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Defense Inventory: Changes in DOD's Inventory Reporting, 1989-1992
(Letter Report, 02/10/94, GAO/NSIAD-94-112).

The Defense Department's (DOD) Supply System Inventory Reports show that
the nominal value of the secondary item inventory--stocks of spare and
repair parts, clothing, medical supplies, and other items--fell nearly
$30 billion during fiscal years 1989-92, from $109.4 billion to $80.2
billion.  The inventory values reported by DOD, however, are not
comparable due to accounting changes that have taken place since 1989.
GAO estimates that the total inventory actually decreased by $7.6
billion during this period. GAO also estimates that the inventory DOD
placed in the potential reutilization/disposal category rose by $7
billion.  If the latest acquisition value of DOD's inventory is revalued
to reflect needed repair costs and scrap values of potential
reutilization/disposal stock, inventory values fell by $12.3 billion
during fiscal years 1989-92 and potential reutilization/disposal stock
increased by less than $200 million.  Congress approved funding of $26.7
billion in fiscal year 1992 and $26 billion in fiscal year 1993 for
secondary inventory items.  These amounts were effectively reduced to
$25.2 billion and $20 billion as a result of congressionally directed
fund transfers from the Defense Business Operations Fund and other
accounts.  DOD requested $26.2 billion for secondary inventory items in
fiscal year 1994.

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

 REPORTNUM:  NSIAD-94-112
     TITLE:  Defense Inventory: Changes in DOD's Inventory Reporting, 
             1989-1992
      DATE:  02/10/94
   SUBJECT:  Military inventories
             Inventory control systems
             Reporting requirements
             Military cost control
             Equipment inventories
             Evaluation methods
             Defense procurement
             Surplus property
IDENTIFIER:  Defense Business Operations Fund
             
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Cover
================================================================ COVER

Report to the Chairman, Subcommittee on Oversight of Government
Management, Committee on Governmental Affairs, U.S.  Senate

February 1994

DEFENSE INVENTORY - CHANGES IN
DOD'S INVENTORY REPORTING,
1989-1992

GAO/NSIAD-94-112

DEFENSE INVENTORY

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

  DBOF - Defense Business Operations Fund
  DOD - Department of Defense
  DLA - Defense Logistics Agency
  GAO - General Accounting Office

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

B-256304

February 10, 1994

The Honorable Carl Levin
Chairman, Subcommittee on Oversight
 of Government Management
Committee on Governmental Affairs
United States Senate

Dear Mr.  Chairman: 

This report responds to your request that we analyze changes in the
Department of Defense's (DOD) secondary item inventory since fiscal
year 1989.  You specifically asked that we provide information on (1)
the total value of this inventory, (2) the value of potential
reutilization/disposal (excess) stock, (3) the impact of revaluations
on the inventory, and (4) annual funding levels for buying secondary
item inventory.  This report includes inventory data for fiscal years
1989 to 1992 and inventory budget figures for fiscal years 1992 to
1994.  We will provide fiscal year 1993 inventory data, fiscal year
1994 appropriations amounts, and DOD's fiscal year 1995 budget
estimates when they become available.\1

--------------------
\1 According to DOD officials, fiscal year 1993 inventory data and
fiscal year 1995 budget estimates will be available in March 1994. 
Adjusted fiscal year 1994 appropriation amounts will also be
available in March 1994. 

   BACKGROUND
------------------------------------------------------------ Letter :1

DOD maintains stocks of spare and repair parts, clothing, medical
supplies, and other support items that are referred to as secondary
inventory items.  DOD reports the amount of its secondary item
inventory annually in its Supply System Inventory Report.  In the
report, DOD also identifies the amount of inventory that has the
potential for reuse by other DOD components or government agencies or
that may be disposed of through sale to the public.  This category of
inventory is known as potential reutilization/disposal stock.  Before
fiscal year 1991, DOD referred to it as potential DOD excess
inventory. 

The Supply System Inventory Report shows the value of inventory as of
the end of each fiscal year.  In this sense, it provides a "snapshot"
of on-hand inventory levels.  The report does not show inventory
changes such as purchases, issues, and disposals.  While our prior
work has shown accuracy problems in the systems providing data for
this report, it is the best data available on DOD-reported inventory
values. 

   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

DOD's Supply System Inventory Reports show that the nominal value of
the secondary item inventory decreased $29.2 billion between fiscal
years 1989 and 1992, from $109.4 billion to $80.2 billion.  However,
the inventory values reported by DOD are not comparable.  This is due
to accounting changes that have taken place since 1989.  Adjusting
DOD's secondary inventory for the changes and valuing it all at the
latest acquisition cost, we estimate that the total inventory
decreased by $7.6 billion between fiscal years 1989 and 1992.  Also
using the acquisition value, we estimate that inventory DOD places in
the potential reutilization/disposal category increased by $7
billion. 

If the latest acquisition value of DOD's inventory is revalued to
reflect needed repair costs and scrap values of potential
reutilization/disposal stock, inventory values decreased by $12.3
billion between fiscal years 1989 and 1992 and potential
reutilization/disposal stocks increased by less than $200 million. 

Congress approved Defense Business Operations Fund (DBOF)\2

customer funding levels of $26.7 billion in fiscal year 1992 and $26
billion in fiscal year 1993 for secondary inventory items.  The
amounts appropriated were effectively reduced to $25.2 billion and
$20 billion, respectively, as a result of congressionally directed
fund transfers from DBOF and other accounts.  In its fiscal year 1994
budget, DOD requested $26.2 billion for secondary inventory items. 

--------------------
\2 DBOF is a financing mechanism that DOD established to satisfy its
components' recurring requirements using a businesslike
buyer-to-seller approach to operations. 

   REPORTED INVENTORY VALUES ARE
   NOT COMPARABLE
------------------------------------------------------------ Letter :3

DOD's Supply System Inventory Reports show that the nominal value of
the secondary item inventory decreased $29.2 billion between fiscal
years 1989 and 1992, from $109.4 billion to $80.2 billion.  The
reports also show that during this period the value of the potential
reutilization/disposal stock decreased by $9.8 billion.  (See table
1.)

                           Table 1
           
            Value of Secondary Item Inventory, as
            Reported by DOD (Fiscal Years 1989-92)

                    (Dollars in billions)

                                          DOD-reported value
                            DOD-reported        of potential
                          value of total      reutilization/
Fiscal year                    inventory      disposal stock
----------------------  ----------------  ------------------
1989                              $109.4               $10.1
1990                               101.7                 8.1
1991                                88.1                 0.2
1992                                80.2                 0.3
Overall change                    (29.2)               (9.8)
------------------------------------------------------------
Note:  Parentheses indicate a decrease. 

The reported amounts, however, are comparable from year to year only
after 1991, primarily because, until then, the services and the
Defense Logistics Agency (DLA) used different methods for valuing the
inventory.  In 1991, DOD established a uniform system for valuing
inventory and began reporting those values in the fiscal year 1991
Supply System Inventory Report.\3 Under this system, the military
services and DLA value all inventory at the latest acquisition cost
except that items needing repair are reduced by estimated repair
costs\4 and potential reutilization/disposal stock is valued at
salvage prices. 

Prior to 1991, the services and DLA used different valuation methods. 
In one case, the reported amounts included figures that DOD
subsequently changed.  For instance: 

  In 1989, the Army and the Air Force valued items in need of repair
     at the acquisition cost.  The two services did not reduce the
     value of such items by the estimated repair costs.  The Navy had
     been deducting the estimated repair cost from the acquisition
     value of items needing repair since 1986. 

  In 1989 and 1990, DLA valued its inventory at "standard prices,"
     which were based on the acquisition cost plus surcharges for
     transportation costs and inventory losses. 

  In 1989 and 1990, the DOD components did not reduce the value of
     the potential reutilization/disposal stock to its salvage value. 
     In establishing the uniform valuation system in 1991, DOD set a
     salvage value of 2.2 percent of acquisition cost.  In 1992, DOD
     increased the salvage value to 2.3 percent of acquisition cost. 

  In 1990, the Navy compared the estimated original acquisition cost
     and the latest acquisition cost and valued its inventory at the
     lower of the two amounts.  Using this method reduced the Navy's
     1990 inventory by $3 billion below the 1989 amount. 

  The Navy adjusted its physical inventory records to agree with its
     financial inventory records in 1991, resulting in a $1.4 billion
     reduction in the value of its inventory. 

--------------------
\3 We recommended that DOD establish a uniform inventory valuation
method in a previous report, Defense Inventory:  Reports Need
Comparable and Comprehensive Data (GAO/NSIAD-91-266, July 17, 1991). 

\4 In a prior report, Financial Audit:  Financial Reporting and
Internal Controls at the Air Logistics Centers (GAO/AFMD-91-34, Apr. 
5, 1991), we recommended that the Army and the Air Force adjust items
needing repair by deducting the estimated repair cost. 

   THE INVENTORY VALUATION METHOD
   USED CAN CHANGE INVENTORY BY
   BILLIONS OF DOLLARS
------------------------------------------------------------ Letter :4

The method used to value inventory can significantly affect the
amount of year-to-year inventory changes.  Depending on the use of
the inventory figures, different valuation methods should be used. 

We made two adjustments to DOD's inventory figures to demonstrate the
effect of different valuation methods.  The first adjustment showed
that inventory decreased by $7.6 billion between 1989 and 1992.  The
second adjustment showed that inventory decreased by $12.3 billion
over the same time period. 

Beginning in 1991, DOD adjusted the latest acquisition value of items
needing repair and recognized the scrap value of items to be
disposed.  These changes are appropriate for financial reporting
purposes.  In this manner, financial report users are provided a
picture that more closely reflects the actual value of the inventory. 

However, for inventory management purposes, such as tracking
inventory trends from year to year, adjustments such as these can be
misleading.  This is particularly the case when comparing inventory
valued at scrap value on a year-to-year basis because the changes in
value are very small even though the actual change in the amount of
inventory may be large.  Also, when valuation methods are changed
year-to-year, trends are distorted and present a confusing picture to
decision makers.  In addition, the increments can be significantly
altered by the valuation method chosen, and if different parts of the
inventory are valued differently, the changes in some parts can be
masked if not looked at separately.  Therefore, it is very important
for decision makers to understand how the inventory is valued, and if
the methods are different for different parts of the inventory, those
parts need to be separated for decision-making purposes. 

To show a year-to-year comparison of the inventory at acquisition
value, we adjusted the reported values of DOD's secondary item
inventory to reflect latest acquisition cost.  This adjustment showed
that the inventory decreased by $7.6 billion between fiscal years
1989 and 1992, from $108 billion to $100.4 billion.  During the same
period, we estimate that the acquisition value of the potential
reutilization/disposal stock increased by $7 billion.  (See table 2.)

                           Table 2
           
              Acquisition Value of Inventory, as
           Estimated by GAO (Fiscal Years 1989-92)

                    (Dollars in billions)

                                           Acquisition value
                                                          of
                             Acquisition           potential
                            value of the      reutilization/
Fiscal year              total inventory      disposal stock
----------------------  ----------------  ------------------
1989                              $108.0                $7.0
1990                               106.8                 8.0
1991                               103.6                 9.4
1992                               100.4                14.0
Overall change                     (7.6)                 7.0
------------------------------------------------------------
Note:  Parentheses indicate a decrease. 

For our second year-to-year comparison, we adjusted the inventory
figures to reflect estimated repair costs for items needing repair
and the scrap price of potential reutilization/disposal stock.  This
adjustment showed that the inventory decreased by $12.3 billion
between fiscal years 1989 and 1992, from $92.5 billion to $80.2
billion.  During the same period, the potential
reutilization/disposal stock valued to scrap prices increased by less
than $200 million.  In 1992, DOD's total inventory was reduced by
$20.2 billion because of revaluations; $13.7 billion of the reduction
was in potential reutilization/disposal stocks.  (See tables 3 and
4.)

                           Table 3
           
             Total Inventory Revalued to Reflect
              Repair Costs and Scrap Values, as
           Estimated by GAO (Fiscal Years 1989-92)

                    (Dollars in billions)

                           Inventory
                                  at
                          acquisitio  Revaluatio    Revalued
Fiscal year                  n value           n   inventory
------------------------  ----------  ----------  ----------
1989                          $108.0     $(15.6)     $92.5\a
1990                           106.8      (15.1)        91.7
1991                           103.6      (15.4)        88.1
1992                           100.4      (20.2)        80.2
Overall change                 (7.6)                  (12.3)
------------------------------------------------------------
Note:  Parentheses indicate a decrease. 

\a The actual figure is $92.46 billion and has been rounded to $92.5
billion. 

                           Table 4
           
            Potential Reutilization/Disposal Stock
             Revalued to Reflect Scrap Prices, as
           Estimated by GAO (Fiscal Years 1989-92)

                    (Dollars in billions)

                           Inventory
                                  at
                          acquisitio  Revaluatio    Revalued
Fiscal year                  n value           n   inventory
------------------------  ----------  ----------  ----------
1989                            $7.0      $(6.8)      $0.154
1990                             8.0       (7.8)       0.175
1991                             9.4       (9.2)       0.207
1992                            14.0      (13.7)       0.321
Overall change                   7.0                 0.168\a
------------------------------------------------------------
Note:  Parentheses indicate a decrease. 

\a The actual figure is $167.5 million and has been rounded to $168
million. 

Informally, DOD officials agreed that the inventory figures reported
in the Supply System Inventory Reports are not comparable from year
to year without adjusting for accounting changes.  These officials
also believe that the methodology we used for estimating the value of
the secondary item inventory to make it comparable year-to-year was
reasonable.  They also stated that billions of dollars of inventory
have been sent to disposal. 

   FUNDING LEVELS FOR THE
   SECONDARY ITEM INVENTORY
------------------------------------------------------------ Letter :5

Funds are appropriated to the military services to purchase secondary
inventory items from DBOF and non-DBOF sources.  Supply managers are
then responsible for obtaining the items from suppliers. 

Table 5 shows funding amounts for secondary items for fiscal years
1992 to 1994.  The table lists the amounts appropriated for fiscal
years 1992 and 1993.\5 Because final adjusted fiscal year 1994
appropriation figures were not available, we are providing the amount
requested by DOD in its fiscal year 1994 budget.  According to a DOD
Comptroller official, comparable figures are not available for fiscal
years 1989 to 1991. 

                           Table 5
           
            Funding Appropriated or Requested for
            Secondary Item Inventory (Fiscal Years
                           1992-94)

                    (Dollars in millions)

Accounts                            1992      1993      1994
------------------------------  --------  --------  --------
Operation and maintenance
Supplies, materials,            $17,263.  $18,238.  $18,304.
 equipment, and other                  5         5         9
 purchases
DBOF fuel                          926.7     927.3     997.7
DBOF materials and supplies      3,548.0   3,866.3   4,041.5
Procurement                      2,051.8   2,115.6   1,924.8
Personnel                          457.9     455.4     471.4
Research and development           365.9     357.2     328.1
Family housing                      27.8      29.2      74.7
Military construction                3.6       1.8       1.9
DBOF\a                           2,017.8      16.6      11.6
============================================================
Total                           $26,663.  $26,007.  $26,156.
                                       0         9         6
------------------------------------------------------------
Note:  According to DOD, Congress directed DOD to transfer $1.5
billion in fiscal year 1992 and $6 billion in fiscal year 1993 from
DBOF and other accounts to the services.  This had the effect of
reducing the actual amount of appropriations required to $25.2
billion and $20 billion, respectively. 

\a The $2 billion in 1992 is for the procurement and repair of
depot-level repairable items that were not charged to customers in
fiscal years 1992 and 1993.  The 1993 and 1994 amounts are to
purchase Air Force war reserve spare parts. 

Table 6 shows the DBOF obligational authority for purchasing
secondary inventory items and the amount of authority to be used to
cover the fund's operating costs. 

                           Table 6
           
               DBOF Obligational Authority for
           Secondary Inventory Items (Fiscal Years
                           1992-94)

                    (Dollars in billions)

Cost category                       1992      1993      1994
------------------------------  --------  --------  --------
Inventory purchases                $16.8     $15.2     $16.5
Cost of operations                   4.0       3.7       3.7
============================================================
Total                              $20.8     $18.9     $20.2
------------------------------------------------------------
Source:  Department of Defense. 

--------------------
\5 Fiscal year 1992 funding data was provided to the Chairman, Senate
Committee on Armed Services, in a joint GAO and DOD letter dated
March 25, 1992 (B-222859). 

   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :6

To perform our review, we analyzed DOD inventory records obtained for
past reviews.  We used Supply System Inventory Reports to determine
the value of the secondary item inventory as reported by DOD.  We
took accounting changes and reporting inaccuracies into account to
estimate the latest acquisition value of both the total inventory and
the potential reutilization/disposal stock and to estimate the effect
of changes in inventory valuation methods. 

We performed our work between January and February 1994 in accordance
with generally accepted government auditing standards.  We did not
obtain written DOD comments on this report.  However, we informally
discussed our methodology and results with DOD officials from the
Office of the Comptroller and the Office of Material Resource
Management Policy and included their comments where appropriate. 

---------------------------------------------------------- Letter :6.1

Unless you publicly announce this report's contents earlier, we plan
no further distribution until 10 days after its issuance.  At that
time, we will send copies to the Secretaries of Defense, the Army,
the Navy, and the Air Force; the Directors of DLA and the Office of
Management and Budget; and other interested parties.  We will also
make copies available to others upon request. 

Please contact me at (202) 512-8412 if you or your staff have any
questions concerning this report.  The major contributors to this
report were John Klotz, Assistant Director, and Louis Modliszewski,
Evaluator. 

Sincerely yours,

Donna M.  Heivilin
Director, Defense Management
 and NASA Issues
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