unit costs of weapon
systems./Footnote1/ The Arms Export Control Act provides a number of ways
to price defense articles and services transferred under the Foreign
Military Sales program, including actual value, replacement value, and
full cost, and requires that the Department of Defense recover, with
specified exceptions, the full estimated cost of administrating such
sales./Footnote2/ As a result of budget pressure from declining sales and
customer complaints about program inefficiencies, the Defense Security
Cooperation Agency, which manages the program, and the military services
have begun a number of reinvention efforts to improve the management and
implementation of the Foreign Military Sales program.

In response to your concerns, we assessed the Foreign Military Sales
program to determine the changes needed to improve the viability of the
program. Specifically, we evaluated (1) whether the Foreign Military Sales
program has achieved full recovery of its administrative costs, (2) the
Defense Security Cooperation Agency's basis for making administrative
account adjustments, and (3) the effectiveness of various Foreign Military
Sales reinvention efforts in terms of cost recovery.

Results in Brief

The Department of Defense does not have sufficient information to
determine the administrative costs associated with the Foreign Military
Sales program. As a result, the Department is unable to use actual cost as
a basis to determine what charges should be applied to foreign military
sales, and does not know if the percentage charged to the customer on the
dollar value of individual sales is appropriately recovering Foreign
Military Sales program costs. The allocation of administrative funds to
activities responsible for implementing the Foreign Military Sales program
is based on past administrative budget outlays and perceived needs. In
addition, the military services directly charge customers for some
administrative tasks on individual sales. These are referred to as program
management charges. Under existing guidelines, the services have
discretion concerning which administrative activities associated with the
Foreign Military Sales program should be funded through the administrative
budget and which should be directly funded through program management
charges.

The Defense Security Cooperation Agency uses estimated sales projections
and the balance of the administrative account to determine whether program
adjustments must be made. Sales projections are judgmental estimates on
the part of the agency's country desk officers and are adjusted by the
Defense Security Cooperation Agency's management. When the administrative
account balance fell below zero, the Defense Security Cooperation Agency
increased fees, sought and obtained legislative relief that allowed
program costs to be moved to Department of Defense appropriations
accounts, and reduced administrative budgets provided to the military
services. Conversely, a recent decision to reduce the administrative fee
charged was justified, in part, by the large balance currently held in the
account. Having a positive balance in the administrative account is
important, since a certain level of funding is needed to carry out work
that has already been paid for by customers; however, too large an account
balance may represent a mismatch between fees and administrative account
allocations to those activities implementing the Foreign Military Sales
program.

Reinvention efforts by the Defense Security Cooperation Agency and
military services include some initiatives that could enable Foreign
Military Sales program managers to better identify costs. However, these
initiatives lack a common approach and are managed as independent efforts.
As a result, these initiatives as currently structured are unlikely to
provide the Defense Security Cooperation Agency with complete and
consistent information about the costs of administering foreign military
sales, thus making it difficult for that agency to ensure that the program
is fully recovering required administrative costs, allocating
administrative budgets appropriately, or accurately assessing the impact
of other reform initiatives. 

We make recommendations in this report for the Department to improve
program management for foreign military sales by directing that efforts to
identify costs use a comprehensive and consistent definition of
administrative tasks, by developing and communicating guidance that
requires consistent application of program management charges, and by
identifying alternative program uses for any excess administrative account
balance.

Background

Under the Foreign Military Sales (FMS) program, the Department of Defense
(DOD) provides defense items, services, and military training through cash
and credit sales, grant, lease, or loan from DOD inventories or through
new procurements under DOD-managed contracts. Individual sales
transactions between the U.S. government and a foreign government range
from sales of major items (such as F-18 aircraft with associated parts,
maintenance, and training) to military clothing or commercial vehicles.
The value of individual sales--otherwise known as cases--ranges from
billions of dollars to less than $100.

The Arms Export Control Act states that FMS sales should include
appropriate charges for administrative services to recover the full
estimated costs of administering sales--with some costs, for example,
fixed base operation costs, specifically excluded--and that such charges
should be calculated on an average percentage basis./Footnote3/ However,
the law does not define the basis for determining if full cost recovery is
achieved. Currently, the Defense Security Cooperation Agency (DSCA)
applies a 
2.5-percent administrative charge on all foreign military sales and a 
3.1-percent logistics support charge on certain spare parts, supply, and
maintenance items./Footnote4/ These charges are collected and held in an
administrative cost clearing account within the FMS Trust Fund. Using this
account, DSCA manages the FMS program by developing an annual
administrative budget that allocates funding to the defense agencies for
the execution of the program.

The FMS Trust Fund, which has an annual balance of approximately 
$5.9 billion, is a vehicle for processing foreign country funds required
for FMS payments to U.S. contractors for new procurements and to DOD
components for sales from DOD stock. This trust fund was established to
facilitate purchases of U.S. defense articles and services by foreign
countries. DSCA uses the administrative cost clearing account, with a
current balance of approximately $500 million, to fund its annual FMS
administrative budget, which supports the FMS infrastructure and the
execution of foreign military sales. In fiscal year 1998, the
administrative budget was $350 million. DSCA and the military services
distribute this budget to over 60 DOD organizations to assist in the
execution of the FMS program. Organizations, such as the military
services, that conduct sales receive 64 percent of FMS administrative
funding while 36 percent goes toward centralized administrative
activities, such as DSCA and the Defense Finance and Accounting Service.
(See app. I for details on FMS budget allocations and the organizations
that receive FMS administrative funding.) Besides the administrative
charges, the military services charge individual sales for administrative
expenses that are not ordinarily supported by the administrative budget,
such as salaries and expenses associated with program management efforts
on weapon system sales.

In early 1998, press accounts drew attention to problems with the FMS
program by highlighting declining FMS sales and growing customer
dissatisfaction. In recent years, the level of foreign military sales has
generally declined, as shown in figure 1. Competition from other
countries' exports as well as from direct commercial sales from U.S.
suppliers to foreign governments is pressuring the program to perform more
efficiently. Although generally supportive of the FMS program, both
foreign customers and U.S. industry are complaining about the costs and
inefficiencies of the program. The use of cost-based rather than fixed-
price contracts and a lack of transparency in the costs are major
irritants. Lack of transparency is illustrated by the uncertainty
regarding what services are paid for through the administrative charge as
compared to direct charges on individual sales. In May 1998, the Deputy
Secretary of Defense called for an effort to examine ways to streamline
the FMS process, stating that there are major opportunities for re-
engineering FMS business practices. DSCA's Director explained that savings
could be achieved through consolidating activities that administer sales.

Figure****Helvetica:x11****1:    Trend in the Value of Foreign Military
                                 Sales, Fiscal Years 1989-
                                 1998
*****************

*****************

Note: In the early 1990s sales increased as a result of the Persian Gulf
War.

Source: DSCA. 

Information on Cost of Administering FMS Is Not Sufficient to Determine
Cost Recovery 

In 1997, the DOD Office of the Inspector General reported that DSCA did
not have reliable information on either the full cost of the FMS program
or the cost of integral tasks that must be performed regardless of the
size of the sale or service being purchased./Footnote5/ The Inspector
General further reported that DSCA and the military services did not have
sufficient information to determine administrative budget needs to plan
for unexpected requirements or to evaluate the efficiencies and
effectiveness of the FMS program. According to DSCA budgeting officials,
the administrative budget that is used to pay for the administrative costs
of foreign military sales is developed and allocated based on past
administrative budget outlays, the perceived needs of the military
services, and overall sales projections rather than on the actual costs.

Our analysis of sales from 1989 through 1998 found that sales valued over
$100 million (equaling less than 1 percent of all foreign military sales)
generated 61 percent of the program's total dollar value of sales, and
sales valued over $14 million (4 percent of FMS sales) generated 82
percent of the dollar value of all sales, but the remaining 96 percent of
foreign military sales generated only 18 percent of the dollar value of
all sales. Because the administrative charges are applied on a percentage
basis to individual sales, administrative revenue collected is a function
of the dollar value of individual sales, with larger sales accounting for
more of the administrative charges collected than smaller sales. While
these smaller sales generate less total revenue, they constitute a sizable
portion of the FMS workload. In 1987, DOD created a 3.1-percent logistic
support charge on certain spare parts, supply, and maintenance items. This
charge was intended to increase administrative revenue from logistics
support sales and offset the program's reliance on the largest sales.
However, in fiscal year 1998 the logistics support charge equaled only 11
percent of total administrative revenue.

Effect of Budget Reductions on Military Services
------------------------------------------------

Over the last 5 years, DSCA has reduced budget allocations to the military
services for funding administrative costs associated with foreign military
sales in an effort to reflect declining sales and anticipated reductions
in administrative revenues. DSCA also reduced budgets to encourage
organizations conducting foreign military sales to become more efficient.
The agency reduced the military services' administrative budgets for
fiscal year 1995 to reflect defense planning guidance that required a 4
percent reduction in civilian manpower as well as presidential guidance
that mandated a 6-percent reduction in overhead costs. Figure 2 shows the
individual military services' actual FMS administrative budgets for fiscal
years 1990 through 1999 as well as budget levels set by the DSCA through
fiscal year 2002. After adjusting for inflation, Air Force, Army, and Navy
administrative budgets have decreased by 18 percent, 23 percent, and 
28 percent, respectively, since fiscal year 1995; current budget plans
call for total reductions of 33 percent, 32 percent, and 38 percent,
respectively by 2002.

Figure****Helvetica:x11****2:    Military Services' FMS Administrative
                                 Budgets, 1990-
                                 2002
*****************

*****************

Source: DSCA.

While reducing FMS administrative budgets, DSCA directed the military
services to "restructure organizations, processes and work year levels, as
necessary, so that the essential security assistance mission is conducted
within the prescribed funding levels." Consequently, each military service
is undergoing streamlining efforts to accommodate DSCA budget reductions.
However, even with streamlining initiatives, the military services have
indicated they will not be able to absorb further budget reductions. For
example, the Air Force's fiscal year 1999 budget plan submitted to DSCA
stated that although the administrative budget estimates were developed
based on projected sales, the number of new sales anticipated indicates
that their workload is not decreasing commensurate with budget reductions.
In the transmittal letter accompanying the plan, the Air Force cautioned
that it would not be able to execute its FMS administrative program if
administrative funding continues to decline. Air Force officials stated
that, under current budgets, they "cannot afford to make a new sale"
unless additional funding is provided. Moreover, Navy officials explained
that decreases in efficiencies are a result of inadequate funding.
According to the Navy, the decreases in administrative budgets are
resulting in an increase in the time it takes to process new sales and a
decline in the number of sales the Navy is able to close. Slow case
closures have been the subject of FMS customer complaints.

Using Program Management Charges
--------------------------------

DOD guidance allows the military services to recover certain costs of
administering FMS sales by applying program management charges directly to
individual sales. These charges are intended for nonroutine levels of
management effort needed to administer a sale. Table 1 shows for fiscal
year 1998 the extent to which these program management charges were used
by each of the services to administer foreign military sales. When program
management charges and administrative budgets are combined, 37 percent of
the military services' funding for FMS administrative costs comes from
program management charges versus 
63 percent from the administrative budget.

Table****Helvetica:x11****1:    Fiscal Year 1998 Program Management
                                Spending and FMS Administrative Budget
                                Spending by Military Service

--------------------------------------------------------------------------
| Dollars in millions                                                    |
|------------------------------------------------------------------------|
|        :      Program       :        FMS         :       Total         |
|        : management charges :   administrative   :                     |
|        :                    :       budget       :                     |
|------------------------------------------------------------------------|
|        : Dollars : Percenta : Dollars : Percenta : Dollars : Percenta  |
|        :         :       ge :         :       ge :         :       ge  |
|------------------------------------------------------------------------|
| Air    :   $63.4 :       42 :   $87.4 :       58 :  $150.8 :      100  |
| Force  :         :          :         :          :         :           |
|------------------------------------------------------------------------|
| Army   :    20.9 :       21 :    80.5 :       79 :   101.4 :      100  |
|------------------------------------------------------------------------|
| Navy   :    47.8 :       48 :    52.7 :       52 :   100.5 :      100  |
|------------------------------------------------------------------------|
| Total  :  $132.1 :       37 :  $220.6 :       63 :  $352.7 :      100  |
--------------------------------------------------------------------------

Source: DSCA and the Departments of the Air Force, Army, and Navy.

Program Management Guidance Permits Discretion
----------------------------------------------

The Security Assistance Management Manual permits discretion concerning
when program management charges may be used and which administrative tasks
should be charged to them./Footnote6/ According to DSCA and military
service officials, the manual does not clearly indicate which tasks should
be funded through program management charges and which tasks should be
funded through the administrative budget. DSCA does not closely monitor
the military services' use of program management charges and has not
addressed the need to consistently apply program management charges on all
FMS sales. For example, in a Navy sale of Commando helicopter depot-level
maintenance valued at $32.8 million, the administrative charge was
$897,000 and the sale had a program management charge of $2.1 million.
According to this sale's letter of offer and acceptance, additional
program management efforts were required to successfully deliver the
material and services ordered. These efforts include program planning,
direction, monitoring, control and coordination, and related travel.
However, in an Army Tank Automotive and Armaments Command sale of 300
refurbished M60 tanks valued at $204 million, the administrative charge
was $5.9 million. This sale had no program management charges. The Army's
case manager explained that the effort to implement this sale was
extraordinary, required intensive management, and in hindsight probably
should have had a program management charge. Tank Automotive and Armaments
Command officials explained that they used their discretion and funded
this effort through the administrative budget.

The military services differ in their reliance on program management
charges. While program management charges represent 48 percent of the
Navy's total administratively related funding, they represent only 
21 percent of such funding for the Army. At key commands that implement
FMS sales, the difference is even more significant. In fiscal year 1998,
the Naval Air Systems Command's program management charges represented 71
percent of the command's total administrative funding as opposed to 
36 percent at the Army Tank Automotive and Armaments Command. Both of
these organizations conduct sales of major weapon systems.

These differences may be related, in part, to the differing abilities of
commands to determine the actual cost of individual sales. The Naval Air
Systems Command has a time and attendance system that is able to capture
personnel costs for work on individual foreign military sales. As a
result, it is easier for the Command to document program management costs
on sales and transfer these costs to the customer. Other commands, such as
the Tank Automotive and Armaments Command, do not have the systems in
place to capture these costs, and officials there told us that they have
only six ongoing sales with program management charges.

Basis for Adjusting the Administrative Budget

Since DSCA is not able to manage based on the cost of conducting foreign
military sales, the agency estimates future sales and uses the
administrative account balance to plan future budgets and adjust
administrative charges. DSCA uses the FMS administrative account to fund
administrative budgets in order to support the FMS infrastructure,
including work required to execute sales and generate new sales. The
administrative account balance is maintained through the 2.5-percent
administrative charge on all sales and the 3.1-percent logistics support
charge on certain items. A positive balance in the administrative account
is desired since funding is needed to support work that has already been
paid for by the customers.

To determine future administrative account balances, DSCA makes sales
projections to anticipate future administrative revenues. DSCA's process
for estimating sales projections is based on subjective analysis and
discretionary adjustments. Sales projections tend to reflect incremental
changes from year to year, even though prior to 1995 wide variations in
actual sales occurred. For example, sales from 1989 through 1990 jumped
from $8.8 billion to $16.6 billion, from 1992 through 1993 jumped from 
$13.9 billion to $31.1 billion, and then from 1994 through 1995 declined
from $13.3 billion to $9.0 billion. Table 2 contains DSCA's sales
projections and actual sales from 1991 through 1999.

Table****Helvetica:x11****2:    Projections of Foreign Military Sales
                                Versus Actual Sales Realized

----------------------------------------------------------------------------
| Dollars in billions                                                      |
|--------------------------------------------------------------------------|
|                     Sales projection by fiscal year                      |
|--------------------------------------------------------------------------|
| Date  : 19 : 19 : 19 : 19 : 19 : 19 : 19 : 19 : 20 : 20 : 2002: 20 : 20  |
| of    : 92 : 93 : 94 : 95 : 96 : 97 : 98 : 99 : 00 : 01 :     : 03 : 04  |
| proje :    :    :    :    :    :    :    :    :    :    :     :    :     |
| ction :    :    :    :    :    :    :    :    :    :    :     :    :     |
|--------------------------------------------------------------------------|
| Sept. : $1 : $1 :    :    :    :    :    :    :    :    :     :    :     |
|  1991 : 2.0: 1.0:    :    :    :    :    :    :    :    :     :    :     |
|--------------------------------------------------------------------------|
| Sept. :    : 17 : $1 : $1 : $1 : $1 : $1 :    :    :    :     :    :     |
|  1992 :    : .0 : 2.0: 2.0: 1.0: 1.0: 0.0:    :    :    :     :    :     |
|--------------------------------------------------------------------------|
| Oct.  :    :    : 11 : 10 : 10 : 10 : 9.0: $9 :    :    :     :    :     |
| 1993  :    :    : .5 : .0 : .0 : .0 :    : .0 :    :    :     :    :     |
|--------------------------------------------------------------------------|
| Oct.  :    :    :    : 9.0: 9.5: 10 : 9.0: 8.5: $1 :    :     :    :     |
| 1994  :    :    :    :    :    : .5 :    :    : 2.0:    :     :    :     |
|--------------------------------------------------------------------------|
| Oct.  :    :    :    :    : 9.8: 9.5: 9.0: 8.5: 12 : $1 :     :    :     |
| 1995  :    :    :    :    :    :    :    :    : .0 : 0.0:     :    :     |
|--------------------------------------------------------------------------|
| Oct.  :    :    :    :    :    : 10 : 10 : 12 : 12 : 11 : $11 :    :     |
| 1996  :    :    :    :    :    : .6 : .5 : .4 : .7 : .3 :  .8 :    :     |
|--------------------------------------------------------------------------|
| Jan.  :    :    :    :    :    :    : 8.9: 9.3: 8.2: 8.3: 7.3 : $7 :     |
| 1998  :    :    :    :    :    :    :    :    :    :    :     : .5 :     |
|--------------------------------------------------------------------------|
| Jan.  :    :    :    :    :    :    :    : 10 : 9.0: 8.3: 7.3 : 7.5: $7  |
| 1999  :    :    :    :    :    :    :    : .8 :    :    :     :    : .5  |
|--------------------------------------------------------------------------|
| May   :    :    :    :    :    :    :    : 10 : 9.0: 10 : 10.0: 10 : 10  |
| 1999  :    :    :    :    :    :    :    : .8 :    : .0 :     : .0 : .0  |
|--------------------------------------------------------------------------|
| Actua : $1 : $3 : $1 : $9 : $1 : $8 : $8 :    :    :    :     :    :     |
| l     : 3.9: 1.1: 3.3: .0 : 0.3: .8 : .2 :    :    :    :     :    :     |
| sales :    :    :    :    :    :    :    :    :    :    :     :    :     |
----------------------------------------------------------------------------

Source: DSCA.

DSCA projects foreign military sales for the current and the next 5 fiscal
years. DSCA country managers or desk officers draft country estimates of
projected sales based on their knowledge and experience as well as through
consultation with other knowledgeable sources. DSCA offers little guidance
or criteria and no systematic tools to its staff concerning how to develop
these estimates. DSCA's Director and Deputy Director are provided
summaries of country estimates and have wide latitude in adjusting the
estimates. For example, in May 1999, sales projections were revised after
DSCA had requested a decrease in the administrative charge from 3 to 
2.5 percent. In January 1999, DSCA had projected sales of $8.3 billion in
fiscal year 2001 to $7.5 billion for fiscal year 2004. Two weeks after
DSCA proposed lowering the administrative charge, the DSCA Comptroller
submitted $10 billion sales projections for the same fiscal years. The
change was based on October 1995 projections, and according to DSCA
managers, the projections did not include any new analysis. The basis for
the upward adjustment, according to DSCA officials, was essentially
judgment. Using the higher sales projections, DSCA estimated higher future
balances for the FMS administrative account, which provided additional
support for the administrative charge reduction.

From 1984 to 1991, when the administrative account consistently had a
negative balance (ranging between $49 million and $389 million as shown in
fig. 3), DSCA initiated various actions to improve the balance. These
included reducing administrative budget allocations, increasing
administrative charges and moving FMS administrative costs to other DOD
appropriated accounts. More recently, in June 1999, DOD decreased the
administrative charge from 3 to 2.5 percent in part because the balance in
the administrative account had grown to $500 million.

Figure****Helvetica:x11****3:    FMS Administrative Account Balance,
                                 Fiscal Years 1983-
                                 1998
*****************

*****************

Source: DSCA.

The following shows the actions taken to adjust the FMS account balance:

o In 1985, the Arms Export Control Act was amended so that the FMS pro
  rata share of fixed base operation costs were eliminated as an expense
  to the FMS administrative account./Footnote7/ Until then, the program
  was required to pay a pro rata share of fixed base operation costs.

o In 1985, timing of payments was revised to collect 50 percent of the
  administrative charge when a foreign military sale commences and the
  remaining 50 percent when equipment or services are delivered. Prior to
  this time, the entire administrative charge was collected as equipment
  and services were delivered.

o In 1987, military staff years associated with administering the program
  were reduced by 20 percent. This reduction equated to $60 million in
  reduced program costs for the first year implemented.

o In 1987, DOD created the 3.1-percent logistic support charge on certain
  spare parts, supply, and maintenance items. This charge was intended to
  increase administrative revenue from smaller sales and offset the
  program's reliance on the largest sales. In fiscal year 1998, the
  logistics support charge was about $37 million, or 11 percent of total
  administrative revenue.

o In 1989, the Arms Export Control Act was amended to allow the FMS
  program to avoid paying for certain costs associated with military
  personnel who worked on the FMS program as well as unfunded civilian
  retirement./Footnote8/ This action was taken in lieu of a proposal to
  increase the FMS administrative charge from 3 to 5 percent. During
  fiscal year 1990, the cost avoidance for the program was about $80
  million. Currently, DSCA data shows that this cost avoidance for 1999
  would also be about $80 million.

o In 1999, the FMS administrative charge was reduced from 3 to 
  2.5 percent in part because the account balance was perceived as too
  high, and DOD wanted to send a message to its foreign customers that
  it was committed to making the FMS program more effective and
  efficient.

In addition, although DSCA uses the administrative account balance as a
basis for decisions relating to administrative charges and budgets, agency
officials acknowledge that there is no guidance on what constitutes a
prudent balance for the administrative account. DSCA officials explained
that a positive account balance is needed to support future work that has
already been paid for by customers. Estimating an appropriate account
balance is difficult since DSCA does not manage based on cost and is not
able to estimate the cost of the work it has committed to. Typically, DSCA
has sought to maintain a level of about 1-1/2 times the yearly
administrative budget, which is roughly equal to the current account
balance of about $500 million.

Reinvention Efforts Lack a Common Approach to Administrative Costs

DSCA and the military services are conducting various separate reinvention
initiatives to improve the management and implementation of the FMS
program. Generally, these initiatives include activities to reduce
budgets, streamline organizations, improve business processes, reduce
cycle times, improve the FMS program for the customers, and team with U.S.
industry to develop hybrid sales with direct commercial and foreign
military program components. As knowledge of program costs is necessary to
many of these initiatives, the military services and DSCA each have
efforts specifically related to identifying costs. However, the separate
efforts take different approaches to address cost issues, have different
coverage, and have not been coordinated.

DSCA has identified cost recovery as a key issue in its reinvention
efforts. In May 1998, DSCA initiated a study to measure the cost of those
key tasks funded by the administrative budget at certain military service
buying commands, such as the cost of pre-sale, customer support, sale
execution, and sale or case closure efforts. The DSCA effort will not
capture the total cost of administering the FMS program since it is
attempting to capture costs charged to the administrative budget and not
administrative costs associated with program management charges.

The Air Force has begun an initiative to outsource a large portion of its
workload, which it hopes will improve efficiency. It will also add program
charges for certain activities that had previously been funded through the
administrative budget. The goal of the initiative is to increase
responsiveness to foreign customers, decrease the time required to execute
and close sales, provide timely sale reconciliation, reduce costs to the
customer, and align fees with services. Under the Air Force initiative,
all activities required to execute a sale will be considered for
outsourcing except inherently governmental functions--such as exercising
program decision authority, contracting officer authority, and financial
authority requiring funds certification. The intent of the Air Force
initiative is to consolidate all personnel and travel costs required for
managing the execution of sales and charge these costs directly on program
management lines, whether those costs are incurred by government personnel
or contractor personnel. As a result, the Air Force would charge personnel
and travel costs previously funded through the administrative budget
directly to sales. In an August 1998 memorandum to DSCA, the Air Force
outlined its initiative and requested a waiver of the current guidance on
program management charges in order to implement the proposal. DSCA did
not respond to the Air Force's request. In March 1999, the Air Force
decided to proceed with implementing its initiative despite DSCA's lack of
response. The Air Force acknowledged in a June 1999 memorandum that the
overall costs to customers may increase as they identify specific
functions and associated costs that could be directly charged to foreign
military sales.

Navy reinvention efforts call for centralized control of Navy
administrative funding and program management funding. The Navy plans to
document their costs of administering foreign military sales to ensure it
is properly reimbursed for these costs. Although the Navy is not yet able
to account for its actual costs in administering foreign military sales,
it already pays for nearly half of its total administrative costs using
program management charges. The Navy strives to charge all costs that can
be associated with a sale directly to that sale. For example, the Naval
Air Systems Command has implemented a time and attendance system that
allows the Command to account for all personnel costs directly associated
with particular sales.

The U.S. Army Security Assistance Command has developed a system that
breaks down the costs of tasks related to administering sales. The Army
plans to allocate its FMS administrative budget according to these tasks.
Army officials believe that this will help them justify their
administrative budget when DSCA is making budget decisions.

Administrative Charge Reduced Without Cost Information
------------------------------------------------------

The most significant action taken under DOD's current reengineering
efforts was the June 1999 decision to reduce the administrative charge
from 3 to 2.5 percent. DSCA stated that this decision was based on planned
streamlining initiatives, anticipated increases in sales as a result of
the Balkan conflict, and a high balance in the FMS administrative account.
According to DOD, the reduction was intended to show the customer that
they were serious about making the process more efficient.

Until mid-May 1999, DSCA's estimates showed that with a 2.5-percent
administrative charge the administrative account would reach a deficit by
2007 (see fig. 4)./Footnote9/ As noted previously, 2 weeks after DSCA's
proposal to cut the administrative charge, foreign military sales
projections were adjusted, putting the future account balance on a more
positive footing. However, DSCA estimates continued to show a downward
slope in the account balance. DSCA's estimate of the administrative
account balance using higher sales estimates did not consider increases in
resources needed to cover the additional administrative costs that would
likely be incurred with additional sales. Increased resources and budgets
could result in a steeper reduction in the administrative account than
shown in figure 4.

Figure****Helvetica:x11****4:    Projected Administrative Account Balance
                                 With 2.5-Percent Administrative Charge at
                                 $7.5 Billion Sales and $10 Billion Sales,
                                 1999-2007
*****************

*****************

Source: DSCA.

Conclusions
-----------

The Foreign Military Sales program is generally required to recover the
full estimated costs of administering sales. Although expected to operate
on a cost recovery basis, DOD does not have the systems in place to
identify the actual cost of administering foreign military sales. Limited
visibility over costs hampers management of costs and affects DSCA's
ability to set fee structures and allocate budgets appropriately. It has
also resulted in excessively wide ranges in the administrative account
balance. In addition, FMS program management is hampered by the lack of a
consistently applied definition of those administrative tasks associated
with implementing sales that should be charged to the overall
administrative account and those that should be charged to program
management. As a result, DSCA's attempts to force program efficiencies by
reducing the funding it provides to the military services may not be
successful. In fact, the services have efforts in place that may be
working at odds with DSCA's efforts. Although each of the services is
attempting to better identify its costs in implementing the FMS program
through various reform initiatives, the Navy is striving to charge cases
directly for all known administrative costs, the Air Force is planning to
charge cases for costs once covered by the administrative budget, and the
Army is collecting cost data to more strongly justify its existing
administrative budget allocation.

Lacking an adequate information base on the administrative costs of
executing FMS sales, clear and consistently applied guidance on when to
use program management funding, and a coordinated approach to reform
efforts, the impact of future program management decisions--such as the
need to change the fee level or structure, attempts to develop hybrid
commercial/government sales, and other DOD initiatives for the program--
will not be understood.

Recommendations

To make certain that future program decisions are made on the basis of
adequate information, we recommend that the Secretary of Defense direct
that current efforts to identify and collect cost information use a
comprehensive and consistent definition of administrative tasks.

To enhance the value of the administrative budget as a management tool, we
recommend that the Secretary of Defense develop and communicate to the
military services guidance that requires consistent application of program
management charges.

To assure that the current FMS administrative account balance is
appropriate, we further recommend that the Under Secretary of Defense
(Comptroller) assess the amount of funds needed to complete existing sales
commitments. If the current administrative account balance exceeds the
needed funds, we recommend that the Secretary of Defense identify
alternative program uses for these funds.

Agency Comments

In commenting on a draft of this report, DOD concurred with three of our
four recommendations. DOD also stated that ongoing reinvention efforts
will address the majority of our recommendations. However, DOD's comments
do not describe how reinvention efforts will address these
recommendations. In certain cases, it is not clear how DOD's proposed
implementation of our recommendations would resolve the problems described
in this report. In addition, DOD stated that our report misrepresents
important facts included in several areas. DOD also provided technical
comments that we have incorporated as appropriate. DOD's comments are
included as appendix II.

In terms of cost information, DOD stated that our report overstates the
position that DOD lacks adequate cost information to manage the FMS
program and assure full cost recovery. However, DOD's comments and
technical remarks focus on cost recovery from a legal perspective. As we
note in the report, the Arms Export Control Act excludes some cost
associated with executing the FMS program from the act's requirement to
recover administrative costs. However, these excluded costs are associated
with the program and should be recognized and considered in decisions made
about managing the program and in any reengineering or reform efforts.
Federal financial accounting standards state that cost information is
essential to managing federal programs in the areas of budgeting and
control, performance measurement, determination of reimbursements and
setting of fees and prices, program evaluations and economic choice
decisions./Footnote10/ Further, the standards require agencies to
accumulate the full cost of outputs regardless of funding sources using
appropriate costing methodologies and cost finding techniques. Having
sufficient information on the total costs of executing the FMS program
might have alleviated DOD's need to seek legislative relief from certain
costs, such as military pay and unfunded civilian retirement benefits,
that resulted in shifting the pay burden from the FMS program and the
foreign customer to DOD's appropriations accounts and ultimately the
taxpayer.

Furthermore, DOD's comments stated that our report infers a connection
between the lack of cost information, the annual FMS administrative
budgets provided to the military services, and the use of program
management charges. While DOD concurred with our recommendations related
to the lack of cost information and program management guidance, the
Department disagrees with our treatment of these issues. We believe there
is a connection between the lack of cost information, annual FMS
administrative budgets, and the use of program management charges. DOD
uses both FMS administrative charges and program management charges to pay
for the cost of executing the FMS program. DOD's criteria, as stated in
its guidance, identify the level of effort expended in performing
management functions as the primary determiner of whether a function or
activity should be funded by the administrative budget or through program
management charges. DOD allows the military services discretion in
determining what level of effort warrants program management charges. As a
result, either program management charges or the administrative budget can
be used as the source of funding for the same activities by different
military services on different foreign military sales. In an environment
in which the services have that level of discretion along with
insufficient cost information, DOD cannot effectively manage the program
by using the FMS administrative budget.

DOD's comment noted that our draft report incorrectly describes the nature
of DSCA activities associated with preparing annual sales estimates.
However, DOD did not explain what was incorrect. DOD explained that we
call their process judgmental, stated that country desk officers lack
guidance or criteria in formulating sales estimates, and said that
estimates were adjusted at the discretion of DSCA management. However,
DSCA's Deputy Director described this process as judgmental in discussions
with us and noted that he substantially changed country desk officers'
sales estimates. DSCA's June 1998 sales estimate guidance offers a format
for reporting sales estimates and includes inflation indexes for adjusting
current year dollars, and suggests that factors such as foreign military
financing credit levels and political and economic considerations should
be considered. This guidance does not offer country desk officers a
methodology to be consistently applied for developing sales estimates.
Estimating sales is not an exact science, but DSCA does not have a system
in place for assessing the probability of future sales, as do large
commercial firms that depend on estimates for key business decisions.
Credible estimates are important for DSCA to plan future budget
allocations and to ensure, as DOD points out, that adjustments related to
management decisions do not appear arbitrary.

DOD commented that our report unfairly suggests that DSCA's only tool for
managing the FMS program is the administrative fund balance. We disagree
with this description of our report and agree that the administrative fund
balance is not the only tool DSCA uses to manage the program. As our
report explains, DSCA uses the administrative budget to allocate resources
to the program and uses the administrative balance as a measure to
determine if change is needed. When DSCA perceives that the balance is not
appropriate, it has taken action to raise or decrease charges, and shift
expenses from the FMS budget to other DOD accounts. An appropriate
administrative balance is an outcome of appropriately aligning costs and
fees. Lacking adequate information on the costs of administering sales,
past efforts to stabilize the administrative account balance have proven
unsuccessful. Moreover, DOD concurred with our recommendation to assess
the funds needed to assure that the administrative account balance is
appropriate.

The Department concurred with our recommendation to make certain that
future program decisions are made on the basis of adequate information by
directing current efforts to identify and collect cost information to use
a comprehensive and consistent definition of administrative tasks. To
implement this recommendation, DOD commented that an ongoing Institute for
Defense Analyses study and detailed Army functional breakouts would
provide information for alternative models. However, the Institute's study
and the Army's work are looking only at tasks currently funded by the FMS
administrative budget, and they are not collecting information on
administrative tasks funded by program management and other administrative
charges to the customer. As we point out in this report, the military
services are performing administrative tasks that are charged to the
administrative budget and to the program management elements of FMS sales.
Our recommendation would require the Department to collect and analyze
information on all FMS administrative tasks, regardless of the funding
source. Without this information, the Department cannot develop a
comprehensive understanding of administrative tasks and related costs or
use this information to provide the basis for management decisions,
including decisions on appropriate budgets and fees that are clearly based
on the cost of executing sales.

The Department concurred with our recommendation to enhance the value of
the administrative budget as a management tool by developing and
communicating guidance to the military services on charges for program
management services. The Department indicated it intends to include
guidance in the next revision to DOD regulations.

The Department concurred with our recommendation to assess the amount of
funds needed to complete existing sales commitments to assure an
appropriate level of the administrative account balance by stating that
the Department will determine an appropriate "safety level." It is not the
intent of our recommendation to set a "safety level" with the sole purpose
of avoiding risk. An appropriate balance in the account should result from
setting fees at a level to cover costs associated with implementing
existing sales. The account balance should clearly be related to the cost
of implementing sales and not some predetermined level.

DOD did not agree with our recommendation to identify alternative program
uses for excess administrative account funds. DOD points out that
administrative account balances are not appropriated funds and are only
available for the purposes for which they were collected under the Arms
Export Control Act. DOD also points out that Congress imposes annual
limits on the amount of these funds that DOD may expend. DOD contends that
it cannot legally implement this recommendation under the current law. We
disagree. The law does not preclude the Secretary of Defense from
identifying alternative program uses for excess administrative account
funds. The Arms Export Control Act permits spending this administrative
funding for FMS administrative functions. Although annual appropriations
laws set a ceiling for FMS administrative spending, the Secretary of
Defense can request a higher ceiling or notify Congress that the ceiling
will be exceeded, as has been done in the past. In identifying alternative
uses, we would expect the Secretary to assess, for example, the value of
spending administrative funds on systems that would ensure proper cost
accounting. In addition, the military services have stated that they have
unfunded needs in their administration of the FMS program. For example,
Navy officials told us that they do not have adequate resources to ensure
that foreign military sales are closed in an expeditious manner, and that
delayed case closure is a significant irritant to its customers. If the
Secretary of Defense chooses to identify program uses outside the
parameters of the Arms Export Control Act, he can request necessary
legislative changes to Congress. For example, the Secretary could request
congressional authority to use FMS administrative funds to reimburse
military pay associated with security assistance.

Scope and Methodology

To evaluate whether the Foreign Military Sales program has achieved full
recovery of its administrative costs, we interviewed and collected
documents from DSCA; the departments of the Army, Navy, and Air Force; and
U.S. industry representatives. However, we did not validate the accuracy
of DSCA's and the services' cost information. To understand outside
factors that could affect the condition of the FMS program, we also
reviewed documents that describe foreign customer dissatisfaction with the
program and interviewed foreign government representatives. We used budget
data from the DSCA Comptroller's Office to analyze total administrative
budget trends and budget allocations for fiscal year 1998. We also
analyzed trends in military services' actual and planned administrative
budgets. We studied data about budgets, workload, and performance metrics
for at least one buying command in each military service that was
allocated a substantial portion of the FMS administrative budget to
evaluate the impact of reductions in military services' administrative
budgets. We analyzed the differences between the military services' total
administrative and program management spending. At the military service
commands visited, we also judgmentally selected about 
50 foreign military sales of various types and dollar values to discuss
the workload related to these sales relative to the administrative and
program management funding of sales. We reviewed guidance on identifying
administrative and program management charges as well as DOD Inspector
General reports related to the FMS program.

To determine the basis for key decisions related to the FMS fee structure
and budget management, we analyzed the rationale for and impact of past
program decisions on the FMS administrative account. We also reviewed
DSCA's process for making sales projections, which is a key component of
estimating future administrative account balances, as well as the model
that DSCA uses to project future administrative account balances. We met
with representatives from two U.S. defense companies to identify how
others develop their foreign military sales projections. We sought to
identify the criteria DSCA uses for determining the appropriate level of
the administrative account balance, but found that no written guidance
exists. We collected documents from and held discussions with officials
from DSCA and the Office of the DOD Comptroller relating to the FMS
administrative account balance, fee structure decisions, budget management
decisions, and sales projections.

To evaluate how various FMS reinvention efforts address cost recovery
issues, we reviewed DSCA's and each individual military service's
reinvention initiatives to determine scope, status, and level of
coordination of FMS reinvention efforts. We collected documents from and
held discussions with officials at the DSCA, Under Secretary of Defense
(Comptroller), the Deputy Under Secretary of the Army for International
Affairs, the U.S. Army Security Assistance Command, the U.S. Army Tank
Automotive and Armaments Command, the Navy International Programs Office,
the Naval Air Systems Command, the Deputy Under Secretary of the Air Force
for International Affairs, the Air Force Aeronautic Systems Center, the
Air Force's F-16 Systems Program Office, the Air Force Security Assistance
Center, the Warner Robbins Air Logistics Center, and the Security
Assistance Directorate of the Defense Finance and Accounting Service Center.

We conducted our work between October 1998 and August 1999 in accordance
with generally accepted government auditing standards.

We are sending copies of this report to Representative Sam Gejdenson in
his capacity as Ranking Minority Member of the House International
Relations Committee and to Senator Jesse Helms and Senator Joseph Biden in
their capacities as Chairman and Ranking Minority Member, respectively, of
the Senate Foreign Relations Committee. We are also sending copies to the
Honorable William S. Cohen, Secretary of Defense, and the Honorable Jacob
J. Lew, Director, Office of Management and Budget. We will also make
copies available to others on request.

Please contact me on (202) 512-4841 if you or your staff have any
questions concerning this report. Major contributors to this report were
Blake Ainsworth, Raymond H. Denmark, Jr., and Lillian I. Slodkowski.

Sincerely yours,
*****************

*****************

Katherine V. Schinasi
Associate Director
Defense Acquisitions Issues

--------------------------------------
/Footnote1/-^See Defense Trade: DOD Savings From Export Sales Are
  Difficult to Capture (GAO/NSIAD-99-191, Sept. 17, 1999).
/Footnote2/-^See sections 21 and 22 of the Arms Export Control Act (22
  U.S.C. 2761 and 2762).
/Footnote3/-^The Arms Export Control Act sets the requirement for recovery
  of FMS costs. Full accounting for the cost of federal programs is
  required by federal financial accounting standards.
/Footnote4/-^In June 1999, DOD reduced the administrative charge from 3 to
  2.5 percent. Also, instead of the 2.5-percent administrative charge, the
  FMS program applies a 5-percent administrative charge to sales of
  nonstandard articles and services.
/Footnote5/-^Foreign Military Sales Administrative Surcharge Fund, DOD
  Office of Inspector General, Report No. 97-227, Sept. 30, 1997. In
  response to the report, DOD activities commented that such information
  was not necessary.
/Footnote6/-^The Security Assistance Management Manual is maintained by
  DSCA and establishes policies and procedures required to manage the FMS
  program and other security assistance programs. 
/Footnote7/-^P.L. 99-83, Aug. 8, 1985.
/Footnote8/-^P.L. 101-165, Nov. 21, 1989.
/Footnote9/-^(GAO/NSIAD-99-161R, May 13, 1999).
/Footnote10/-^Statement of Federal Financial Accounting Standard,
  "Managerial Cost Accounting Concepts and Standards for the Federal
  Government." (SFFAS No. 4, July 31, 1995).

BREAKDOWN OF FOREIGN MILITARY SALES ADMINISTRATIVE FUNDING AND ORGANIZATIONS
===========================================================================

Table 3 shows the fiscal year 1998 budget allocations that the Defense
Security Cooperation Agency (DSCA) distributed among Department of Defense
(DOD) organizations. Organizations with the primary responsibility of
implementing foreign military sales (FMS) received 
64 percent of this allocation, while 36 percent went to centrally managed
and implemented activities. As shown in figure 5, over 60 organizations
received FMS funding. While the military services receive FMS funding from
DSCA, they are responsible for managing this funding and distributing it
among their subordinate commands.

Table****Helvetica:x11****3:    Fiscal Year 1998 FMS Administrative Budget
                                Allocation and Roles of Primary FMS
                                Organizations

------------------------------------------------------------------------
|               :      FY 1998      :  :                               |
|               :  Administrative   :  :                               |
|               :    Budget $350    :  :                               |
|               :      million      :  :                               |
|----------------------------------------------------------------------|
| Organization  : Dollars : Percent :  : Description                   |
|               :     (in :      of :  :                               |
|               : million :  budget :  :                               |
|               :      s) :         :  :                               |
|----------------------------------------------------------------------|
| Centrally managed and implemented activities                         |
|----------------------------------------------------------------------|
| Defense       :  $38.39 :    11.0 :  : Operates DOD's centralized    |
| Finance and   :         :         :  : FMS billing, collecting,      |
| Accounting    :         :         :  : and trust fund accounting     |
| Service       :         :         :  : system.                       |
|----------------------------------------------------------------------|
| Defense       :   14.87 :     4.2 :  : Manages the overall FMS       |
| Security      :         :         :  : program. Acts as the DOD      |
| Cooperation   :         :         :  : focal point for tracking      |
| Agency        :         :         :  : arms transfers, budgetary,    |
|               :         :         :  : legislative, and other        |
|               :         :         :  : security assistance issues.   |
|----------------------------------------------------------------------|
| Defense       :   15.08 :     4.3 :  : Contractor development cost   |
| Security      :         :         :  : of a single, centralized      |
| Assistance    :         :         :  : security assistance           |
| Management    :         :         :  : management system.            |
| System        :         :         :  :                               |
|----------------------------------------------------------------------|
| Defense       :   12.28 :     3.5 :  : Hosts the FMS legacy system   |
| Information   :         :         :  : database with which the       |
| Systems Agency:         :         :  : Defense Security Assistance   |
|               :         :         :  : Management System             |
|               :         :         :  : interfaces.                   |
|----------------------------------------------------------------------|
| Defense       :    8.05 :     2.3 :  : DSCA organization tasked      |
| Security      :         :         :  : with developing the single,   |
| Assistance    :         :         :  : centralized security          |
| Development   :         :         :  : assistance management         |
| Center        :         :         :  : system--the Defense           |
|               :         :         :  : Security Assistance           |
|               :         :         :  : Management System.            |
|----------------------------------------------------------------------|
| Defense       :    4.69 :     1.3 :  : Centralized DOD school for    |
| Institute of  :         :         :  : security assistance           |
| Security      :         :         :  : management. Provides          |
| Assistance    :         :         :  : instruction for U.S.          |
| Management    :         :         :  : government, foreign           |
|               :         :         :  : government, and industry      |
|               :         :         :  : personnel.                    |
|----------------------------------------------------------------------|
| Security      :   23.75 :     6.8 :  : DOD elements, regardless of   |
| assistance    :         :         :  : actual title, located in a    |
| organizations :         :         :  : foreign country with          |
| --overseas    :         :         :  : assigned responsibilities     |
|               :         :         :  : for carrying out security     |
|               :         :         :  : assistance management.        |
|----------------------------------------------------------------------|
| Management    :   10.65 :     3.0 :  : Reserve held by DSCA.         |
| Reserve       :         :         :  :                               |
|----------------------------------------------------------------------|
| Reimbursements:   -1.05 :   -0.30 :  :                               |
|----------------------------------------------------------------------|
| American      :    1.06 :    0.30 :  : A nonprofit organization      |
| Institute in  :         :         :  : established to conduct FMS    |
| Taiwan        :         :         :  : administrative functions.     |
|----------------------------------------------------------------------|
| Sale implementing activities                                         |
|----------------------------------------------------------------------|
| Air Force     :   87.39 :    25.0 :  : The military services and     |
|--------------------------------------: defense agencies are          |
| Army          :   80.50 :    23.0 :  : responsible for the           |
|--------------------------------------: execution of military         |
| Navy          :   52.73 :    15.1 :  : assistance programs. For      |
|--------------------------------------: the FMS program, the          |
| National      :    0.63 :     0.2 :  : military service or defense   |
| Security      :         :         :  : agency is responsible for     |
| Agency        :         :         :  : preparing a Letter of Offer   |
|--------------------------------------: and Acceptance and            |
| Defense       :    0.59 :     0.2 :  : implementing foreign          |
| Logistics     :         :         :  : military sales. The           |
| Agency        :         :         :  : implementing agency is        |
|--------------------------------------: responsible for the overall   |
| National      :    0.40 :     0.1 :  : management of actions that    |
| Imagery and   :         :         :  : will result in delivery of    |
| Mapping Agency:         :         :  : the materials or services     |
|               :         :         :  : set forth in the Letter of    |
|               :         :         :  : Offer and Acceptance that     |
|               :         :         :  : was accepted by a foreign     |
|               :         :         :  : country or international      |
|               :         :         :  : organization.                 |
------------------------------------------------------------------------

Figure****Helvetica:x11****5:    DOD Organizations That Receive FMS
                                 Funding
*****************

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COMMENTS FROM THE DEPARTMENT OF DEFENSE
=======================================

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GAO Comments

The following are our comments on the Department of Defense's letter dated
October 25, 1999.

   1.Our report does not state that the Arms Export Control Act requires
         the accumulation of actual full cost for defense articles and
         services transferred under the Foreign Military Sales program.
         This sentence that DOD refers to describes the Arms Export
         Control Act requirement that the United States government not
         sell items under the FMS program at a loss. This sentence also
         describes that the act generally requires the program to recover
         costs associated with the implementation of the FMS program. We
         have adjusted language in this report to more precisely
         characterize the act, and clearly state that there are exceptions
         to the requirement of full cost recovery.

   2.DOD's comment is referring to our report's reference to customer
         complaints concerning program inefficiencies. We do not believe
         that FMS program inefficiencies are only perceived. The Deputy
         Secretary of Defense, in October 1998, stated that "One of the
         things we've noticed is that there's been a definite trend of
         countries wanting to abandon foreign military sales as an
         approach and going to direct commercial sales as an alternative.
         In large measure, I think that's being driven by the
         inefficiencies that come with foreign military sales. It's
         cumbersome, it's time consuming, it's heavily rule bound."

   3.We agree with DOD's characterization of the law and believe the
         sentence accurately reflects that characterization. Our statement
         notes that we evaluated "whether the foreign military sales
         program has achieved full recovery of its administrative costs"
         and explains the scope of our review by defining the objectives
         of our audit. These objectives were derived from the requester's
         initial request letter and in consultation with committee staff.
         Based on the requester's concern regarding the future viability
         of the program, we examined how the FMS program has recovered its
         costs, including certain costs such as military pay for which the
         program has sought and obtained legislative relief.

   4.Our report did not state that DOD was required to fully recover all
         actual administrative costs. However, the Arms Export Control Act
         requires the FMS program to recover certain costs. Our report
         faults DOD for not having sufficient information to determine
         whether it is recovering these costs. Furthermore, the federal
         financial accounting standard for cost accounting concepts and
         standards explains that collecting cost information is essential
         to managing federal government programs in the areas of budgeting
         and control, performance measurement, determination of
         reimbursements and setting of fees and prices, program
         evaluations, and economic choice decisions. These accounting
         standards require agencies to accumulate the full cost of outputs
         through appropriate costing methodologies or cost finding
         techniques. While DOD is not required by law to fully recover
         cost, identifying the full cost of administering the FMS program
         is a good business practice identified in federal financial
         accounting standards.

   5.We have changed the context of this sentence to add clarity to our
         message. DOD's comment noted that we should cite the Arms Export
         Control Act when stating that the Department lacks sufficient
         information to determine if it is fully recovering FMS
         administrative costs. The scope of our work was to assess the
         future viability of the program and not just to assess DOD's
         compliance with the act. Our work demonstrates that DOD does not
         have sufficient information related to the costs of the FMS
         program, whether these costs are required to be recovered by the
         Arms Export Control Act or not.

   6.We agree with DOD's characterization of the law that there are
         exclusions to full cost recovery. As noted on page 3 of this
         report, "the Arms Export Control Act provides a number of ways to
         price defense articles and services transferred under the Foreign
         Military Sales program, including actual value, replacement
         value, and full cost, and requires that the Department of Defense
         recover, with specified exceptions, the full estimated cost of
         administrating such sales."

   7.The DOD comment reflects Air Force budget planning levels for fiscal
         year 1995. Our report uses actual fiscal year 1995 FMS
         administrative spending by the military services as provided by
         DSCA budgeting officials. The figures in our report remain
         accurate as of August 3, 1999.

   8.We have updated the report to include this new information provided
         by DOD.

(707426)

Figure 1:  Trend in the Value of Foreign Military Sales, Fiscal Years 1989-
19987

Figure 2:  Military Services' FMS Administrative Budgets, 1990-20029

Figure 3:  FMS Administrative Account Balance, Fiscal Years 1983-199814

Figure 4:  Projected Administrative Account Balance With 2.5-Percent
Administrative Charge at $7.5 Billion Sales and $10 Billion Sales, 1999-
200719

Figure 5:  DOD Organizations That Receive FMS Funding30

Table 1:  Fiscal Year 1998 Program Management Spending and FMS
Administrative Budget Spending by Military Service10

Table 2:  Projections of Foreign Military Sales Versus Actual Sales 
Realized                                        13

Table 3:  Fiscal Year 1998 FMS Administrative Budget Allocation 
and Roles of Primary FMS Organizations          29

*** End of document. ***