GAO-01-37R Navy’s Inventory Reporting

United States General Accounting Office

Washington, DC 20548

October 27, 2000

Mr. Charles P. Nemfakos

Senior Civilian Official for the Office

of the Assistant Secretary of the Navy

(Financial Management and Comptroller)

Subject: Financial Management: Improvements Needed in the Navy’s Reporting of General

Fund Inventory

Dear Mr. Nemfakos:

As a part of our annual audit of the governmentwide financial statements, we reviewed the

compilation of the inventory1 line item included in the Department of the Navy’s fiscal year

1999 Principal Financial Statements, which report general fund operations.2 Inventory

reported by the general fund consists primarily of operating materials and supplies, which

includes sponsor owned material,3 ammunition, contractor held material, and other

classifications of inventory.

The Navy does not have central reporting of general fund inventory, and the systems used to

maintain accountability over inventory are not integrated with core accounting systems.

Therefore, the Navy relies on manual “data calls” to compile inventory data for financial

reporting. To review the compilation of the inventory line item, we reviewed the Navy

information obtained through the data call process to evaluate the completeness and accuracy

of reported inventory and to determine whether inventory was properly classified. However,

because of the lack of system integration and central inventory management, it is not possible

to ensure that all inventory owned by the Navy is identified through the data call process or

1

Federal accounting standards define inventory as tangible personal property that is held for sale, operating

materials and supplies consumed in normal operations, and stockpile materials held due to statutory

requirements for use in national defense.

2

General fund activities are funded by direct appropriations. In contrast, other Navy activities are funded by

working capital funds, which are revolving funds used as a source of financing for supplies and services that

will be paid for by the customer.

3

Sponsor owned materials are items purchased, held, and managed by Navy program managers to support

mission requirements for the production, life-cycle maintenance, and installation of weapon systems.
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by our review. As we have previously testified,4 deficient logistics systems continue to

impair the Navy’s ability to both effectively maintain visibility and prepare reliable financial

reports for these assets. Over the long-term, the Navy will need to develop and implement

integrated financial and logistical systems to provide for accurate financial reporting and

improved visibility.

We noted that the Navy has acted on a number of past audit recommendations to improve

financial reporting. For example, the Navy reported four classes of inventory this year that

were not reported previously. The newly reported categories included sponsor owned

material of $5.5 billion, residual assets5 of $584 million, Navy material held by the Coast

Guard of $101 million, and contractor held material of $11.3 billion.6 The inclusion of these

items, plus other changes, tripled the Navy’s reported inventory value from the previous

fiscal year.

Although these changes improved the Department of the Navy’s financial reporting, we

identified a number of errors and omissions in the financial statements that continue to affect

the reporting of inventory. These problems included (1) sponsor owned material was not

accurately reported, (2) ammunition reported was not properly valued and not all ammunition

was reported, (3) property in the possession of contractors was not properly classified, and

(4) certain shipboard materials were not reported. This letter summarizes our findings so that

the Navy can address these issues as it compiles its fiscal year 2000 financial information and

to ensure that the Navy considers these issues as it moves towards its long-term solution of

integrated systems.

Sponsor Owned Material Not Accurately Reported

The Navy reported $5.5 billion of sponsor owned material. We traced the value reported in

the financial statements to supporting data. As discussed earlier, the Navy used a manual

“data call” process to compile data for financial statement reporting because current systems

cannot provide consolidated reporting of inventory on hand. We found that the financial

statements did not always match the information submitted by commands that hold this

inventory. For example, the Naval Sea Systems Command (NAVSEA) submitted a figure of

$3.2 billion for sponsor owned material, but the amount used for financial statement

compilation was $2.9 billion–a difference of $300 million. NAVSEA officials confirmed

that $3.2 billion should have been reported. Navy officials stated that the 1999 beginning

inventory value of $2.9 billion was reported in error as the 1999 ending inventory amount.

The error resulted from a lack of familiarity with the data call document, according to Navy

officials.

4

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

2000).

5

Residual assets are excess items stored at redistribution sites as ships are decommissioned or overhauled. This

material is redistributed free of charge from these sites.

6

Contractor held material was incorrectly reported as property, plant, and equipment (PP&E) in 1998.
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Additionally, the Naval Audit Service reported7 that the Naval Air Systems Command could

only estimate a value for its sponsor owned inventory because it did not have a system in

place to capture and report this material. Its estimate of $2 billion represented over a third of

the $5.5 billion of sponsor owned material reported. Further, Navy personnel were unable to

provide support for the estimate.

Ammunition Not Properly Valued and Not Completely Reported

Our review of ammunition reported identified a number of errors, omissions, or instances of

noncompliance with financial accounting standards.

• The Navy did not report air-launched guided missile support items or NAVSEA ASROC

(anti-submarine rocket) material.8 The value of these items at September 30, 1999,

according to inventory records, was $7.8 million and $41.6 million, respectively.

Officials said that this was an unintentional omission.

• Ammunition items needing repair, including the unserviceable items discussed below,

were not separately identified or revalued to reflect the estimated cost of repair. The full

value of items needing repair, according to inventory records, was $1.4 billion for the

four ammunition categories that the Navy reported for fiscal year 1999.9 Federal

accounting standards require that inventory values be reduced for estimated repair costs

for financial reporting. Navy officials stated that the ammunition items needing repair

were not revalued in accordance with federal accounting standards because Department

of Defense (DOD) regulations10 require ammunition to be reported at full cost, without a

provision for reducing the value for estimated repair costs. However, these regulations

refer only to the reporting of ammunition on the Supply System Inventory Report

(SSIR),11 not to financial statement reporting. As a result, the on-hand ammunition

balance was overstated. This failure to revalue ammunition in need of repair was also

reported by the Naval Audit Service in its report on its audit of the Department of the

Navy’s fiscal year 1998 financial statements.12

• The Navy did not completely classify, revalue, and report its excess, obsolete, and

unserviceable inventory. Statement of Federal Financial Accounting Standard (SFFAS)

No. 3, Accounting for Inventory and Related Property, defines excess inventory as stock

7

Department of the Navy Principal Statements for Fiscal Year 1999: Inventory and Related Property, Net (NAS

report no. N2000-0023, May 15, 2000).

8

The Navy groups its inventory and related property into categories based upon the type of material and the

organization that manages the material. These groupings are called cognizance codes or simply COGs. The

air-launched guided missile support items discussed here are 4E COG items, and the ASROC material is

designated 8S COG.

9

The 4E and 8S COGs are not included in this figure because they were not reported in 1999, as noted above.

10Department of Defense Materiel Management Regulation (DOD 4140.1-R), May 1998.

11The SSIR is an annual DOD inventory report to the Congress that has specific regulations on its presentation.

12Department of the Navy Principal Statements for Fiscal Year 1998: Inventory and Related Property, Net

(NAS report no. 98-0004, March 31, 1999).
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that exceeds the demand expected in the normal course of operations; obsolete inventory

as inventory that is no longer needed due to changes in technology, laws, customs, or

operations; and unserviceable inventory as damaged inventory that is more economical to

dispose of than to repair. SFFAS No. 3 and the Department of Defense Financial

Management Regulation (DOD 7000.14-R, volume 4, chapter 4) require that excess,

obsolete, or unserviceable inventory be reported at its estimated net realizable value.

Excess - The Navy reported only excess items in the “Excess, Obsolete, and

Unserviceable” category of materials. Further, for the excess ammunition reported for

fiscal year 1999, the Navy did not revalue it to net realizable value in accordance with

federal accounting standards and the DOD Financial Management Regulation. Navy

officials stated that the excess ammunition was not revalued because DOD regulations13

require ammunition to be reported at full cost, without a provision for revaluing excess,

obsolete, and unserviceable items to net realizable value. As stated previously, the

regulations cited by Navy officials refer only to the reporting of ammunition on the SSIR,

and not to financial statement reporting. As a result, the value of the on-hand balance was

overstated.

Obsolete - Obsolete ammunition was not reported in the fiscal 1999 financial statements.

Navy officials could not explain why obsolete ammunition items were not reported. In

1998, inventory records indicated that obsolete ammunition was $202 million.

Unserviceable - The Navy did not identify and revalue unserviceable ammunition items,

but rather reported all ammunition in need of repair, including unserviceable items, at full

value. As noted previously, this resulted in overstating the on-hand balance.

Property in the Possession of Contractors Not Properly Classified

As previously noted, the Navy properly reclassified its contractor held material–comprised of

property in the possession of contractors, government furnished material, and contractor

acquired material–to the inventory line item for fiscal year 1999. The value of that material

totaled a reported $11.3 billion. However, Navy officials indicated that items reported as

property in the possession of contractors included some items already installed on ships

during construction or repair. The installed items should not be classified as inventory but

rather accounted for as part of the ship. As a result, the inventory line item was overstated by

the value of installed items included as property in the possession of contractors. The value

of this misclassification has not been determined.

Problems classifying inventory and other property in the possession of contractors are not

limited to the Navy. The Under Secretary of Defense (Comptroller) has asked the Defense

Contract Audit Agency (DCAA) to review the valuation and classification of property or

material in the possession of contractors. This review includes the classification and value of

materials (operating materials and supplies and inventory) in the possession of contractors,

including materials that have already entered the repair or production process but are still

reported as property in the possession of contractors. DCAA expects to issue a report on its

assessments and conclusions in early fiscal year 2001.

13Department of Defense Materiel Management Regulation (DOD 4140.1-R), May 1998.
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Certain Shipboard Materials Not Reported

The Navy continued to exclude inventory aboard some of its ships14 from its reporting of

operating materials and supplies. Such treatment is not consistent with federal accounting

standards. According to SFFAS No.3, an end user is any component of a reporting entity that

obtains goods for direct use in the component’s normal operations. However, SFFAS No. 3

goes on to state that any component of a reporting entity that maintains or stocks operating

materials and supplies for future issuance shall not be considered an end user.

In 1996, we first reported15 that shipboard inventories were omitted from the Navy’s

financial statement reporting. Since that time, the Navy has changed the categories of

inventories in its financial reporting to include supplies aboard aircraft carriers and other

large vessels as working capital fund items held for sale. With this change in reporting, the

Navy has acknowledged that inventories maintained at storage locations onboard its large

ships that are available for future issuance are not yet in the hands of end users and therefore

represent reportable operating materials and supplies in accordance with SFFAS No. 3. The

Navy, though, has continued to take the position that shipboard inventories held for future

use aboard smaller combatant ships should be considered in the hands of the end user and

therefore should not be reported. However, we continue to maintain that, like inventories

held in supply on the Navy’s large vessels, these smaller combatant ships also have central

supply functions that maintain inventories held for future issuance to operating units

throughout the ship. Consequently, these smaller combatant ship inventories, like those on

its large vessels, are not yet in the hands of end users and therefore should be reported as

operating materials and supplies.

The Naval Audit Service previously reported that the value of these excluded shipboard

operating materials and supplies was $9.4 billion as of September 30, 1998. We have

previously reported that this issue affects not only financial reporting but asset visibility as

well. Specifically, we reported16 that the lack of Navy-wide visibility over shipboard

inventories substantially increased the risk that the Navy may request funds to obtain

additional unnecessary inventories because responsible managers did not receive information

that excess inventories were already on hand in other locations.

Conclusions

The Navy has made several improvements in identifying and reporting its inventory.

However, errors in the compilation and reporting of those assets continue to affect the

reliability of the Navy’s financial reports. Additionally, some policy issues, such as the

revaluation of ammunition and the reporting of shipboard inventories held for future use,

14The excluded inventory was for smaller combatant ships such as cruisers, frigates, destroyers, and submarines.

15See Navy Financial Management: Improved Management of Operating Materials and Supplies Could Yield

Significant Savings (GAO/AIMD-96-94, August 16, 1996).

16CFO Act Financial Audits: Programmatic and Budgetary Implications of Navy Financial Data Deficiencies

(GAO/AIMD-98-56, March 16, 1998).
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need to be resolved to reflect current federal accounting standards and DOD regulations as

the Navy moves forward in its efforts to produce complete and reliable financial statements.

We are making recommendations to improve, to the extent practical, the current manual,

noncentralized process used to compile the Navy’s inventory data. However, these

measures, while vital in the short term, can only be considered interim steps to improve data

accuracy, given the accountability and financial reporting limitations inherent in the current

process. The ultimate, longer term solution to providing accurate financial reporting and

improved visibility will require the development and implementation of integrated financial

and logistical systems.

Recommendations for Executive Action

We recommend that you take the following actions to correct the types of errors and

omissions that we identified in the compilation of the Navy’s inventory information.

• Develop a review process so that data call information on sponsor owned material is

correctly reported.

• Document the basis of any estimates of sponsor owned material to facilitate managerial

reporting and auditor review.

• Develop a review process for ammunition reporting so that all types of ammunition are

included in the Navy’s financial reports, including air-launched guided missile support

items and anti-submarine rocket material.

• Properly classify and disclose ammunition in the “excess, obsolete, and unserviceable”

categories in accordance with SFFAS No. 3.

• Review the reporting of contractor held material to determine what portion of the $11.3

billion reported should not be classified as inventory and determine proper financial

statement classification. This should include coordination with the DOD-wide DCAA

project that is reviewing property in the possession of contractors.

In addition, we recommend that you revise the Navy’s policies for compiling its financial

statements so that they are in accordance with federal accounting standards and the DOD

Financial Management Regulation. Specifically, (1) ammunition items needing repair and

those categorized as excess, obsolete, and unserviceable should be revalued appropriately to

comply with SFFAS No. 3 and the DOD Financial Management Regulation and

(2) shipboard inventories aboard smaller combatant ships should be reported as operating

materials and supplies in accordance with federal accounting standards.

Finally, you should consider the issues discussed in this letter in the development and

implementation of the long-term systems solution for proper accounting and improved

visibility of the Navy’s inventory.

Agency Comments and Our Evaluation

We requested comments on a draft of this report from the Secretary of Defense or his

designee. On October 19, 2000, the Principal Deputy, Assistant Secretary of the Navy
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(Financial Management and Comptroller) provided us with comments, which are reprinted in

the enclosure. DOD concurred with our recommendations and stated that the Department of

the Navy remains committed to producing consistent, timely, useful, and complete data and

information for its managers to use in making decisions and processing financial reports. We

are pleased that the Navy is working to reduce the number of systems used to account for

operating materials and supplies through standardization and consolidation and to ensure that

those remaining systems meet federal accounting standards.

The DOD response also stated that the treatment of Navy shipboard inventories aboard

smaller combatant ships remains a reporting issue to be resolved by the Navy’s Operating

Materials and Supplies Working Group in coordination with the DOD Office of the

Comptroller. We agree and have clarified our position as discussed in this letter. We

reiterate our long-held position that until these items are in the hands of the end users, they

should be reported as operating materials and supplies in accordance with federal accounting

standards.

-----

We would appreciate a written response within 60 days of the date of this letter on actions

you have taken or plan to take to address our recommendations.

Copies of this letter are being sent to Nelson Toye, Deputy Chief Financial Officer, Office of

the Under Secretary of Defense (Comptroller), and to interested congressional committees.

Copies will be made available to others upon request. If you have further questions regarding

these findings, please contact Geoffrey B. Frank, Assistant Director, at (202) 512-9518 or me

at (202) 512-9095. Key contributors to this assignment were William Cordrey and Lisa

Warde.

Sincerely yours,

Lisa G. Jacobson

Director

Financial Management and Assurance

Enclosure
Enclosure

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Comments From the Department of the Navy
Enclosure

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Enclosure

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Enclosure

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Enclosure

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