GAO

United States General Accounting Office

Report to the Chairman and Ranking

Minority Member, Subcommittee on

Readiness and Management Support,

Committee on Armed Services, U.S.

Senate

July 2000 DEFENSE

ACQUISITIONS

Prices of Marine Corps

Spare Parts Have

Increased

GAO/NSIAD-00-123

Page 1 GAO/NSIAD-00-123 Defense Acquisitions

Contents

Letter 3

Appendixes Appendix I: Scope and Methodology 20

Appendix II: Marine Corps Surcharge and Price Change Rates 22

Appendix III: Average Percentage Changes in Standard Prices,

Fiscal Years 1995-99 and 1997-99 29

Appendix IV: Marine Corps Sales and Average Percentage Price

Increases by Federal Supply Group, Fiscal

Years 1997-99 30

Appendix V: Comments From the Department of Defense 31

Appendix VI: GAO Contacts and Staff Acknowledgments 34

Tables Table 1: Marine Corps Surcharge and Price Change Rates 7

Table 2: Elements Used to Compute Marine Corps Surcharge Rates,

Fiscal Years 1997-2000 23

Table 3: Estimated Costs and Projected Sales, Fiscal Years 1997-98 24

Table 4: Estimated Costs and Projected Sales, Fiscal Years 1998-99 25

Table 5: Estimated Costs and Projected Sales, Fiscal Years 1999-2000 26

Table 6: Customer Change Rates, Fiscal Years 1997-2000 27

Figures Figure 1: Marine Corps Logistics Base, Albany, Georgia 6

Figure 2: Changes in Marine Corps Prices Compared With Changes in

Prices of Similar Items in the Private Sector 8

Figure 3: Effect of Annual Price Adjustments on the Price of a

Communication Terminal 9

Figure 4: Example of Setting Part Prices 12

Figure 5: Reported Repair Costs as a Percentage of Standard Prices 13

Figure 6: Accumulated Gains by Fiscal Year 15
Page 2 GAO/NSIAD-00-123 Defense Acquisitions
Page 3 GAO/NSIAD-00-123 Defense Acquisitions

United States General Accounting Office

Washington, D.C. 20548

National Security and

International Affairs Division

B-281206 Letr

July 31, 2000

The Honorable James M. Inhofe, Chairman

The Honorable Charles S. Robb, Ranking Minority Member

Subcommittee on Readiness and Management Support

Committee on Armed Services

United States Senate

Because of concerns by military commands about increasing prices for

spare parts, you requested that we examine spare part prices to determine

whether they were increasing at a rate faster than inflation and the extent

to which surcharges, suppliers’ prices, and other factors contributed to

price increases.

This is the first in a series of reports examining price trends of spare parts

managed by the military services. This report contains information on

reparable spare parts1 the Marine Corps uses to maintain ground combat

and support equipment such as vehicles, radars, and radio receivers.

Specifically, it addresses (1) changes in the prices of reparable parts

compared with the prices of similar items in the private sector and the

reasons for the price changes and (2) the accuracy of prices set by the

Marine Corps.

Defense pricing policy requires the Marine Corps to establish prices for

spare parts it manages at the beginning of each fiscal year. The Marine

Corps manages its reparable spare parts under a revolving stock fund and

charges its field units and repair facilities (referred to as customers) for

parts provided. A surcharge is added to the cost of the parts to cover the

costs of managing, storing, and distributing the parts.

To determine whether prices of Marine Corps spare parts were increasing

at a rate faster than inflation, we examined the price trend for the 703

different parts the Marine Corps managed from fiscal year 1995 through

1999.2 Of these 703 parts, the Marine Corps sold 313 to customers during

1 Reparable spare parts are parts that can be economically repaired, whereas consumable

parts are expendable items such as paint, fuel, and supplies.

2 These 703 parts were the only ones the Marine Corps managed over the entire period.
B-281206

Page 4 GAO/NSIAD-00-123 Defense Acquisitions

fiscal years 1997-99. We reviewed the prices of these 313 parts to determine

the reasons for price changes. To review spare part prices, we examined

the procedures and methods the Marine Corps used to compute prices.

Specific information on our scope and methodology is in appendix I.

Results in Brief Prices of the 703 parts we examined increased by an average of about

14 percent over the 4-year period from fiscal year 1995 through 1999, while

prices for similar items sold in the private sector dropped by 0.2 percent

over the same period. Prices for these 703 parts fluctuated during this

4-year period, dropping by about 10 percent during the first 2 years and

increasing by about 27 percent during the last 2 years. Prices of the 313

parts sold to customers followed the same pricing pattern. The major cause

of the sharp price increase during the latter years was increases in

surcharge rates. The cost of procuring the parts from suppliers influenced

the price of only 26 parts.

The Marine Corps did not follow Defense pricing regulations in setting

prices and, as a result, the prices of most parts sold to Marine Corps

customers were not correct. In particular, the approach used to adjust

prices of repaired parts from year to year was not consistent with Defense

regulations. The Marine Corps’ approach led to wider price fluctuations

than the approach called for in Defense pricing regulations. Moreover,

prices for many parts were higher than they would have been had repair

costs been used to set prices. Mathematical and computer program errors

were also made. These problems contributed to the Marine Corps having

an accumulated gain of about $48 million from the sale of spare parts at the

end of fiscal year 1999. Defense policy requires revolving funds to operate

with the long-term objective of breaking even.

The Marine Corps has initiated actions to correct its method for setting

prices. We are recommending that the Marine Corps prepare an action plan

for completing corrections so that changes will be incorporated in fiscal

year 2001 prices. In written comments on a draft of this report, the

Department generally agreed with our findings and recommendation but

took exception to the use of the term “profit” in our draft report to describe

the Marine Corps’ accumulated gain from supply operations. To avoid any

misunderstanding, we substituted the term “accumulated gain” for “profit”

to describe the position of the fund.
B-281206

Page 5 GAO/NSIAD-00-123 Defense Acquisitions

Background The Marine Corps stocks different types of reparable spare parts, ranging

from diesel engines to electronic components. Each year the Marine Corps

purchases a few new parts from suppliers but obtains most of the parts

needed to support its operations by refurbishing broken ones that

customers turn in for repair. Between July 1, 1996, and June 30, 1998, for

example, the Marine Corps purchased only 61 different parts from

suppliers. These parts included items such as circuit card assemblies,

diesel engines, and radio frequency amplifiers.

In the late 1980s, the Department of Defense concluded that the military

services should manage reparable spare parts using revolving stock funds.

The primary goal of a revolving fund is to focus attention on the total costs

of operations in order to provide goods and services at the lowest costs. A

revolving fund is intended to operate much like a commercial business,

procuring inventory to satisfy customer needs, stocking it until sold, and

using the cash from sales to pay for all associated operating costs,

including procurement of replacement inventory. Generally, a revolving

fund relies on sale revenues to finance its operations and is not intended to

make a profit over the long term.

In fiscal year 1994, the Marine Corps placed 890 different parts—less than

one-third of the parts it was managing at that time—into the stock fund and

started charging its customers for the parts. The Marine Corps placed the

remainder of its reparable parts into the stock fund in fiscal year 1998 and

began charging customers for them in fiscal year 2000. In fiscal year 1999,

the Marine Corps was managing 3,200 different reparable spare parts with a

total inventory value of $480 million. These parts are stored in depots3 until

a Marine Corps customer needs them. Figure 1 shows parts in storage at

the Albany, Georgia, depot.

3 The Marine Corps has two depots—one at Barstow, California, the other at Albany,

Georgia. The Defense Logistics Agency operates these depots and distributes spare parts for

all types of Marine Corps ground combat and support equipment.
B-281206

Page 6 GAO/NSIAD-00-123 Defense Acquisitions

Figure 1: Marine Corps Logistics Base, Albany, Georgia

Source: Marine Corps.

The Marine Corps establishes a price—called a standard price—for each of

its reparable spare parts and uses these prices to charge customers for

parts they order. Defense pricing procedures require that standard prices

be set by taking the most recent purchase price and adding a surcharge.

The surcharge is designed to recoup supply management costs such as

salaries, obsolescence, and storage expenses. The Marine Corps revises

standard prices annually by using one of two approaches. If a part has been

procured recently,4 the Marine Corps applies a surcharge to the purchase

price to establish a standard price for the following fiscal year. If a part has

not been procured recently, the Marine Corps revises the price of the part

by applying a price change rate5 to the current standard price of the part.

Both the surcharge and price change rate vary from year to year (see

table 1).

4 Recently procured parts are those that have been purchased during a specific 12-month

period. The 12-month procurement window for fiscal year 1999, for example, was July 1,

1997, through June 30, 1998.

5 The Marine Corps computes the price change rate by calculating the percentage difference

between the current and prior fiscal year surcharge rates (adjusted for inflation).
B-281206

Page 7 GAO/NSIAD-00-123 Defense Acquisitions

Table 1: Marine Corps Surcharge and Price Change Rates

Source: Marine Corps.

Appendix II contains a discussion of these rates, including how they are

computed.

When a customer orders a part, the Marine Corps charges the standard

price if the customer does not return a broken part that can be

economically repaired. When a broken part is returned, however, the

Marine Corps charges the customer an exchange price, which is less than

the standard price. Most Marine Corps sales are made at the lower

exchange prices, which are set using 57 percent of a part’s standard price.

Prices Increased in

Response to Changes

in Surcharge Rates

Prices of the parts we examined fluctuated during the 4-year period from

fiscal year 1995 through 1999, dropping during the first 2 years and

increasing sharply during the last 2 years. Prices for the 313 parts sold to

customers followed the same pricing pattern. Increases in surcharge rates

caused the major part of the sharp price increase during the latter 2 years.

These surcharges recover the costs of managing, storing, and distributing

parts.

Prices of 703 Parts

Increased About 14 Percent

in Fiscal Years 1995-99

From fiscal year 1995 through 1999, prices of the 703 parts we examined

increased by an average of about 14 percent, or about 3 to 4 percent

annually. The producer price index we used showed that prices for similar

items sold in the private sector dropped by about 0.2 percent during the

(in percent)

Fiscal year Surcharge rate Price change rate

1995 44.01 0.70

1996 39.50 -9.10

1997 24.59 -10.69

1998 43.75 19.17

1999 45.83 3.61
B-281206

Page 8 GAO/NSIAD-00-123 Defense Acquisitions

same period.6 Figure 2 compares the changes in the prices of these 703

parts with changes in the prices of similar items in the private sector.

Figure 2: Changes in Marine Corps Prices Compared With Changes in Prices of

Similar Items in the Private Sector

Source: our analysis of Marine Corps data.

Prices of the 703 parts fluctuated considerably during the 4-year period,

dropping by about 10 percent during the first 2 years and increasing by

about 27 percent during the last 2 years. Appendix III shows the average

percentage price change for these 703 parts.

The Marine Corps sold 313 of the 703 parts for $38 million during fiscal

years 1997-99. The price changes for these parts followed the same pattern

as the price changes for all 703 parts—dropping during the first 2 years and

6 There is no inflation index that directly relates to Marine Corps spare parts. To

approximate inflation for these parts, we used the producer price index, which is a family of

indexes that measures average changes in the selling prices received by domestic producers

of goods and services. We selected the index for the commodity group Intermediate

Materials and Components for Manufacturing less Foods and Feed. We used the subgroup

Materials and Components for Manufacturing, which includes items such as motor vehicle

parts, electronic components and accessories, motors, and generators. These items are

similar to the Marine Corps spare parts we examined.

-15

-10

-5

0

5

10

15

20

25

Average Marine Corps

Price Change

-1.30 -9.61 20.59 5.93

PPI Change 0.67 -0.22 0.40 0.22

Fiscal year

1995-96

Fiscal year

1996-97

Fiscal year

1997-98

Fiscal year

1998-99

Percent
B-281206

Page 9 GAO/NSIAD-00-123 Defense Acquisitions

increasing during the last 2 years. Appendix IV shows the average price

change for the 313 parts.

Increases in Surcharge

Rates Were Major Cause of

Price Increases

Marine Corps customers were affected far more by price increases

resulting from changes in surcharge rates than by changes in procurement

prices. Of the 313 parts sold to Marine Corps customers, prices for 273 of

these parts increased primarily because of the price change rates applied to

standard prices. The price change rate is derived from the same elements

used to compute the surcharge and is essentially the difference between

the current and prior year’s surcharge rate. The 273 parts accounted for

about 88 percent of the $38 million in sales to Marine Corps customers.

The Marine Corps’ pricing of a communication terminal illustrates how the

price of that part increased during fiscal years 1997-99 as a result of

increases in the price change rates (see fig. 3).

Figure 3: Effect of Annual Price Adjustments on the Price of a Communication

Terminal

Source: our analysis of Marine Corps data.

As shown by figure 3, the price of the communication terminal increased

from $11,810 in fiscal year 1997 to $14,581 in fiscal year 1999, an increase of

$2,771. To compute the fiscal year 1998 price, the Marine Corps applied the

19.17-percent price change rate to the part’s fiscal year 1997 price. To

compute the fiscal year 1999 price, the Marine Corps applied the

$14,581

$14,073

$11,810

$11,000 $12,000 $13,000 $14,000 $15,000

Fiscal year 1999

Fiscal year 1998

Fiscal year 1997
B-281206

Page 10 GAO/NSIAD-00-123 Defense Acquisitions

3.61-percent price change rate to the part’s fiscal year 1998 price. In total,

the Marine Corps increased the price of this part by about 23 percent by

applying the price change rates for fiscal years 1998 and 1999 as shown in

table 1. The Marine Corps increased the prices of the other 272 parts in the

same manner.

Prices for the remaining 26 parts7 changed in response to changes in the

cost of procuring the parts from suppliers. Prices for these parts increased

by an average of 68 percent in fiscal years 1997-99.

Marine Corps Errors in

Pricing Spare Parts

Defense financial management procedures require the military services to

calculate standard prices for spare parts annually. These procedures

stipulate that the revenue from sales is not to exceed the costs of supplying

the parts over the long term. However, the Marine Corps has not followed

Defense procedures in calculating spare part prices, resulting in prices that

were higher or lower than they should have been. Prices for some spare

parts were unrealistic because the Marine Corps did not compute prices on

the basis of actual repair costs.8 In addition, some prices computed by the

Marine Corps were incorrect because of mathematical mistakes, computer

program flaws, or other errors. These conditions contributed to the Marine

Corps reporting an accumulated gain of about $48 million at the end of

fiscal year 1999 from the sale of spare parts in fiscal years 1994-99. In

addition, the Marine Corps regulation containing policies and procedures

for pricing spare parts is outdated.

Computation of Standard

and Exchange Prices

Defense Financial Management Regulation 7000.14-R requires the military

services to compute two different prices for reparable spare parts each

fiscal year. One of these prices is called a standard price. Regulations

stipulate that the standard price consist of the most current procurement

price paid plus a surcharge. The second price is the exchange price. This is

used when customers turn in a reparable item. Regulations provide that the

7 We excluded 14 parts from our analysis because the Marine Corps did not change the price

of the parts in at least 1 year, made a mathematical error in pricing the part, or did not have

a procurement history for the part.

8 It should be noted that our financial statement audits have highlighted the Department’s

continuing problems in capturing and accurately reporting full costs. See Department of

Defense: Progress in Financial Management Reform (GAO/T-AIMD/NSIAD-00-163, May 9,

2000), p. 31.
B-281206

Page 11 GAO/NSIAD-00-123 Defense Acquisitions

exchange price be computed by either adding a surcharge to a part’s repair

costs or taking a percentage of a part’s standard price. The regulations

require that an exchange price be set for groupings of similar parts.

The Marine Corps revises standard prices each fiscal year by using one of

two approaches. If a part has been procured recently, the Marine Corps

applies a surcharge rate to the procurement price to establish a standard

price for the following fiscal year. If a part has not been procured recently,

the Marine Corps applies a price change rate to the standard price to

establish a new standard price for the next fiscal year. The Marine Corps’

use of the price change rate to compute standard prices has caused prices

to be overstated in some years and understated in others.

In their annual pricing process, the other military services comply with

Defense pricing procedures by removing the current year’s surcharge from

the standard price—thus leaving the latest procurement price—and then

adding the next year’s surcharge. The Marine Corps’ approach, however, is

completely different. The Marine Corps adds the price change rate to a

part’s current standard price to compute the next year’s standard price.

To illustrate the effect of the Marine Corps’ methodology, we used both

approaches to compute prices for a driveshaft assembly the Marine Corps

purchased at a unit price of $279.79 in fiscal year 1996. The Marine Corps’

approach resulted in a fiscal year 1999 standard price that was about

6 percent higher than it would have been had the price been computed in

accordance with regulations (see fig. 4).
B-281206

Page 12 GAO/NSIAD-00-123 Defense Acquisitions

Figure 4: Example of Setting Part Prices

Source: our analysis of Marine Corps data.

In addition to standard prices, exchange prices established by the Marine

Corps are higher than they would have been had actual repair costs been

used to compute them. In fiscal year 1997, the Marine Corps began

calculating exchange prices for parts by charging customers 57 percent of

the standard price. Marine Corps officials told us that they developed the

factor using the average repair costs of a random number of parts, but they

were unable to provide documentation showing how they arrived at the

57-percent factor.

We obtained the Marine Corps’ recorded repair costs of 65 different parts

refurbished in 1998. Of these 65 parts, 58 (about 89 percent) were in four

federal supply groups.9 We calculated average exchange prices by groups

on the basis of repair costs provided by the Marine Corps. As shown in

figure 5, the exchange prices we computed using reported repair costs

ranged between 25 and 35 percent of the standard prices for parts in these

groups and averaged 33 percent of standard prices of all parts. Because the

9 The federal supply classification system is used to classify supply items identified under

the federal cataloging program. A federal supply group is used to group similar items

(including spare parts) into broad commodity categories for management purposes.

$340.00

$390.00

$440.00

Marine Corps pricing

method

$348.59 $415.41 $430.41

Method used by other

services

$348.59 $402.20 $408.02

FY97 FY98 FY99

Difference: $22.39

( 6 percent )
B-281206

Page 13 GAO/NSIAD-00-123 Defense Acquisitions

Marine Corps computes exchange prices at 57 percent of standard prices,

the prices charged to customers were 22 to 32 percentage points higher

than they should have been.

Figure 5: Reported Repair Costs as a Percentage of Standard Prices

Source: our analysis of Marine Corps data.

After we presented our analysis to Marine Corps officials, they agreed that

the standard 57-percent factor was not the most equitable way to compute

exchange prices.

Errors in Calculating

Standard Prices and Billing

Customers

In some cases, the Marine Corps established incorrect standard prices for

parts because of mathematical mistakes, computer program flaws, or

oversights. These problems included the following:

35

28 27

25

0

10

20

30

40

FSG 25 FSG 58 FSG 59 FSG 61

Percent

FSG 25: Vehicular equipment components

FSG 58: Communication, detection, and coherent radiation equipment

FSG 59: Electrical and electronic equipment components

FSG 61: Electric wire and power distribution equipment
B-281206

Page 14 GAO/NSIAD-00-123 Defense Acquisitions

• The price change rate for fiscal year 1999 was 3.61 percent, but the

Marine Corps added 36.1 percent to the prices of its reparable spare

parts to establish fiscal year 1999 prices. The Marine Corps charged its

customers these erroneous prices from October 1 through December 31,

1998. After recognizing the error, the Marine Corps repriced the parts

and refunded customers about $2.4 million in overcharges. We brought

to the Marine Corps’ attention 16 additional parts that had not been

repriced at the time of our review.

• The Marine Corps did not compute standard prices using the most

recent procurement prices when it placed the remaining parts in the

stock fund in fiscal year 1998. We noted 20 instances in which the most

recent procurement prices were not used. As a result, 14 parts were

underpriced by $330 to $28,832 and 6 parts were overpriced by $31 to

$15,750 in fiscal year 1999.

• The Marine Corps calculated standard prices for at least 88 parts placed

in the stock fund in fiscal year 1998 by using a price change rate of

19.17 percent. It should have used the 43.75-percent surcharge rate, as

directed by Marine Corps headquarters. As a result, 86 of these parts

were underpriced by $15 to $83,769 in fiscal year 1999.

• The Marine Corps computed some prices in fiscal years 1998-99 on the

basis of outdated procurement prices. As a result, prices for some parts

were incorrect.

• The Marine Corps used a 19.17-percent price change rate to calculate

fiscal year 1998 standard prices for parts not recently procured. We

recalculated the price change rate and found that it should have been

17.77 percent.

• The Marine Corps was not billing customers for parts purchased from

contractors and shipped directly to customers. This practice is contrary

to Defense Financial Management Regulation 7000.14-R, which requires

that customers be billed for the acquisition cost of a part plus an

appropriate surcharge. The Marine Corps agreed that it had not billed

customers for direct-shipped parts, but was unable to provide the dollar

value of these parts.

Sales Revenues Exceeded

Costs in Fiscal Years 1994-99

Marine Corps budget documents showed an accumulated gain of about

$48 million at the end of fiscal year 1999 (see fig. 6). The flawed processes

used by the Marine Corps to price parts, coupled with the pricing errors

and oversights previously discussed, contributed to this condition.
B-281206

Page 15 GAO/NSIAD-00-123 Defense Acquisitions

Figure 6: Accumulated Gains by Fiscal Year

Source: our analysis of Marine Corps data.

Defense Financial Management Regulation 7000.14-R states that revolving

funds are expected to operate on a break-even basis over time—that is, not

make a profit or incur a loss but simply recover all costs.

Marine Corps Regulation for

Pricing Spare Parts Is

Outdated

The Marine Corps does not have an up-to-date regulation for pricing

reparable spare parts that are managed by the stock fund. The latest

regulation containing pricing guidance is in Marine Corps Order 4443.8F,

dated July 6, 1989, before the Marine Corps placed reparable spare parts in

the stock fund and began charging customers for them. The Marine Corps

did issue a logistics bulletin in April 1994 that discussed stock fund pricing

matters, but the bulletin was not a regulation. The Marine Corps has no

written guidance setting out current policies and procedures concerning

such matters as how standard and exchange prices are to be developed.

Corrective Actions Initiated

by the Marine Corps

After reviewing our findings, officials from the Office of the Assistant

Secretary of the Navy (Financial Management and Comptroller) and the

Marine Corps agreed to update the Marine Corps pricing regulation. They

$20.1

$35.1

$31.1

$40.8

$35.9

$47.8

$0

$10

$20

$30

$40

$50

FY94 FY95 FY96 FY97 FY98 FY99

Dollars in millions
B-281206

Page 16 GAO/NSIAD-00-123 Defense Acquisitions

also agreed to review and correct the prices of all reparable spare parts

managed by the Marine Corps. In addition, they agreed to

• discontinue using the price change rate to compute standard prices for

parts not recently procured and to use the approach prescribed by

Defense regulations;

• discontinue use of the standard 57-percent factor to compute exchange

prices and use repair costs plus a surcharge or, when repair costs are

not available, a percentage of parts’ standard prices calculated by

groupings of similar parts;

• establish procedures to prevent the future occurrence of the pricing

errors we found; and

• make an assessment to determine whether the Marine Corps should

reduce its surcharge, resulting in lower prices and in turn bringing the

accumulated gain closer to zero.

Conclusions Actions being taken by the Marine Corps should correct the pricing

problems we found. If properly implemented, these corrective actions

should significantly improve the accuracy of Marine Corps spare part

prices, reduce the amount of accumulated gains on the sales of parts, and

provide procedures for use by Marine Corps personnel in managing stock

fund operations. These actions should be implemented so that prices

established for fiscal year 2001 are correct.

Recommendation We recommend that the Secretary of Defense direct the Commandant of

the Marine Corps to prepare an action plan with target dates for completing

corrective actions so that changes are incorporated in fiscal year 2001

prices.

Agency Comments and

Our Evaluation

In written comments on a draft of this report, the Department of Defense

generally agreed with our recommendation and principal findings.

However, the Department objected to our use of the term “profit” when

discussing the accumulated gains10 from supply operations, saying it

believed the term “profit” was misleading. In support of that point, the

10 The Department uses the term “accumulated operating result.”
B-281206

Page 17 GAO/NSIAD-00-123 Defense Acquisitions

Department provided a cash flow analysis from fiscal year 1995 through

1999 that shows cash collections exceeded disbursements by $68.5 million

during that time period. In addition, the Department stated that from fiscal

year 1992 through 1994, disbursements exceeded collections by

$103.8 million, leaving a net loss of $35.3 million over the entire period of

fiscal year 1992 through 1999. Accordingly, the Department requested the

word profit be removed from our report.

We do not agree that the cash flow analysis (showing collections and

disbursements) presented by the Department is a more appropriate

measure of the accumulated operations of the Marine Corps supply

management system than accumulated gains or losses. Federal accounting

standards require agencies to prepare reports on the results of operations

on an accrual rather than cash basis because an accrual basis provides a

better matching of an entity’s use of resources with the period of concern.

Cumulative accrual-based information (shown as accumulated gains or

losses) will be considerably different than cumulative cash-based data if, as

happens in the stock fund, the Marine Corps pays for repair of an item and

holds the item in inventory for several years before selling it to its

customers. On a cash basis, disbursements for repairs will be recorded

when payment for the repair is made, usually in the year repaired. On an

accrual basis, repair expenses will be recognized and revenue recorded in

the year the item is sold. In accordance with Defense regulations, the

Marine Corps has reported the operating position of the fund on an accrual

basis. In February 2000, the Marine Corps reported an accumulated gain of

$48 million and that result is presented in this report. However, to avoid any

confusion, we have used the term “accumulated gain” rather than “profit”

to describe the position of the fund.

The Department also provided technical comments, which we have

incorporated where appropriate. The Department of Defense’s comments

appear in appendix V.

We are sending copies of this report to the appropriate congressional

committees; the Honorable William S. Cohen, Secretary of Defense; the

Honorable Richard Danzig, Secretary of the Navy; General James L. Jones,

Commandant of the Marine Corps; and the Honorable Jacob J. Lew,

Director, Office of Management and Budget.
B-281206

Page 18 GAO/NSIAD-00-123 Defense Acquisitions

GAO contacts and major contributors to this report are listed in

appendix VI.

David E. Cooper

Defense Acquisitions Issues
Page 19 GAO/NSIAD-00-123 Defense Acquisitions
Page 20 GAO/NSIAD-00-123 Defense Acquisitions

Appendix I

Scope and Methodology ApApenednxidexiIs

To determine changes in the prices of Marine Corps reparable spare parts,

we first reviewed the historical pricing of the 890 parts initially placed in

the stock fund to identify those that remained in the fund during the 5-year

period of fiscal years 1994-99. For the 703 parts we identified as remaining

in the stock fund throughout the 5-year period, we used simple averages to

compute both the annual price changes and the average price change in

fiscal years 1995-99. We averaged the percentage changes in the standard

prices to compute the price change for each year. We were unable to

compute price trends for the entire 5-year period because neither the

Marine Corps nor the Defense Logistics Information Services1 could

provide fiscal year 1994 standard prices. We also identified those parts sold

between October 1, 1996, and April 25, 1999. We computed the average

price change for these parts and analyzed these changes in detail.

To establish an inflation index for these price trends, we used the producer

price index commodity group Intermediate Materials, Supplies, and

Components minus Foods and Feeds. This tracks partly processed

commodities that require further processing to reach the finished goods

stage. To eliminate such items as processed fuels, we used the subgroup

Materials and Components for Manufacturing. This includes items such as

motor vehicle parts, electronic components and accessories, motors, and

generators. We judged the items in this subgroup to be the most similar to

those managed by the Marine Corps. We did not use the consumer price

index because it focuses on consumer goods and does not contain items

similar to Marine Corps reparable spare parts.

To evaluate the processes the Marine Corps uses to price spare parts, we

examined the practices it uses to compute standard and exchange prices.

We also examined Defense Financial Management Regulation 7000.14-R,

which contains pricing guidance and establishes the benchmark against

which stock fund performance is to be measured. Specifically, it sets the

accumulated operating result, that is, accumulated gain or loss, as the

standard for breaking even. We used those figures, provided in the

President’s Budget, to determine whether the Marine Corps was complying

with Defense policy. We also reviewed procurement prices paid, surcharges

added, and repair costs of parts. We compared the Marine Corps’ processes

with those the other services use to establish standard and exchange

prices. We also examined the Marine Corps’ calculations of surcharges and

1 The Defense Logistics Information Services, part of the Defense Logistics Agency,

maintains logistics data, including standard prices for all the military services.
Appendix I

Scope and Methodology

Page 21 GAO/NSIAD-00-123 Defense Acquisitions

the price change rates and their application to procurement and standard

prices. In addition to determining whether the Marine Corps was setting

prices as it intended, we examined the prices the Marine Corps actually

charged its customers.

While we did not validate or verify computer-generated data, we obtained

information from Marine Corps officials showing how the data was

generated and used in the annual pricing processes to establish prices. We

compared computer-generated data with information from other sources,

when available, and made Marine Corps officials aware of instances in

which data was questionable or wrong. In those instances, we attempted to

determine whether the errors were caused by what the Marine Corps

actually did by comparing the questionable data with information obtained

from other sources such as the Defense Logistic Information Services. We

also provided details of questionable transactions to Marine Corps officials

and requested that they review the information to determine its accuracy.

We performed our work at Marine Corps Headquarters and at the Marine

Corps Logistics Base, Albany, Georgia; the Office of the Assistant Secretary

of the Navy (Financial Management and Comptroller); and the Office of the

Under Secretary of Defense (Comptroller) and discussed various aspects of

the pricing of Marine Corps reparable spare parts with officials there.

We performed our work between February 1999 and May 2000 in

accordance with generally accepted government auditing standards.
Page 22 GAO/NSIAD-00-123 Defense Acquisitions

Appendix II

Marine Corps Surcharge and Price Change

Rates ApendxiI

This appendix discusses changes in the Marine Corps’ surcharge and price

change rates in fiscal years 1997-2000. We did not include information on

fiscal year 1996 rates because problems with Marine Corps supply

management systems caused some of the data for this year to be wrong. We

included information on the fiscal year 2000 rates because the data was

available.

For parts that have been procured recently, the Marine Corps adds a

surcharge to the acquisition costs to establish standard prices. For parts

that have not been procured recently, the Marine Corps adds a change

rate—the customer price change rate—to the existing standard prices to

establish standard prices for the next fiscal year. The price change rate is

computed by using the surcharge rates.

Surcharge Rates To compute the surcharge rate, the Marine Corps estimates the costs of its

supply management operations and projects the amount of anticipated

sales in the next fiscal year. The Marine Corps divides the estimated costs

by the projected sales to arrive at the surcharge rate. Changes in either

estimated costs or projected sales would cause the surcharge rate to

change from year to year. Table 1 shows the elements the Marine Corps

used to compute surcharge rates in fiscal years 1997-2000.1

1

We did not validate the estimated costs or projected sales the Marine Corps used to

compute the rates. However, we reported in May 1999 that the Department of Defense had

long-standing problems accumulating and reporting the full costs associated with working

capital fund operations. These problems have resulted in large fluctuations in surcharge

rates and, therefore, in the prices charged to customers. See Status of Financial

Management Weaknesses and Actions Needed to Correct Continuing Challenges

(GAO/T-AIMD/NSIAD-99-171, May 4, 1999).
Appendix II

Marine Corps Surcharge and Price Change

Rates

Page 23 GAO/NSIAD-00-123 Defense Acquisitions

Table 2: Elements Used to Compute Marine Corps Surcharge Rates, Fiscal Years

1997-2000

a

Managing reparable spare parts (includes estimated costs for labor, utilities, and base support).

b

Operating storage depots.

c

Replacing parts that can no longer be repaired.

d

Replacing parts that were lost or became obsolete.

e

Transportation for part shipments.

f

Adjustments for prior years’ gains or losses in supply operations.

g

Costs added to recover cash for Navy stock fund losses.

h

Costs of operating automated information systems.

i

Will not compute due to rounding.

Source: Marine Corps.

The fluctuation in surcharge rates responded, in large part, to changes in

certain cost elements. For example, in some years, part of the prior year

gain was applied to reduce the costs of operations—in fiscal year 1997 this

element reduced costs by one-third. In other years, no reduction took

place. Other charges affecting the cost of operations, and therefore,

surcharge rates, included a charge to recover cash for Navy stock fund

losses and a charge for operating the automated information system.

Fiscal Years 1997-98 In fiscal years 1997-98, the surcharge rate increased from 24.59 percent to

43.75 percent. Table 2 shows the estimated costs and projected sales the

Marine Corps used to compute the surcharge rates for these fiscal years.

(dollars in millions)

Element

Fiscal year

1997 1998 1999 2000

Estimated cost of operations

Supply operationsa $4.0 $4.3 $3.5 $4.4

Distribution depotsb 1.3 1.6 2.4 5.2

Depot washoutc 1.0 1.0 1.0 1.3

Obsolescence/lossesd 0.2 0.2 0.2 0.2

Transportatione 0.1 0.2 0.1 0.1

Prior year gains/lossesf (2.2) - (0.9) 0.3

Cash recoveryg 1.6 0.5 -

System sustainmenth - - 2.0 1.4

Total $4.4 $8.9 $8.8 $12.9

Projected sales $17.9 $20.3 $19.2 $35.10

Surcharge rate (percent) 24.59i 43.75i 45.83 36.75
Appendix II

Marine Corps Surcharge and Price Change

Rates

Page 24 GAO/NSIAD-00-123 Defense Acquisitions

Table 3: Estimated Costs and Projected Sales, Fiscal Years 1997-98

a

Will not compute due to rounding.

Source: our analysis of Marine Corps data.

In fiscal year 1998, estimated costs more than doubled (from $4.4 million to

$8.9 million) while projected sales rose only 13.4 percentage points. Two

elements accounted for most of the increase in estimated costs. First, in

fiscal year 1997, the Marine Corps lowered estimated costs by $2.2 million

to return to customers gains from prior years’ supply management

operations (shown in table 2 as prior year gains/losses). In 1998, the Marine

Corps made no adjustment for this item. Second, the Marine Corps

contributed $1.6 million to the Navy stock fund in fiscal year 1998 because

of the fund’s financial difficulties (shown in table 2 as cash recovery).2

There was no charge for this item in fiscal year 1997.

(dollars in millions)

Element

Fiscal year

1997 1998 Difference

Estimated cost of operations

Supply operations $4.0 $4.3 $0.3

Distribution depots 1.3 1.6 0.3

Depot washout 1.0 1.0 0.0

Obsolescence/losses 0.2 0.2 0.0

Transportation 0.1 0.2 0.1

Prior year gains/losses (2.2) 2.2

Cash recovery 1.6 1.6

System sustainment

Total $4.4 $8.9 $4.5

Projected sales $17.9 $20.3 $2.4

Surcharge rates (percent) 24.59a 43.75a 19.16

2 This was the first time since spare parts were initially placed in the stock fund in fiscal

year 1994 that the Department of Defense directed the Marine Corps to contribute cash to

the Navy’s portion of the stock fund.
Appendix II

Marine Corps Surcharge and Price Change

Rates

Page 25 GAO/NSIAD-00-123 Defense Acquisitions

Fiscal Years 1998-99 In fiscal years 1998-99, the surcharge rate experienced a more modest

change, increasing from 43.75 percent to 45.83 percent. Table 3 shows the

estimated costs and projected sales the Marine Corps used to compute the

surcharge rates.

Table 4: Estimated Costs and Projected Sales, Fiscal Years 1998-99

a

Will not compute due to rounding.

Source: our analysis of Marine Corps data.

Despite the small change in the surcharge rate, there were large changes in

the estimated costs of several elements:

• A $2-million charge was added to maintain automated information

systems previously managed by the Defense Logistics System Center

(shown in table 3 as system sustainment).

• The charge for operating distribution depots increased by $800,000

because the Defense Logistics Agency increased its charges.

• A $500,000 charge for cash recovery was added to contribute to the

solvency of the Navy stock fund.

• Costs were decreased by $900,000 for prior year gains to return those

gains to customers.

(dollars in millions)

Element

Fiscal year

1998 1999 Difference

Estimated cost of operations

Supply operations $4.3 $3.5 $(0.8)

Distribution depots 1.6 2.4 0.8

Depot washout 1.0 1.0 0.0

Obsolescence/losses 0.2 0.2 0.0

Transportation 0.2 0.1 (0.1)

Prior year gains/losses (0.9) (0.9)

Cash recovery 1.6 0.5 (1.1)

System sustainment 2.0 2.0

Total $8.9 $8.8 $(0.1)

Projected sales $20.3 $19.2 $(1.1)

Surcharge rates (percent) 43.75a 45.83 2.08
Appendix II

Marine Corps Surcharge and Price Change

Rates

Page 26 GAO/NSIAD-00-123 Defense Acquisitions

Fiscal Years 1999-2000 In fiscal years 1999-2000, the surcharge rate dropped from 45.83 percent to

36.75 percent. Table 4 shows the estimated costs and projected sales the

Marine Corps used to compute the surcharge rates for these fiscal years.

Table 5: Estimated Costs and Projected Sales, Fiscal Years 1999-2000

a

Will not compute due to rounding.

Source: our analysis of Marine Corps data.

The surcharge rate dropped primarily because of a sharp increase in

projected sales. This increase came about because the Marine Corps began

charging customers for more than 2,000 additional parts it added to the

stock fund in 1998. Before fiscal year 2000, customers were not charged for

these parts, and the costs to manage them were funded through direct

appropriations.

(dollars in millions)

Element

Fiscal year

1999 2000 Difference

Estimated cost of operations

Supply operations $3.5 $4.4 $0.9

Distribution depots 2.4 5.2 2.8

Depot washout 1.0 1.3 0.3

Obsolescence/losses 0.2 0.2 0.0

Transportation 0.1 0.1 0.0

Prior year gains/losses (0.9) 0.3 1.2

Cash recovery 0.5 (0.5)

System sustainment 2.0 1.4 (0.6)

Total $8.8 $12.9 $4.1

Projected sales $19.2 $35.1 $15.9

Surcharge rates (percent) 45.83a 36.75 9.08
Appendix II

Marine Corps Surcharge and Price Change

Rates

Page 27 GAO/NSIAD-00-123 Defense Acquisitions

There were changes in cost elements as well:

• Costs for supply operations, distribution depots, and depot washout

rose by $4 million primarily to support the increased number of parts

managed by the fund.

• $300,000 was added for prior year gains/losses to recover from

customers prior years’ fund losses, whereas $900,000 was returned to

customers in fiscal year 1999 for prior years’ gains.

• Costs for system sustainment decreased.

• There was no cash recovery assessment for the Navy’s portion of the

stock fund.

Price Change Rate Defense Financial Management Regulation 7000.14-R requires that a

customer price change rate be computed each fiscal year. Office of the

Secretary of Defense and Navy officials told us that the price change rate

should be used to make adjustments to the amount of appropriated funds

requested by customers to purchase spare parts. If the price change is a

negative percentage, the customer’s budget request is reduced. If the price

change is a positive percentage, the customer’s budget request is increased.

Although the Marine Corps is using the price change rate to compute

standard prices, this rate was never intended to be used for this purpose.

Table 5 shows the rates the Marine Corps computed for fiscal years 1997-

2000.

Table 6: Customer Change Rates, Fiscal Years 1997-2000

a

The rate should have been 17.77 percent in fiscal year 1998, as explained in the report.

Source: Marine Corps.

The price change rate is derived from the same elements (estimated costs

and projected sales) used to compute surcharge rates and is essentially the

percentage difference between the current and prior fiscal year surcharge

(in percent)

Fiscal year

1997 1998 1999 2000

(10.69) 19.17a 3.61 (5.14)
Appendix II

Marine Corps Surcharge and Price Change

Rates

Page 28 GAO/NSIAD-00-123 Defense Acquisitions

rates (adjusted for inflation). If there are large changes in surcharge rates

between fiscal years, there will be large changes in the price change rates.
Page 29 GAO/NSIAD-00-123 Defense Acquisitions

Appendix III

Average Percentage Changes in Standard

Prices, Fiscal Years 1995-99 and 1997-99 ApendxiI

a

The federal supply classification system is used to classify supply items identified under the federal

cataloging program. A federal supply group is used to group similar items (including spare parts) into

broad commodity categories for management purposes.

b

The average annual price increase for these parts was 3.4 percent.

Federal supply groupa

Total price change percentage

Number of

parts 1995-99 1997-99

10 − Weapons 17 76.5 19.0

12 − Fire control equipment 21 7.1 31.9

23 − Ground effect vehicles, motor vehicles, trailers, and cycles 4 57.3 33.2

25 − Vehicular equipment components 45 12.9 30.9

28 − Engines, turbines, and components 23 11.3 20.9

29 − Engine accessories 4 71.3 23.5

39 − Materials handling equipment 2 0.2 23.5

43 − Pumps and compressors 4 0.2 23.5

48 − Valves 1 72.2 23.5

49 − Maintenance and repair shop equipment 11 46.0 77.5

58 − Communication, detection, and coherent radiation equipment 128 13.7 31.2

59 − Electrical and electronic equipment components 316 9.5 23.1

60 − Fiber optics materials, components, assemblies, and accessories 2 0.2 23.5

61 − Electric wire, and power and distribution equipment 52 8.4 29.9

66 − Instruments and laboratory equipment 38 4.6 24.1

70 − Automatic data processing equipment, software, supplies, and support

equipment

26 17.4 28.4

81 − Containers, packaging, and packing supplies 9 41.5 23.5

Totals/averages 703 13.6b 26.8
Page 30 GAO/NSIAD-00-123 Defense Acquisitions

Appendix IV

Marine Corps Sales and Average Percentage

Price Increases by Federal Supply Group,

Fiscal Years 1997-99 ApendxiIV

Note: Sales are for October 1, 1996, through April 25, 1999.

a

Total does not add because of rounding.

Federal supply group

Number of

parts Sales value

Percentage of

total sales

value

Average

percentage price

increase

1997-99

10 − Weapons 13 $1,932,867.00 5.1 17.6

12 − Fire control equipment 12 2,999,853.00 7.9 38.2

23 − Ground effect vehicles, motor vehicles, trailers, and

cycles

1 196,304.00 0.5 23.5

25 − Vehicular equipment components 31 3,429,578.00 9.0 34.3

28 − Engines, turbines, and components 13 4,224,967.00 11.1 13.0

29 − Engine accessories 2 836,926.00 2.2 23.5

43 − Pumps and compressors 2 175,058.00 0.5 23.5

49 − Maintenance and repair shop equipment 4 82,310.00 0.2 172.2

58 − Communication, detection, and coherent radiation

equipment

77 18,817,272.00 49.6 35.2

59 − Electrical and electronic equipment components 123 3,757,243.00 9.9 22.7

60 − Fiber optics materials, components, assemblies, and

accessories

1 2,432.00 0.0 23.5

61 − Electric wire, and power and distribution equipment 14 870,637.00 2.3 39.5

66 − Instruments and laboratory equipment 7 248,509.00 0.7 22.7

70 − Automatic data processing equipment, software,

supplies, and support equipment

8 56,985.00 0.2 23.0

81 − Containers, packaging, and packing supplies 5 319,359.00 0.8 23.5

Totals/averages 313 $37,950,299.00a 100.0 29.6
Page 31 GAO/NSIAD-00-123 Defense Acquisitions

Appendix V

Comments From the Department of Defense ApendxiV
Appendix V

Comments From the Department of Defense

Page 32 GAO/NSIAD-00-123 Defense Acquisitions

Now on p. 23.

Deleted from report.

Now on p. 14.
Appendix V

Comments From the Department of Defense

Page 33 GAO/NSIAD-00-123 Defense Acquisitions
Page 34 GAO/NSIAD-00-123 Defense Acquisitions

Appendix VI

GAO Contacts and Staff Acknowledgments ApendxiVI

GAO Contacts David E. Cooper (202) 512-4841

Karen S. Zuckerstein (202) 512-6785

Acknowledgments In addition to those named above, George C. Burdette, Maria Storts,

Michele Mackin, Robert DeRoy, Catherine Baltzell, Charles Perdue, and

Gregory Pugnetti made key contributions to this report.

(707388) Letr
Ordering Information The first copy of each GAO report is free. Additional copies of

reports are $2 each. A check or money order should be made out to

the Superintendent of Documents. VISA and MasterCard credit

cards are accepted, also.

Orders for 100 or more copies to be mailed to a single address are

discounted 25 percent.

Orders by mail:

U.S. General Accounting Office

P.O. Box 37050

Washington, DC 20013

Orders by visiting:

Room 1100

700 4th St. NW (corner of 4th and G Sts. NW)

U.S. General Accounting Office

Washington, DC

Orders by phone:

(202) 512-6000

fax: (202) 512-6061

TDD (202) 512-2537

Each day, GAO issues a list of newly available reports and

testimony. To receive facsimile copies of the daily list or any list

from the past 30 days, please call (202) 512-6000 using a touchtone

phone. A recorded menu will provide information on how to obtain

these lists.

Orders by Internet:

For information on how to access GAO reports on the Internet,

send an e-mail message with “info” in the body to:

info@www.gao.gov

or visit GAO’s World Wide Web home page at:

http://www.gao.gov

To Report Fraud,

Waste, or Abuse in

Federal Programs

Contact one:

• Web site: http://www.gao.gov/fraudnet/fraudnet.htm

• e-mail: fraudnet@gao.gov

• 1-800-424-5454 (automated answering system)

United States

General Accounting Office

Washington, D.C. 20548-0001

Official Business

Penalty for Private Use $300

Address Correction Requested

Bulk Rate

Postage & Fees Paid

GAO

Permit No. GI00