United States General Accounting Office

GAO Report to the Chairman, Subcommittee

on Military Readiness, Committee on

National Security, House of

Representatives

June 1998 AIR FORCE SUPPLY

MANAGEMENT

Analysis of Activity

Group’s Financial

Reports, Prices, and

Cash Management

GAO/AIMD/NSIAD-98-118

GAO United States

General Accounting Office

Washington, D.C. 20548

Accounting and Information

Management Division

B-278060 

June 8, 1998

The Honorable Herbert H. Bateman

Chairman, Subcommittee on Military Readiness

Committee on National Security

House of Representatives

Dear Mr. Chairman:

This report, one in a series1

 you requested on the financial operations of the Department of

Defense’s (DOD) Working Capital Funds, addresses the Air Force supply management activity

group. This supply management activity group supports combat readiness by procuring critical

material and making repair parts available to its customers such as military units. The group

operates under the working capital fund concept, where customers are to be charged the costs

of providing goods and services to them. During fiscal year 1997, the group was responsible for

inventory with a reported value of about $24.5 billion.

As requested, this report discusses (1) the accuracy and consistency of the Air Force supply

management activity group’s accounting and budgetary reports, (2) the group’s price-setting

process, and (3) the Air Force Working Capital Fund’s cash management practices.

We are sending copies of this report to the Ranking Minority Member of your Subcommittee;

the Chairmen and Ranking Minority Members of the Senate Committee on Armed Services; the

Senate Committee on Appropriations, Subcommittee on Defense; the House Committee on

Appropriations, Subcommittee on National Security; the Senate and House Committees on the

Budget; the Secretary of Defense; the Secretary of the Air Force; and the Director of the

Defense Finance and Accounting Service. Copies will also be made available to others upon

1

We issued two reports on the Navy Ordnance activity group (GAO/AIMD/NSIAD-97-74, March 14, 1997, and

GAO/AIMD/NSIAD-98-24, October 15, 1997).
B-278060 

request. If you have any questions about this report, please call Greg Pugnetti, Assistant

Director, at (202) 512-6240. Other major contributors to this report are listed in appendix II.

Sincerely yours,

Jack L. Brock, Jr.

Director, Governmentwide and Defense Information Systems

Accounting and Information

 Management Division

David R. Warren

Director, Defense Management

National Security and International

 Affairs Division

Page 2 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
B-278060 

Page 3 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Executive Summary

Purpose The supply management activity group is the Air Force’s primary

purchaser of inventory and the largest activity group in the Defense

Working Capital Funds. In view of the group’s significance to the working

capital funds and Air Force readiness, the Chairman, Subcommittee on

Military Readiness, House Committee on National Security, asked GAO to

evaluate (1) the accuracy and consistency of the Air Force supply

management activity group’s accounting and budgetary reports, (2) the

group’s price-setting process, (3) the Air Force Working Capital Fund’s

cash management practices, including the practice of advance billing

customers to maintain an adequate cash balance, and (4) the effectiveness

of the supply management activity group in providing needed inventory

items to customers in a timely manner. This report responds to the first

three financial issues discussed above. GAO plans to issue a separate report

on the fourth issue dealing with the group’s effectiveness in meeting

customers’ needs.

Background The Air Force supply management activity group provides about two

million types of inventory items, including weapon system spare parts,

fuels, and medical-dental supplies, to customers which consist primarily of

DOD organizations.1 DOD reported that the group had $24.5 billion in

inventory at the end of fiscal year 1997 and about $12 billion in revenue

from the sale of goods to its customers during fiscal year 1997. The group

is part of the Air Force Working Capital Fund, a revolving fund that relies

on sales revenue, rather than direct congressional appropriations, to

finance its operations. Working capital funds are to (1) generate sufficient

revenues to cover the full costs of their operations and (2) operate on a

break-even basis over time—that is, not make a profit nor incur a loss. It is

essential that the working capital funds operate efficiently since every

dollar spent inefficiently results in less funds available for other defense

spending priorities.

The Air Force supply management activity group generates revenue by

selling customers inventory and billing them at predetermined prices

(standard prices). Those prices, which typically are to be stable

throughout the fiscal year, consist of two major elements: (1) the

acquisition or repair cost of the inventory sold plus (2) operational costs,

such as salaries and storage costs. In developing the prices for individual

inventory items which are to reflect the full cost, the Air Force adds a

surcharge to the acquisition cost or repair cost of items to recover the

operational costs. Customers primarily use operations and maintenance

1

The supply management activity group also sells inventory items to foreign governments.

Page 4 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Executive Summary

appropriations to pay for the inventory items. Payments from customers

replenish the cash balance in the Air Force Working Capital Fund, which is

used to finance ongoing operations.

Results in Brief The Air Force has had difficulties producing reliable financial information

on the supply management activity group’s operations, setting prices for

inventory the group sells to customers, and generating sufficient cash to

help discontinue the Air Force Working Capital Fund’s practice of advance

billing its customers since 1993. These weaknesses impair the Air Force’s

ability to (1) ensure that customers can purchase inventory items when

needed and (2) achieve the goals of the working capital funds, which are

to focus management attention on the full costs of carrying out operations

and to manage those costs effectively.

At the core of many of the supply management activity group’s financial

management weaknesses is its inability to produce reliable information on

its cost of goods sold and net operating results (the difference between

annual revenue and expenses). This financial information is critical since

the activity group must set prices that reflect the expected costs of

providing inventory items to customers. If these data are inaccurate, the

activity group’s prices may not cover its full cost of operations or generate

enough cash to pay its bills, which has been the case in recent years. Until

the Air Force can (1) develop accurate information on the supply

management activity group’s net operating results and cost of goods sold,

(2) use this information to develop an effective price-setting process that

enables the supply management activity group to operate on a break-even

basis and helps ensure that customers receive adequate funding to

purchase needed inventory items, and (3) acquire and use management

tools for projecting cash outlays, its customers will remain susceptible to

wide price fluctuations and a corresponding depletion of funds. Further,

the Air Force Working Capital Fund will have to continue to advance bill

customers so that it has enough cash to pay its bills. Finally, senior

managers and those responsible for providing oversight will continue to

lack the information they need to make informed decisions on Air Force

supply operations.

Page 5 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Executive Summary

Principal Findings

Long-Standing Financial

Reporting Problems

Continue

GAO has previously reported2 that DOD has had long-standing problems in

preparing accurate financial reports on its working capital fund

operations. DOD has frequently acknowledged that working capital funds’

financial reports were inaccurate and cited actions being taken to correct

this problem. GAO found that some of these actions have not yet been

completed, and serious financial reporting problems still exist. The Air

Force supply management activity group’s net operating result and cost of

goods sold information contained in DOD’s monthly accounting reports and

Chief Financial Officer reports sent to the Congress have consistently

varied by billions of dollars. For example, the fiscal year 1996 net

operating results reported in the monthly accounting report and the Chief

Financial Officer report, which should agree with each other, differed by

$4.2 billion. Further, the budget justification report reflected a third,

different net operating result, which was not reconciled to the accounting

reports. As a result, DOD, the Air Force, and the Congress have not received

accurate information on the Air Force supply management activity group’s

net operating results—a critical piece of information since it is one factor

used in setting prices to be charged to customers in subsequent years. The

cost of goods sold represents the single largest expense to the activity

group.

Congressional defense committees have raised concerns about the

working capital funds’ financial and management problems over the last

several years. To improve the management of the working capital funds,

the National Defense Authorization Act for Fiscal Year 1997 required DOD

to develop a corrective action plan by September 30, 1997. GAO found that

the plan DOD developed to address this requirement does not contain the

specific steps that need to be taken to correct the problems. DOD officials

told GAO that (1) they are identifying the detailed steps for correcting the

problems addressed in the plan and (2) correcting many of the problems

will require improving the existing accounting and logistical systems or

developing new systems, which will take some time to show results.

2

Defense Business Operations Fund: Management Issues Challenge Fund Implementation

(GAO/AIMD-95-79, March 1, 1995); Defense Business Operations Fund: Improved Pricing Practices and

Financial Reports Are Needed to Set Accurate Prices (GAO/AIMD-94-132, June 22, 1994); Financial

Management: Status of the Defense Business Operations Fund (GAO/AIMD-94-80, March 9, 1994); and

Letter to Congressional Committees on the Defense Business Operations Fund (GAO/AFMD-93-52R,

March 1, 1993).

Page 6 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Executive Summary

Difficulties Encountered in

Developing Prices

Two objectives of the supply management activity group’s price-setting

process are to (1) establish prices for individual inventory items that are to

reflect the expected full cost of providing these items to customers and

(2) develop the activity group’s composite, or aggregate, price change that

is used in budgeting so that customers have the funds available to buy

needed inventory items from the activity group. During the budget

process, the composite price change is approved by the Under Secretary

of Defense (Comptroller).

GAO found that the Air Force lacks controls to ensure the composite price

change approved by the Under Secretary of Defense (Comptroller) during

the budget process is properly implemented. For example, the supply

management activity group’s fiscal year 1997 prices for repairable

inventory items were reduced by about 18 percent, effective April 1, 1997,

when budget execution data showed that customers were spending much

more than expected for purchases of inventory. According to Air Force

officials, this problem occurred because the supply management activity

group had to pay more than budgeted for repairing items, causing prices to

the customers to be higher than those approved during the budget review

process. Air Force officials told GAO that if they had not lowered prices in

April 1997, their customers would have run out of funds before the end of

the fiscal year.

Further, the Air Force revised its cost allocation procedures at the

beginning of fiscal year 1998 to better match the group’s estimated

operational costs with the prices charged for individual inventory items.

The activity group now estimates the costs associated with (1) individual

supply activities—the five Air Logistics Centers—and allocates each

Center’s costs to only those items that the center manages and

(2) procuring inventory items to replace items that can no longer be

repaired and allocates the estimated replacement cost to the item being

replaced. Prior to fiscal year 1998, all of the activity group’s estimated

operating costs were aggregated and then spread uniformly to all the items

that the Air Force manages. The new procedure, together with the

increased awareness of the need for reliable financial data, should

eventually allow Air Force managers to better identify inefficient

operations and activities and to make more informed decisions about

managing the group’s infrastructure costs.

However, the Air Force’s ability to achieve these benefits is constrained by

a lack of reliable data. For example, because it lacks reliable sales revenue

and operational cost data for individual Air Logistics Centers, the Air

Page 7 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Executive Summary

Force changed the amount of operating cost allocated to individual

inventory items after prices were established for fiscal year 1998. This

resulted in three different sets of prices for individual inventory items

during fiscal year 1998. The Air Force’s initial allocation of funding has left

some customers with either too much or too little funding for purchasing

needed items. Although Air Force headquarters can alleviate this problem

by reallocating available funds, it lacks the reliable historical and budget

execution data it needs to do so effectively.

Air Force Working Capital

Fund and Supply

Management Activity

Group Cash Management

Problems

GAO has previously reported that the working capital funds have had a

long-standing cash management problem and have adopted the practice of

advance billing customers. Since 1993, the funds have advance billed

customers for work not yet performed in order to have enough cash to pay

their bills. DOD initially expected the funds to generate sufficient cash to

eliminate advance billing in fiscal year 1995. When this did not occur, DOD

called for an end to advance billing in fiscal year 1996, and again in fiscal

year 1997, in its working capital fund budgets. The Air Force had steadily

reduced its working capital fund’s outstanding advance billing balance

from about $1.3 billion in February 1995 to $77 million in November 1996.

However, to ensure that the fund’s cash balance would remain positive,

the Air Force advance billed customers over $1 billion in December 1996

and about $700 million in the June/July 1997 time period. As of the end of

fiscal year 1997, the Air Force Working Capital Fund had an outstanding

advance billing balance of $464 million. This working capital fund cash

balance would have been a negative $340 million if the Air Force had not

advance billed customers.

Since the Air Force maintains one cash balance at the overall Air Force

Working Capital Fund level and the supply management activity group is

responsible for more than half of the Fund’s cash collections and

disbursements, it is important that the Air Force supply management

activity group properly manage cash. GAO found that the activity group did

not accurately project cash collections from foreign military sales.

Specifically, inaccurate projection of foreign military sales resulted in

actual cash collections being about $429 million less than budgeted from

fiscal year 1993 through fiscal year 1996. Air Force officials stated that

they need better management tools, such as a cash forecasting model for

projecting cash collections and disbursements. They also stated that they

do not have the basic information for projecting cash outlays, such as item

managers’ projections on when items will be delivered from contractors

and subsequent payment made to the contractors.

Page 8 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Executive Summary

The Air Force recognizes that it has a cash problem and increased its

working capital fund customer prices for fiscal years 1998 and 1999 to

generate an additional estimated $275 million. If these price increases do

not alleviate the cash problem, the Air Force may have to continue

increasing prices to generate cash.

Recommendations GAO is making recommendations to the Secretary of Defense and the

Secretary of the Air Force for improving the Air Force supply management

activity group’s financial reporting, price-setting, and cash management

practices. These recommendations focus on (1) developing a plan to

improve the accuracy of the group’s financial reports, especially the cost

of goods sold and net operating results figures that are included in the

financial reports, (2) developing procedures to ensure that approved

prices are actually implemented and used to charge customers for

inventory purchases, (3) assessing the impact of price changes on

customers to determine whether goods are acquired by customers when

needed and taking funding reallocation actions, as appropriate, and

(4) improving the Air Force’s cash management practices by developing a

cash forecasting model that includes the capabilities to forecast required

cash levels, end-of-period cash positions, and disbursements to be made in

future years.

Agency Comments In its written response to this report, DOD concurred with GAO’s findings

and recommendations and identified actions the Department and the Air

Force are taking to correct the identified deficiencies. For example, DOD

has begun considering ways to improve its method for calculating

inventory valuations as well as to improve financial statement reporting.

DOD further stated that the actions it is taking to implement GAO’s

recommendations should improve the reliability and accuracy of the Air

Force’s supply activity group’s operations.

Page 9 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Contents

Executive Summary 4

Chapter 1 

Introduction

12

Objectives, Scope, and Methodology 15

Chapter 2 

Long-Standing

Financial Reporting

Problems Continue

18

Working Capital Funds Need Accurate Financial Reports to

Manage Operations

18

Persistent Financial Reporting Problems in the Working Capital

Funds

19

SMAG’s Financial Reports Are Unreliable and Inconsistent 21

Conclusions 25

Recommendations 25

Agency Comments 26

Chapter 3 

Difficulties

Encountered in

Developing Prices

27

Two Separate Processes Used to Develop Customers’ Funding

Levels and Prices for Individual Items

27

Pricing Procedures Do Not Ensure That Approved Price Changes

Are Properly Implemented

29

New Cost Allocation Procedures and Data Problems Have

Created Customer Budgeting Problems

30

Conclusions 33

Recommendations 34

Agency Comments 34

Chapter 4 

Air Force Working

Capital Fund and

SMAG Cash

Management

Problems

35

The Importance of Cash for Working Capital Funds 35

Air Force Working Capital Fund Is Still Advance Billing

Customers

36

SMAG’s Cash Collection and Disbursement Projections Not

Accurate

39

Conclusions 41

Recommendations 42

Agency Comments 42

Appendixes Appendix I: Comments From the Department of Defense 44

Appendix II: Major Contributors to This Report 47

Page 10 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Contents

Tables Table 2.1: SMAG’s Reported Net Operating Results for Fiscal

Years 1994 Through 1996

22

Table 2.2: SMAG’s Reported Cost of Goods Sold for Fiscal Years

1992 Through 1996

24

Table 3.1: SMAG’s Authorized Composite Price Changes for

Fiscal Years 1992 Through 1998

28

Table 3.2: Examples of Fiscal Year 1998 Price Changes for

Sacramento ALC-Managed Items

32

Table 3.3: SMAG Surcharges for Five ALCs as of December 1,

1997

32

Table 4.1: Dollar Amount Reported in Account Called Other Asset

Accounts Receivable—Deliveries Suspense

40

Table 4.2: Reparable Support Division Original and Revised

Projected Outlay Rates

41

Figures Figure 1.1: Supply Management Activity Group Operations 13

Figure 4.1: Air Force Working Capital Fund Reported Cash

Balance

38

Abbreviations

AFMC Air Force Materiel Command

ALC Air Logistics Center

DFAS Defense Finance and Accounting Service

DOD Department of Defense

FMS Foreign Military Sales

GAO General Accounting Office

SMAG Supply Management Activity Group

Page 11 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Chapter 1 

Introduction

The Air Force supply management activity group (SMAG) helps to maintain

combat readiness and sustainability by supplying the Air Force with items

necessary to support troops, weapon systems, aircraft, communications

systems, and other military equipment. In doing so, SMAG is responsible for

about two million items, ranging from weapon system spare parts to fuels,

food, medical and dental supplies and equipment, and uniforms. SMAG is

the largest supply management activity in Defense—it reported $12 billion

in revenue and $24.5 billion in inventory for fiscal year 1997.

SMAG operations are financed as part of the Air Force Working Capital

Fund, which was formerly a part of the Defense Business Operations

Fund. In December 1996, the Under Secretary of Defense (Comptroller)

dissolved the Defense Business Operations Fund and created four working

capital funds1

 to clearly establish the military services’ and DOD

components’ responsibilities for managing the functional and financial

aspects of their respective activity groups. The funds are to operate by

charging customers the full costs of goods and services provided to them

as currently defined in the Department of Defense’s (DOD) Financial

Management Regulation, Volume 11B, Reimbursable Operations, Policy

and Procedures—Defense Business Operations Fund.

The primary goal of the current working capital fund financial structure is

to focus the attention of all levels of management on the full costs of

carrying out certain critical DOD business operations and the management

of those costs. Unlike a private sector enterprise which has a profit

motive, the four working capital funds are to operate on a break-even

basis over time by recovering the full costs incurred in conducting the

business operations. Accomplishing this requires DOD managers to become

more conscious of operating costs and make fundamental improvements

in how DOD conducts business since customers have a defined amount of

funds to pay for goods and services. It is critical for the working capital

funds to operate efficiently since every dollar spent inefficiently is one less

dollar available for other defense spending priorities.

As figure 1.1 illustrates, SMAG receives orders from customers to purchase

inventory items. Customers use appropriated funds, primarily Operation

and Maintenance appropriations, to finance these orders. SMAG provides

the inventory items to customers and bills customers on the basis of

predetermined prices—commonly referred to as standard prices, which

generally are to be in force throughout the entire fiscal year. SMAG uses

payments from customers to replenish the inventory sold to customers by

1

The four working capital funds are the Army, Navy, Air Force, and Defense-wide.

Page 12 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Chapter 1 

Introduction

(1) buying new inventory items or (2) ordering repair services of existing

inventory from industry and DOD depot maintenance activities as well as to

cover operating costs. SMAG procures critical material and makes repair

parts available to its customers through five inventory control points:

Ogden Air Logistics Center (ALC), Ogden, Utah; Oklahoma City ALC,

Oklahoma City, Oklahoma; Sacramento ALC, Sacramento, California; San

Antonio ALC, San Antonio, Texas; and Warner Robins ALC, Warner Robins,

Georgia.2

 The five ALCs report to the Air Force Materiel Command (AFMC),

located at Dayton, Ohio.

Figure 1.1: Supply Management Activity Group Operations

Supply Management 

Activity Group (SMAG)

Customers (base-level, Suppliers

depots, foreign military 

sales, other)

SMAG provides inventory 

to customers

Suppliers provide new and 

repaired inventory 

Using appropriated or 

revolving funds, customers 

order inventory from 

SMAG

SMAG (1) buys new 

inventory from industry or (2) 

orders repair services of 

existing inventory from 

industry and DOD depot 

maintenance activities

Source: Department of the Air Force.

2

The Air Force is in the process of closing the Sacramento and San Antonio ALCs based on the 1995

Base Realignment and Closure recommendations.

Page 13 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Chapter 1 

Introduction

SMAG’s operations are divided into two main categories: wholesale and

retail. Wholesale operations encompass about 200,000 types of inventory

items (generally weapon system related) for which the Air Force is the

inventory control point. SMAG procures, manages, and sets the prices that

customers will pay for these wholesale items. The wholesale prices

include SMAG’s operational support cost, such as civilian salaries and

accounting costs. SMAG adds a surcharge to the acquisition cost or repair

cost of the individual inventory items to recover its operating costs. SMAG

retail inventory operations encompass items that are managed by the other

services, Defense agencies,3

 or government agencies. These non-Air Force

entities are the inventory control points for these items and, therefore, set

the prices for these items. The retail portion of SMAG purchases these items

from the non-Air Force entities and then resells them to customers.

Since fiscal year 1991, the composition of the inventory items and costs

managed by SMAG has significantly changed, making it more complicated

for SMAG to manage, budget, and account for inventory. Prior to fiscal year

1991, SMAG consisted of the following six divisions: (1) systems support,

(2) general support, (3) fuels, (4) medical/dental, (5) commissary, and

(6) the Air Force Academy Cadet Store. The systems support division—the

only wholesale division—procured consumable items (items that are

replaced rather than repaired) for aircraft, missiles, and their major

components.

Beginning in fiscal year 1991, the Air Force added two new wholesale

divisions to its stock fund operations: the reparable support and cost of

operations divisions. The reparable support division procures depot level

repairables and pays for the repair of these repairable inventory items.

Managing repairable items was a new function for SMAG,

4

 and it

complicated the budgeting and accounting for inventory items since SMAG

did not have any experience in setting prices to recover the cost to repair

items. The cost of operations division included the overhead costs for the

five inventory control points of the stock fund which also complicated

matters for the stock fund since these costs were not previously captured

and included in the prices charged customers. The effect of adding the

repairable support and cost of operations divisions to the stock fund is

significant. For example, in fiscal year 1997, the Air Force reported

3

The Defense Logistics Agency manages most consumable items.

4

Prior to fiscal year 1991, repairable items were not part of SMAG. The Air Force used procurement

appropriations to centrally purchase repairable items and provided these items to customers free of

charge. When an item needed repair, the customers returned the item and received a replacement item

free of charge.

Page 14 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Chapter 1 

Introduction

wholesale division sales of about $6.8 billion of which only a reported

$500 million pertained to the systems support division—the only

wholesale division that existed prior to fiscal year 1991.

Three other changes also impacted SMAG’s operations.

• In fiscal year 1992, the commissary division was transferred from SMAG to

the Defense Commissary Agency. The Air Force budgets show that the

commissary division had estimated sales of $2.6 billion to $2.8 billion per

year in the early 1990s.

• About 475,000 consumable items were transferred from the system

support division to the Defense Logistics Agency from fiscal year 1992

through 1997. The transfer of these items significantly reduced the number

of items managed by the systems support division to about 125,000 items.

• On October 1, 1997, the Air Force consolidated SMAG’s three wholesale

divisions into one wholesale division called the Materiel Support Division.

The Air Force created the Materiel Support Division to provide better cost

visibility. Now, the estimated costs associated with each ALC are included

in the prices of inventory items they manage. Previously, these costs were

spread across the board to all inventory items.

Objectives, Scope,

and Methodology

The objectives of our review were to evaluate the (1) accuracy and

consistency of SMAG’s accounting and budgetary reports, (2) SMAG’s

price-setting process, and (3) Air Force Working Capital Fund’s cash

management practices, including the practice of advance billing

customers.

To evaluate the accuracy and consistency of SMAG’s accounting and

budgetary reports, we (1) obtained and analyzed the Defense Working

Capital Fund Accounting Report (1307), the Air Force Defense Business

Operations Fund Chief Financial Officer Annual Financial Statement,

5

 and

the Air Force’s Working Capital Fund budget justification report for fiscal

years 1992 through 1996,6

 (2) interviewed Air Force and Defense Finance

and Accounting Service (DFAS) officials to determine why reports covering

the same period provided widely different results, and (3) analyzed the

DOD Working Capital Fund report, dated September 1997, that was

prepared in response to the National Defense Authorization Act for Fiscal

Year 1997, to determine the actions DOD is planning to improve the

5

In December 1996, DOD dissolved the Defense Business Operations Fund and created four working

capital funds.

6

The fiscal year 1996 reports were the most recent reports at the time of our work.

Page 15 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Chapter 1 

Introduction

accuracy of the working capital fund’s accounting report. We also met

with DOD Inspector General and Air Force Audit Agency officials to discuss

the accuracy of SMAG’s financial reports.

The quantitative financial information used in this report on SMAG’s

financial operations was produced from DOD’s systems—which have long

been reported to generate unreliable data. We did not independently verify

this information. The DOD Inspector General has cited system deficiencies

and internal control weaknesses as major obstacles to the presentation of

financial statements that would fairly present the Defense Business

Operations Fund financial position for fiscal years 1993 through 1996.

To evaluate SMAG’s price setting-process, we (1) obtained and analyzed the

budget documents used in setting prices, (2) interviewed Air Force

comptroller and program officials at Headquarters and AFMC to discuss the

rationale for the various factors, including cost reduction goals, used to

develop SMAG’s prices charged customers, (3) analyzed documents on the

new price-setting procedures and interviewed Air Force officials to

determine if the Air Force encountered problems in implementing the new

procedures, and (4) analyzed budget documents concerning prices and

interviewed Air Force officials to determine why the Air Force changed

the fiscal years 1997 and 1998 prices once they were implemented.

To evaluate the Air Force’s Working Capital Fund’s cash management

practices, including its practice of advance billing customers, we

(1) collected and analyzed financial information related to the cash

balances, advance billings, collections, disbursements, accounts

receivable, and accounts payable from fiscal year 1992 through fiscal year

1997, (2) obtained and analyzed DOD and Air Force guidance on managing

cash, and (3) interviewed officials in the Office of the Under Secretary of

Defense (Comptroller), Air Force Headquarters, and AFMC concerning the

cash management practices and the Air Force’s continual need to advance

bill customers to alleviate the cash shortage problem. We also analyzed the

DOD Working Capital Fund report, dated September 1997, that was

prepared in response to the National Defense Authorization Act for Fiscal

Year 1997, to determine the actions DOD is planning to improve the

working capital fund’s cash management practices. We did not

independently verify the reported cash information.

We performed our work at the headquarters, Offices of the Under

Secretary of Defense (Comptroller) and Air Force, Washington, D.C.; Air

Force Materiel Command, Dayton, Ohio; the Sacramento Air Logistics

Page 16 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Chapter 1 

Introduction

Center, Sacramento, California; Headquarters, Defense Finance and

Accounting Service, Arlington, Virginia; Defense Finance and Accounting

Service Denver Center, Denver, Colorado; Air Combat Command, Langley

Air Force Base, Virginia; Air Mobility Command, Scott Air Force Base,

Illinois; and Air Force Space Command, Peterson Air Force Base,

Colorado. Our work was performed from August 1997 through May 1998,

in accordance with generally accepted government auditing standards.

The Department of Defense provided written comments on a draft of this

report. We incorporated DOD’s comments where appropriate. These

comments are discussed in chapters 2, 3, and 4 and are reprinted in

appendix I.

Page 17 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Chapter 2 

Long-Standing Financial Reporting

Problems Continue

We have previously reported that DOD has had long-standing problems in

preparing accurate working capital fund financial reports, particularly

with regard to the accuracy of net operating results (the difference

between annual revenue and expenses). These data are critical in setting

prices and ensuring that the funds break-even over time. The problems we

identified were attributable to significant deficiencies in the working

capital fund accounting systems as well as a lack of sound internal

controls.

We found that these financial reporting problems persist in SMAG’s

accounting and budgeting reports, where we identified billions of dollars

of unexplained differences in the reported net operating results each year

from fiscal years 1992 through 1996. Because SMAG’s financial reports

cannot be relied upon, DOD cannot be certain (1) of the actual operating

results for SMAG or (2) whether the prices SMAG charges its customers are

reasonable.

In recognizing the funds’ financial reporting problems and other

inefficiencies in fund operations, the National Defense Authorization Act

for Fiscal Year 1997 required DOD to develop an improvement plan by

September 30, 1997. In response to this requirement, DOD acknowledged

that the working capital funds have financial reporting problems and

arrived at decisions to address them. It has not yet though developed a

detailed implementation plan that lays out the specific steps that need to

be taken to correct the problems.

Working Capital

Funds Need Accurate

Financial Reports to

Manage Operations

Having accurate financial reporting information is essential to monitoring

fund operations, preparing budgets, and setting proper prices. For

example, without accurate financial reports on SMAG, DOD and Air Force

managers cannot effectively

• analyze trends, such as annual or monthly increases or decreases in

billings to and reimbursements from customers to reduce or eliminate the

need for additional working capital;

• perform monthly aging analysis of accounts receivable to identify old

outstanding transactions; and

• measure the progress of execution data against the original budget, such

as monitoring estimated and actual collection and disbursement amounts

to assess operational and financial problems.

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Volume 1 of the Department of Defense Financial Management Regulation

recognizes that DOD accounting systems should provide critical data for

use in budget formulation and monitoring budget execution. Thus, it

requires that financial management data be recorded and reported in the

same manner throughout DOD components and that accounting

information be synchronized with budgeting information.

Persistent Financial

Reporting Problems in

the Working Capital

Funds

As mentioned earlier, we have previously reported1 that DOD has had

long-standing problems in preparing accurate working capital fund

financial reports, particularly with regard to the accuracy of the net

operating results. For example, in March 1993, we reported that although

SMAG’s fiscal year-end 1992 financial report—as prepared by DFAS—showed

a loss of $8.6 billion, an Air Force analysis disclosed a profit of

$800 million. The $9.4 billion difference exceeded SMAG’s total revenue

reported by DFAS for that year. Similarly, in March 1994, we reported that

the Navy supply management activity group’s monthly financial report for

May 1993 showed a profit of $23.1 billion which was over five times

greater than the $4.3 billion in reported revenue for the same month and,

therefore, was in error. We reported in March 1995, that due to a $6 billion

clerical error, the Army supply management activity group reported an

operating loss of $8.5 billion for fiscal year 1994 on a program that

reported revenue of $7 billion for the same period. In addition, the DOD

Inspector General has not been able to express an opinion on the accuracy

of the Defense Business Operations Fund2

 financial statements for fiscal

years 1993 through 1996 due to significant deficiencies in the accounting

systems and the lack of sound internal control structure.

DOD has frequently acknowledged that the working capital funds’ financial

reports are inaccurate—in the Acting Comptroller’s February 2, 1993,

letter to the congressional defense committees; in the Defense Business

Operations Fund September 24, 1993, improvement plan; and in DOD’s

February 2, 1994, response to our October 1993 letter on the Defense

Business Operations Fund improvement plan.

1

Defense Business Operations Fund: Management Issues Challenge Fund Implementation

(GAO/AIMD-95-79, March 1, 1995); Defense Business Operations Fund: Improved Pricing Practices and

Financial Reports Are Needed to Set Accurate Prices (GAO/AIMD-94-132, June 22, 1994); Financial

Management: Status of the Defense Business Operations Fund (GAO/AIMD-94-80, March 9, 1994); and

Letter to Congressional Committees on the Defense Business Operations Fund (GAO/AFMD-93-52R,

March 1, 1993).

2

The Defense Business Operations Fund is now called the Army, Navy, Air Force, and Defense-wide

Working Capital Funds.

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More recently, DOD reported in its fiscal years 1996 and 1997 Annual

Statement of Assurance as required by the Federal Managers’ Financial

Integrity Act that inadequate accounting and reporting for the working

capital funds, including the Air Force SMAG, were major control

deficiencies. The Air Force also recognized SMAG financial reporting as a

material weakness in its fiscal year 1997 Statement of Assurance. In this

statement, the Air Force reported weaknesses in inventory valuation and

noted the adverse effect it has on forecasting budget requirements. It

stated that correcting this problem will result in more accurate inventory

pricing and budgets. The Air Force also reported that internal controls

were not sufficient to ensure that SMAG accounts were accurately reflected

in financial statements.

DOD has stated in the past that it was acting to correct these financial

reporting problems. For example, in the Defense Business Operations

Fund improvement plan dated September 1993, DOD stated that the

primary causes of the financial reporting problems were (1) inconsistent

or insufficient policy guidance and (2) inadequate financial systems. DOD’s

September 1993 plan identified numerous actions needed to correct the

deficiencies identified with the guidance and financial systems.

However, because these long-standing problems continued, the

congressional Defense committees acted to mandate improvements in the

financial operations of the working capital funds. Specifically, the National

Defense Authorization Act for Fiscal Year 1997 required DOD to prepare a

plan by September 30, 1997, to improve the management and performance

of the working capital funds. Among other things, the Act required DOD to

address the issue involving financial reporting requirements.

In response to the authorization act requirement, DOD developed a plan to

improve the management and performance of its working capital funds. In

this plan, dated September 1997, DOD stated that the working capital funds

have financial reporting problems and DOD recognized that (1) differences

between the budgeting and accounting reports for the same information

confuses managers and should be eliminated, (2) large adjustments

significantly affecting the operating results can occur as long as 4 months

after the “as of” date and undermine management’s confidence in the

reports, (3) a formal reconciliation of the various reports is not presently

performed, and (4) eliminating the differences—or providing a

reconciliation—would make reports more useful to decisionmakers and

restore creditability and confidence in the reports.

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DOD’s plan also identifies decisions made to correct these financial

reporting problems which include (1) developing policies and procedures

for reconciling budgetary and accounting reports, (2) developing a

handbook that identifies the differences between the various reports to

assist managers in monthly report analysis, and (3) revising the cost of

goods sold treatment and presentation in the 1307 accounting report.

The DOD September 1997 plan does a good job in identifying the problems

hindering accurate financial reporting and the decisions reached to resolve

the problems. However, DOD does not yet have an implementation plan

that identifies (1) the specific tasks that need to be accomplished,

(2) individual DOD component’s responsibilities when two or more

components are involved with correcting the problem, or (3) milestones

that could provide a basis for monitoring progress. DFAS officials told us

that they are developing the detailed tasks that need to be performed.

SMAG’s Financial

Reports Are

Unreliable and

Inconsistent

Financial reporting weaknesses still persist in SMAG’s accounting and

budgeting reports. Our comparison of SMAG’s accounting and budgeting

reports for fiscal years 1992 through 1996 identified billions of dollars of

differences in the reported net operating results and cost of goods

sold—two factors that are integral in developing prices to be charged

customers. Without reliable financial reports, DOD cannot be certain if

SMAG’s prices will recover the costs of providing inventory to its

customers. Moreover, the Congress, DOD, and the Air Force will not have

the information they need for oversight and decision-making purposes.

SMAG’s Accounting

Reports and Chief

Financial Officer Reports

Are Inconsistent

We compared SMAG’s net operating results reported in its Chief Financial

Officer reports (the working capital fund’s annual financial statement) and

in its 1307 accounting reports (the fund’s monthly accounting report which

provides data on fund operations, including revenue earned, expenses

incurred, profits, and losses) for fiscal years 1992 through 1996 and

identified annual differences totaling billions of dollars. For the 3 most

recent fiscal years, these differences are detailed in table 2.1. Both of these

reports provide budget execution data on SMAG and, therefore, should

provide the same information.

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Table 2.1: SMAG’s Reported Net

Operating Results for Fiscal Years

1994 Through 1996

(Dollars in millions)

Fiscal year CFO report 1307 report Difference

1994 $ (119.4) $3,355.0 $3,474.4

1995 (12,873.1) (4,642.9) 8,230.2

1996 2,162.6 (2,022.2)a 4,184.8

aThis is the original 1307 accounting report issued in November 1996. This report was revised in

April 1997 so that the figures contained in this report and the CFO report would match.

As indicated in the above table, for fiscal year 1996, the original fiscal

year-end 1307 accounting report, issued in November 1996, showed that

SMAG had a net operating loss of about $2 billion. After this report was

issued, DFAS made four revisions in preparing the SMAG portion of the Chief

Financial Officer report, which had a major impact on SMAG’s net operating

results. Specifically, DFAS adjusted the net operating results to show

• a positive $459 million in versions one and two of the Chief Financial

Officer report,

• a negative $11 billion in version three, and

• a positive $2.2 billion balance in version four—the final Chief Financial

Officer report.

After these changes were made, DFAS revised the original 1307 so that the

amounts in that report would match the amounts in the CFO report. The

size of these changes is significant, especially considering the fact that

SMAG’s total revenue was $12.8 billion, according to the Chief Financial

Officer report.

The Air Force Has Not

Reconciled the Net

Operating Result

Differences in the

Accounting Report and the

Budget Justification

Report

We also compared SMAG’s reported net operating results in the 1307

accounting report to the Air Force Working Capital Fund budget

justification report—which provides reported actual and budgetary data

on revenue, expenses, net operating results, and prices and is also

essential to managing SMAG operations. Again, we identified significant

differences totaling billions of dollars for fiscal years 1992 through 1996.

For example, the 1307 accounting report showed that SMAG lost about 

$2 billion during fiscal year 1996 while the budget report showed that it

lost $99 million.

Differences between these two reports are expected since not all the

accounts used to determine the net operating results in the 1307

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Problems Continue

accounting report are used to develop the net operating results in the

budget. For example, if Air Force disposes of inventory items and does not

plan to replace these items, it does not consider this an expense for

budgeting purposes. However, for accounting purposes, this is considered

an expense that reduces the net operating results. The Department of

Defense Financial Management Regulation (DOD 7000.14-R) requires

business activities to (1) explain the differences between the net operating

results shown in the 1307 accounting report and those used in the budget

formulation of prices charged customers as shown in the budget,

(2) identify and justify the net operating result amounts in the 1307

accounting report that DOD components request be excluded from the

prices, and (3) obtain approval from the Office of the Under Secretary of

Defense (Comptroller) for the amounts to be excluded. The Air Force did

not reconcile the net operating results shown in these two reports as

required because it believed that the 1307 accounting report was incorrect.

Given the magnitude of the net operating result differences reported in the

1307 accounting report, Chief Financial Officer report, and the budget, it is

clear that the figures contained in these reports cannot be relied upon for

oversight and decision-making. Without knowing the net operating results,

the Air Force cannot determine whether the prices being charged SMAG’s

customers will allow it to recover its costs and operate on a break-even

basis. In some cases, the prices might have been set too high because of

erroneous net operating result data. In other cases, prices might have been

set too low to recover the costs of providing goods and services, thereby

resulting in a cash shortage. (See chapter 3 for a discussion of SMAG pricing

problems and chapter 4 for a discussion of cash problems.)

SMAG Cannot Determine

an Accurate Cost of Goods

Sold Amount

A root cause of SMAG’s inability to accurately report on its financial

operations is that it cannot determine an accurate cost of goods sold. The

cost of goods sold is an important factor used in arriving at the group’s

annual net operating results (revenue less expenses, which include the

cost of goods sold, equals net operating results). Our comparison of SMAG’s

cost of goods sold reported in its Chief Financial Officer reports, 1307

accounting reports, and budget justification reports for fiscal years 1992

through 1996 identified differences totaling billions of dollars. These

differences are detailed in table 2.2.

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Table 2.2: SMAG’s Reported Cost of

Goods Sold for Fiscal Years 1992

Through 1996

(Dollars in millions)

Fiscal year CFO report 1307 report Budget report

1992 $8,745 $8,909 $7,719

1993 7,743 8,754 7,656

1994 9,889 7,476 8,313

1995 15,901 7,132 8,935

1996 10,929 10,390 8,204

Office of the Under Secretary of Defense (Comptroller) and/or DFAS

officials told us that DOD’s logistical and accounting systems are not

capable of providing the necessary information to identify the actual

(historical) cost of goods sold amount based on normal commercial

practices such as the first-in, first-out cost or weighted average cost of the

items sold. Therefore, DOD uses the latest acquisition cost method to value

inventory and arrive at the cost of goods sold which is permissible under

the Statement of Federal Financial Accounting Standards No. 3, Inventory

and Related Property.

DOD uses a summary-level formula to adjust the value of inventory from

the standard (selling) price to the latest acquisition cost by removing

surcharges for operating costs from the standard price. Once DOD

determines the latest acquisition cost, it then uses the following general

formula for computing the cost of goods sold:

Beginning inventory at beginning-of-the-period latest acquisition cost3

Less: Beginning allowance for unrealized holding gains/losses

Plus: Purchases of goods for sale

Less: Disposal or other drawdown of goods other than sale

Equals: Cost of goods available for sale

Less: Ending inventory at end-of-the-period latest acquisition cost

Plus: Ending allowance for unrealized holding gains/losses

Equals: Cost of goods sold

However, as evidenced by the reported differences shown in table 2.2, DOD

has had problems implementing this formula to compute the cost of goods

sold. Office of the Under Secretary of Defense (Comptroller) and DFAS

3

Since the latest acquisition cost method provides that the latest invoice price (price SMAG paid to

acquire the item from a vendor) be used to value all like inventory items regardless of the amount paid

for the items, the inventory needs to be revalued to reflect unrealized holding gains and losses to arrive

at an approximation of the historical (actual) value of the inventory. The amount of unrealized gain or

loss is the difference between the recorded value of the inventory and the actual cost to acquire the

inventory.

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officials also told us that in order to determine the actual (historical) cost

of the goods sold, the method for valuing inventory must be changed from

the current method of using the latest acquisition cost to valuing inventory

based on historical costs. If DOD changes its method for valuing inventory,

it must ensure that its method complies with the Statement of Federal

Financial Accounting Standards No. 3.

These officials further stated that by valuing inventory at historical cost,

DOD would know the cost of each individual item sold, something it does

not know now. This information could then be summarized for reporting

on the supply management activity groups’ financial operations in DOD’s

monthly accounting reports. However, the officials stated that before

inventory could be valued at historical cost, DOD would have to either

(1) modify its existing logistical and accounting systems or (2) develop

new ones. Either option would be a long-term effort.

Conclusions SMAG’s financial reports cannot be relied upon to provide DOD and Air

Force management or the Congress reliable information on SMAG’s results

of operations. DOD has discussed this financial reporting problem in its

September 1997 plan on improving the working capital funds and has

identified several actions to correct the problem. However, it has not yet

developed a detailed implementation plan to help ensure that the

problems are corrected. Until SMAG can (1) determine its cost of goods sold

and (2) reconcile the net operating results reported in the 1307 report to

the net operating results reported for budgeting purposes, SMAG’s financial

reports will continue to be questioned and lack credibility, and it will be

extremely difficult, or impossible, to determine if the prices charged

customers reflect what they need to be in order to recover costs.

Recommendations To ensure that DOD acts to correct SMAG’s financial reporting problems and

develop an accurate cost-of-goods sold figure, we recommend that the

Secretary of Defense develop a detailed implementation plan to ensure

that the actions identified by DOD in September 1997 to correct the

financial reporting problems are carried out promptly. The plan should

(1) identify specific actions that need to be taken including the

modification of existing systems or development of new systems,

(2) establish milestones, (3) clearly delineate responsibilities for

performing the tasks in the plan, and (4) ensure compliance with

accounting standards on accounting for inventory and related property.

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To help link information contained in the accounting report to budget

formulation, we also recommend that the Secretary of the Air Force direct

a reconciliation of the net operating results in the 1307 accounting report

to the reported actual net operating results in the budget justification

report that is used for budgeting purposes.

Agency Comments In its written comments, DOD concurred with our recommendation to

develop a detailed implementation plan to ensure that the actions

identified by DOD in September 1997 to correct the financial reporting

problems are carried out in a timely manner. DOD has established three

working groups that will develop specific implementation and execution

plans and procedures for financial reporting. These three groups will meet

throughout the summer of 1998 with reports expected later this year.

DOD also concurred with our recommendation to reconcile the net

operating results in the 1307 accounting report to the reported actual net

operating results in the budget justification report that is used for

budgeting purposes. DOD stated that additional lines have been added to

the Working Capital Fund 1307 accounting reports to help explain the net

operating differences that are reflected in the two reports.

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Difficulties Encountered in Developing

Prices

DOD policy requires the military services to develop prices for the working

capital funds and use these prices as a basis for determining customer

funding requirements. The baseline for this process should be the cost of

buying and/or repairing items that are sold—which is known as the cost of

goods sold. The Air Force, however, does not have reasonably reliable

estimates of the number and type of items that SMAG customers will need

or the expected cost of buying and/or repairing these items. Since it

cannot use the cost of goods sold as the basis for SMAG’s prices, the Air

Force has had to resort to using two separate processes to develop prices.

The first process is used to develop a composite, or aggregate, price

change in terms of percentage from one fiscal year to the next. This price

change is then used to develop customers funding levels. The second

process is used to establish prices for individual inventory items that

reflect the expected cost of providing these items to customers.

Ideally, these two processes would ensure that customers will have

sufficient funds to buy the items they need. However, this objective is not

always accomplished for the following two reasons. First, there are no

checks to ensure that the composite price changes approved by the Under

Secretary of Defense (Comptroller) are implemented. Second, problems

with the implementation of new procedures for allocating operating cost

to individual inventory items could result in some customers receiving

either too much or too little funding in fiscal year 1998, and have left Air

Force officials without the reliable historical and/or budget execution data

they need to effectively reallocate funds.

Two Separate

Processes Used to

Develop Customers’

Funding Levels and

Prices for Individual

Items

The two primary objectives of SMAG’s price-setting process are to ensure

that (1) prices charged for individual items reflect the expected cost of

providing these items to customers and (2) SMAG’s composite, or aggregate,

price change is identified—so that it can be properly factored into

customer budgets. Because it lacks reliable data on SMAG’s cost of goods

sold (see chapter 2) and reasonable estimates of customers’ needs,1

 the Air

Force cannot accomplish these objectives through the traditional

approach—developing prices for individual items and then applying these

prices to estimates of customer needs as the basis for determining

customer funding requirements. As a result, it uses a summary-level

analysis to establish a composite price change for SMAG customers and, in

turn, customer funding levels, and then attempts to establish prices for

individual items that are consistent with the composite price change.

1

SMAG officials acknowledge that it can provide only “ballpark” estimates of customer requirements,

in part, because customer funding levels are developed between 9 and 15 months before the start of

the fiscal year when they go into effect.

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Prices

Customer Funding Levels

Are Based on Historical

Data and Expected

Changes

During the annual budget review process, the Air Force develops an

estimate of customer funding requirements that is subsequently approved

by the Office of the Under Secretary of Defense (Comptroller). This

estimate is based on factors such as (1) what customers have spent on

inventory purchases in the past, (2) anticipated changes in requirements,

such as planned deactivations of units, and (3) expected changes in SMAG’s

costs, such as the anticipated effect of planned cost reduction actions. For

example, during fiscal years 1997 through 1999, using this estimating

process, SMAG’s prices and its customers’ funding levels were reduced by

about $950 million to reflect the savings the Air Force expects to achieve

from its Lean Logistics initiative.2

During the annual budget review process, Air Force headquarters also

develops, and the Office of the Under Secretary of Defense (Comptroller)

approves, a composite, or aggregate, price change that represents the

average percentage price increase or decrease that SMAG customers will

experience during the budget year. As shown in table 3.1, from fiscal years

1992 through 1998, SMAG’s authorized composite price change ranged from

a 26.7 percent increase to a 26.2 percent decrease.

Table 3.1: SMAG’s Authorized

Composite Price Changes for Fiscal

Years 1992 Through 1998

Fiscal year Percent of composite price change

1992 (26.2)

1993 20.7

1994 26.7

1995 (9.9)

1996 (16.5)

1997 (1.2)

1998 19.3

Source: DOD budget documents.

Actual Prices Are Based on

Latest Acquisition Costs or

Latest Repair Costs Plus

Surcharges

To ensure that SMAG and other working capital fund activities operate on a

break-even basis over time, DOD policy requires that prices be (1) based on

expected costs and (2) adjusted to return prior year profits to customers

or recoup prior year losses from them. It also requires that the prices be

established at the beginning of the fiscal year and remain constant

throughout the year.

2

This initiative is expected to reduce the amount of time required to satisfy customers’ requests and, in

turn, to reduce the number of items that SMAG must buy or repair.

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Prices

Prices that customers actually pay for SMAG’s individual inventory items

are determined by adding a surcharge to each item’s latest acquisition cost

or latest repair cost. Specifically, “standard” prices are determined by

adding surcharges to the latest acquisition costs, and “exchange” prices

are determined by adding surcharges to the latest repair costs. SMAG

charges exchange prices when customers turn in broken repairable items

and receive serviceable items in return. It charges standard prices for all

nonrepairable items and for repairable items if customers do not turn in

broken items.

The surcharges that are added to the price of each inventory item are

expected to cover SMAG’s operational costs for such things as salaries,

inventory storage, and accounting and automated data processing

services. They also cover other factors, such as (1) reductions to reflect

the anticipated effect of cost reduction initiatives and (2) returning profits

or recouping prior year losses. Between fiscal years 1994 and 1998, these

surcharges ranged from a low of $1.0 billion to a high of $2.1 billion and

accounted for between 30 and 50 percent of SMAG’s expected wholesale

revenue.

Pricing Procedures

Do Not Ensure That

Approved Price

Changes Are Properly

Implemented

It is important that the prices established for individual items be

consistent with the composite price change approved by the Under

Secretary of Defense (Comptroller) and used in budgeting. If actual prices

are set lower than the approved level, then customers may have more

funds than they need and scarce resources may be wasted. Conversely, if

actual prices are set higher than the approved level, then customers may

not have enough funds to buy the items they need.

However, the Air Force does not have effective procedures to ensure that

the actual prices are, in fact, consistent with the composite price change

that has been approved by the Under Secretary of Defense (Comptroller).

It generally does not know that there is a problem with SMAG’s prices until

and unless the problem is reflected in budget execution data. For example,

SMAG’s fiscal year 1997 prices were reduced by about 18 percent, effective

April 1, 1997, when budget execution data showed that customers were

spending much more than expected for inventory items, and Air Force

officials determined that customers did not have sufficient funds to last

the remainder of the fiscal year.

According to Air Force headquarters officials, this problem occurred

because (1) SMAG had to pay more than budgeted for the repair of items

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Difficulties Encountered in Developing

Prices

and (2) when these higher-than-expected costs were incorporated into

SMAG’s prices, it caused SMAG’s composite price increase to be higher than

the one approved by the Office of the Under Secretary of Defense

(Comptroller) during the budget review process. Reducing SMAG’s prices

without reducing its cost adversely affected SMAG’s net operating results

and the Air Force Working Capital Fund’s cash balance.

The Air Force has recognized that it needs to take additional steps in the

price-setting process. Specifically, after the prices for individual items are

established and before the start of the fiscal year, the Air Force believes,

and we agree, that it should (1) determine if the new prices, when applied

to the best available estimate of customer orders, will result in the

approved composite price change and (2) adjust the prices for individual

inventory items, if necessary. AFMC officials acknowledged the need for

corrective action such as this and indicated that they plan to take it.

New Cost Allocation

Procedures and Data

Problems Have

Created Customer

Budgeting Problems

New procedures for allocating SMAG’s operational costs to individual

inventory items (calculating surcharges), combined with data reliability

problems, have resulted in fiscal year 1998 price changes that have varied

significantly not only from one inventory item to the next but also from

one month to the next. As a result, the Air Force’s initial allocation of

funding to SMAG customers left some with either too much or too little

funding. Further, although Air Force headquarters can and has alleviated

this problem by reallocating available funds, it lacks the reliable historical

and budget execution data it needs in order to properly do so now and in

the future.

Goal of New Procedures Is

to More Accurately

Allocate Costs

As discussed above, prior to fiscal year 1998, SMAG recouped its expected

operational costs by applying a standard surcharge percentage to all

wholesale items. The advantage of this approach is that it does not require

reliable data on an individual supply activity’s operational costs or

projected revenue—because all operational costs are aggregated and then

allocated uniformly to all items at all supply activities. The disadvantage is

that, under this approach, the operations of inefficient supply activities

are, in essence, subsidized by more efficient activities. This, in turn, makes

it difficult to identify inefficient operations and activities, and causes many

customers to pay either more or less than they should for their inventory

purchases. For example, if one ALC’s overhead costs were higher than the

other four ALCs’, some of its overhead costs would be included in the

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Difficulties Encountered in Developing

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prices charged by the other four ALCs even though they may operate more

efficiently.

On October 1, 1997, the Air Force made two major changes in SMAG’s cost

allocation procedures in order to better match costs with the prices

customers were being charged. First, under the new cost allocation

procedures, SMAG will, where possible, identify the estimated costs

associated with individual supply activities—the five ALCs—and allocate

each ALC’s costs to only those items that it manages. Second, the estimated

cost of procuring inventory items to replace repairable items that can no

longer be repaired economically (condemned items) will be recouped by

adding a surcharge to the cost of the item being replaced rather than by

adding a standard surcharge to all repairable items, which was the

previous practice.

Air Force headquarters officials stated that the implementation of the new

cost allocation procedures has led to increased awareness of costs and

increased emphasis on accurately estimating both costs and sales revenue.

For example, they told us that because SMAG’s operational costs are now

allocated, where possible, directly to the individual ALCs that incur them,

the ALCs are now much more aware of and concerned about these costs.

Similarly, they noted that, because the ALCs’ overhead cost allocations and

surcharge percentages are based largely on their projected sales revenues,

there is also increased emphasis on accurately projecting individual ALC’s

sales revenue.

SMAG Lacks Data Needed

to Effectively Implement

Its New Cost Allocation

Procedures

To effectively implement the new cost allocation procedures, SMAG needs

reliable sales revenue and operational cost data for individual ALCs.

However, it has neither—in part because it did not begin accumulating

actual sales data for individual ALCs until fiscal year 1997. As a result,

SMAG’s initial fiscal year 1998 prices, which became effective on October 1,

1997, were based on unreliable sales and operating cost data and,

therefore, had to be revised, effective November 1. In addition, because

some of the November 1, 1997 price changes were not processed properly

by the ALCs’ automated systems, another price change had to be

implemented for many items, effective December 1, 1997.

Each of these price changes was based on a reallocation of sales revenue

and/or operational costs among the five ALCs and was associated with a

major change in the size of the surcharges added to individual items. For

example, the surcharges used to establish exchange prices for Sacramento

Page 31 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Chapter 3 

Difficulties Encountered in Developing

Prices

ALC-managed items ranged from a low of about 46.6 percent to a high of

287.1 percent.

Table 3.2 shows how these changes affected the price of individual items.

For example, customers paid $8,859 for an alternating generator on

October 1. On November 1, customers paid $23,391—about 2.6 times as

much as the price on October 1. On December 1, they paid $16,727.

Table 3.2: Examples of Fiscal Year

1998 Price Changes for Sacramento

ALC-Managed Items

Price

Item description

Type

price

Fiscal

year 1997

October

1997

November

1997

December

1997

Klystron tube Exchange $114,326 $147,750 $279,001 $279,001

Traveling wave tube Exchange $ 74,273 $200,190 $200,190 $179,849

Alternating generator Exchange $ 7,307 $ 8,859 $ 23,391 $ 16,727

Load coil Standard $ 5,838 $ 7,104 $ 10,623 $ 11,059

Extractor tool Standard $ 570 $ 5,570 $ 8,093 $ 8,676

These large price changes distort SMAG customers’ budget execution data

for fiscal year 1998 and make it difficult for the customers and those

providing oversight over their operations to determine if an appropriate

level of funding has been provided.

New Cost Allocation

Procedures Have Created

Customer Budgeting

Problems

Although SMAG’s December 1, 1997, price change resulted in surcharges of

at least 25 percent for all items at all ALCs, the surcharges are especially

high for Sacramento ALC-managed items. This is primarily because

Sacramento, which is scheduled to close in July 2001, has a much lower

sales volume than the other ALCs and therefore, must spread its

operational costs over a smaller base. As shown in table 3.3, the

surcharges added to Sacramento’s standard prices (132.3 percent) and

exchange prices (176.8 percent) are at least three times higher than those

of the other ALCs.

Table 3.3: SMAG Surchargesa for Five

ALCs as of December 1, 1997 ALC Standard price surcharge Exchange price surcharge

Oklahoma City 26.5% 45.0%

Ogden 36.9% 45.0%

San Antonio 26.0% 40.4%

Sacramento 132.3% 176.8%

Warner Robins 26.1% 32.4%

aStandard surcharges are expressed as a percent of the latest acquisition cost, while exchange

surcharges are expressed as a percent of the latest repair cost.

Page 32 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Chapter 3 

Difficulties Encountered in Developing

Prices

Because the ALCs used a standard surcharge in fiscal year 1997,

Sacramento’s substantially higher fiscal year 1998 surcharges will cause

price increases for its items to be much higher than the SMAG average. As a

result, customers that rely heavily on the Sacramento ALC for their support,

such as those that operate communications-electronics and space systems,

are the ones that are most likely to have received insufficient funding. For

example, the Air Force Space Command used more than half of its fiscal

year 1998 spares funding during the first quarter of the year, and Space

Command officials believe that their units will be unable to acquire the

parts they need unless Air Force headquarters provides additional funds or

they can transfer funds from another program.

Customers that purchase inventory from the other ALCs also expressed

concern. For example, officials of the Air Combat Command—which

purchases inventory items from all the ALCs—stated that the

implementation of the new cost allocation procedures have caused them

“tremendous concern.” They acknowledged that the numerous pricing

changes that occurred during fiscal year 1998 make it virtually impossible

for them to determine whether they will have sufficient funding to cover

their needs during fiscal year 1998. However, their analysis shows that

they expect to experience funding shortages in most of their major

weapons systems in fiscal year 1998 if additional funds are not provided.

Because (1) SMAG’s new procedures for allocating operating cost to

individual inventory items significantly impacted the fiscal year 1998

prices charged customers for individual items and (2) the overall impact

varied significantly from one customer to the next, the Air Force does not

have historical data on the amount of money needed by individual

customers to purchase inventory. Air Force budget officials told us that it

would take at least 1 to 2 years, perhaps even more, of actual experience

to have sufficient data to reliably estimate individual customer needs. As a

result, although the Air Force has already adjusted customer funding

levels once, these officials acknowledged that they will have to continue to

monitor budget execution data and to make further adjustments if

necessary.

Conclusions To develop prices that will enable SMAG to operate on a break-even basis,

the Air Force needs reliable information on (1) SMAG’s expected cost of

goods sold and on (2) the expected sales revenue and operational costs of

the individual ALCs. However, the Air Force does not have this reliable

information. It also does not have adequate procedures to ensure that

Page 33 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Chapter 3 

Difficulties Encountered in Developing

Prices

customers receive sufficient funds to purchase required inventory items

and, as a result, had to reduce SMAG’s prices half way through fiscal year

1997 so that customers would not run out of money. Compounding this

problem are the new cost allocation procedures and the implementation of

those procedures which resulted in three different sets of prices so far

during fiscal year 1998. This has caused substantial price fluctuations

during fiscal year 1998 that may cause customers to either purchase fewer

inventory items than they planned or transfer funds from other accounts.

Recommendations As recommended in the previous chapter, the Air Force needs to develop

an effective process for determining the cost of goods sold. In addition, we

recommend that the Secretary of the Air Force

• assess the impact of price changes to determine whether customers can

acquire the goods they need in fiscal year 1998 and take funding

reallocation actions, as appropriate, to meet the highest priority needs;

and

• direct the AFMC Commander to develop and implement procedures to

ensure that the prices that are established for individual inventory items

are consistent with the composite prices developed and approved by the

Office of the Under Secretary of Defense (Comptroller) during the budget

process.

Agency Comments In commenting on this report, DOD concurred with our recommendation to

assess the impact of price changes to determine whether customers can

acquire the goods they need in fiscal year 1998 and take funding

reallocation actions as appropriate. The Air Force has already begun the

process of reallocating resources to customers to ensure program integrity

(vital functions can be performed). DOD also concurred with our

recommendation to develop and implement procedures to ensure that the

prices that are established for individual inventory items are consistent

with the composite prices developed and approved by the Office of the

Under Secretary of Defense (Comptroller).

Page 34 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Chapter 4 

Air Force Working Capital Fund and SMAG

Cash Management Problems

The Air Force maintains one cash balance at the overall Air Force Working

Capital Fund level and manages the fund’s cash at that level. To ensure

that the fund maintains an adequate level of cash to pay its bills, it is

essential that managers (1) accurately project cash collections and

disbursements and (2) actively monitor the fund’s cash position by

performing such analyses as comparing budget estimates for collections

and disbursements to actual collections and disbursements and

determining the reasons for the variances. DOD policy requires that if the

level of cash becomes low and there is a possibility of incurring an

Antideficiency Act1

 violation, immediate actions be taken to resolve the

cash shortage by advance billing customers for work not yet performed.

Since June 1993, the Army, Navy, and Air Force Working Capital Funds,

have experienced cash shortages and have advance billed customers for

work not yet performed to ensure that sufficient funds were available to

meet day-to-day operating expenses. DOD initially expected the working

capital funds to eliminate advance billing in fiscal year 1995. However, the

Air Force Working Capital Fund has not achieved this goal and has

continued the practice of advance billing customers.

Since SMAG is the largest activity group in the Air Force Working Capital

Fund, it is critical that SMAG properly manage its collections and

disbursements. However, we found that SMAG did not accurately project

cash (1) collections from sales and (2) disbursements for inventory items

purchased from vendors. Further, SMAG was not adequately monitoring

account receivable balances and outlay rates, which would have enabled it

to identify the problem of inaccurately projecting collections and

disbursements so that corrective actions could be taken to resolve the

problem.

The Importance of

Cash for Working

Capital Funds

Cash generated from the sale of goods and services is the primary means

by which the working capital funds activities pay their bills. The position

where the cash balances start each year depends on the outcome of many

decisions made during the budget process with regard to (1) projecting the

volume of inventory items that will be sold, (2) estimating costs, and

(3) setting prices to recover the estimated full cost of the goods and

services. During the execution of the budget, the working capital funds

operate much like a checking account: collections increase the fund’s cash

balance, and disbursements (such as salaries and purchases of inventory)

1

The Antideficiency Act, 31 U.S.C. 1341(a)(1) provides that no officer or employee of the government

shall make or authorize an expenditure or obligation exceeding the amount of an appropriation of

funds available for the expenditure or obligation.

Page 35 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Chapter 4 

Air Force Working Capital Fund and SMAG

Cash Management Problems

reduce the cash balance. To the extent that the decisions, such as cost

reduction initiatives, made during the budget process are reasonably

accurate, the funds’ cash balances should fall between the minimum and

maximum amount required by DOD. However, if the decisions are not

accurate, the funds could have too much or not enough cash.

According to DOD’s Financial Management Regulation, Volume 11B, the

working capital funds are to maintain the minimum cash balance

necessary to meet both operational requirements and to meet

disbursement requirements in support of the capital asset program. In

essence, the funds are to maintain a minimum cash balance which, at the

same time, is sufficient to cover expenses, such as paying employees for

repairing aircraft and vendors for inventory items. DOD’s policy further

requires the funds to maintain cash levels to cover 7 to 10 days of

operational costs and 4 to 6 months of capital asset disbursements. To

comply with DOD’s policy, the Air Force Working Capital Fund should

maintain a cash balance between about $465 million and $670 million. If

the Air Force Working Capital Fund’s level of cash drops below the

minimum required balance and there is a possibility of incurring an

Antideficiency Act violation, actions will be taken to resolve the cash

shortage by advance billing customers.

Within the working capital fund there are three major activity

groups—depot maintenance, supply management, and information

services—whose operations significantly impact the fund’s cash balance.2

Of these activity groups, SMAG is the largest with 65 percent, or about

$8.8 billion in reported disbursements out of the total $13.5 billion in

reported disbursement made by the Air Force Working Capital Fund in

fiscal year 1997.

Air Force Working

Capital Fund Is Still

Advance Billing

Customers

We have previously reported3 that the Defense Working Capital Funds

have had a long-standing cash management problem including the practice

of advance billing customers. Since 1993, the working capital funds have

advance billed customers because they have not been able to generate

enough cash to pay their bills. When the responsibility for managing cash

2

Beginning in fiscal year 1998, the United States Transportation Command’s transportation activity

group was transferred from the Defense Working Capital Fund to the Air Force Working Capital Fund.

3

Defense Working Capital Funds: DOD Faces Continued Challenges in Eliminating Advance Billing

GAO/T-AIMD/NSIAD-97-221, July 22, 1997; Defense Business Operations Fund: DOD is Experiencing

Difficulty in Managing the Fund’s Cash (GAO/AIMD-96-54, April 10, 1996; Defense Business Operations

Fund: Management Issues Challenge Fund Implementation (GAO/AIMD-95-79, March 1, 1995); and

Financial Management: Status of the Defense Business Operations Fund (GAO/AIMD-94-80, March 9,

1994).

Page 36 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Chapter 4 

Air Force Working Capital Fund and SMAG

Cash Management Problems

was returned to the military services and DOD components in

February 1995,4

 the Air Force (as well as the Army and Navy) continued to

advance bill customers so that its cash portion of the Defense Business

Operations Fund would not have a negative balance.

According to DOD budget documents, DOD anticipated that the working

capital funds, including the Air Force Working Capital Fund, would be able

to generate enough cash to eliminate advance billing in fiscal year 1995.

This was to be achieved by (1) not replacing sold inventory on a

one-for-one basis, (2) reducing costs, and (3) increasing prices for various

reasons, such as to recoup prior year losses. When the fund failed to

generate this cash, subsequent DOD budgets provided for an end to

advance billing in fiscal year 1996, and again in fiscal year 1997. We found,

however, that the Air Force Working Capital Fund did not achieve DOD’s

goal of eliminating the routine practice of advance billing customers.

The Air Force steadily reduced the Working Capital Fund’s outstanding

advance billing balance from about $1.3 billion in February 1995 to

$77 million in November 1996. At the same time, the Fund’s cash balance

declined from $1.1 billion to $90 million. To ensure that its cash balance

would remain positive, the Air Force Working Capital Fund advance billed

customers over $1 billion in December 1996 and about $700 million in the

June/July 1997 period. As of fiscal year end 1997, the Air Force Working

Capital Fund’s reported outstanding advance billing balance was

$464 million. Air Force officials told us that they now plan to eliminate the

outstanding advance billing balance by the end of fiscal year 1999.

The following figure shows the (1) reported cash balance for the Air Force

Working Capital Fund and (2) cash balance if the Air Force Working

Capital Fund had not advance billed its customers from February 1995

through September 1997.

4

When the Defense Business Operations Fund was established, the responsibility for managing cash

was placed under the Office of the Secretary of Defense (Comptroller) level. On February 1, 1995, cash

management and the related Antideficiency Act responsibilities were returned to the military services

and DOD component level.

Page 37 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Chapter 4 

Air Force Working Capital Fund and SMAG

Cash Management Problems

Figure 4.1: Air Force Working Capital

Fund Reported Cash Balance (Dollars

in millions)

Note: Cash policy requires about $465 million to $670 million.

2/95 6/95 6/96 6/97

-600

-400

-200

0

200

400

600

800

1,000

1,200

Cash balance

W/O adv. bill.

Source: DOD. We did not independently verify this information.

The Air Force recognizes that it has a cash shortage problem and added

surcharges to generate cash totaling (1) $200 million to SMAG’s fiscal years

1998 and 1999 customers’ prices and (2) $75 million to the Air Force Depot

Maintenance Activity Group’s fiscal years 1998 and 1999 prices. If these

cash surcharges do not alleviate the problem, the Air Force may have to

continue adding a surcharge to the prices to generate cash.

Further, to improve cash management in the Air Force Working Capital

Fund, the Air Force held a meeting in February 1998. Attending the

meeting were officials from the Office of the Secretary of the Air Force,

AFMC, DFAS, and various ALCs. The Air Force developed specific action

items for the Depot Maintenance, Information Services, and Supply

Management Activity Groups. According to Air Force officials, accounting

system enhancements should result in better forecasting which will help

the Air Force reduce the need for additional cash surcharges and advance

billings. A follow-up meeting to discuss progress is scheduled for

November 1998.

Page 38 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Chapter 4 

Air Force Working Capital Fund and SMAG

Cash Management Problems

SMAG’s Cash

Collection and

Disbursement

Projections Not

Accurate

To facilitate the cash management process, DOD policy requires that the

working capital funds develop cash plans which include estimated

collection and disbursement data. Being able to accurately project

collections and disbursements is critical to the working capital funds’

ability to maintain an adequate level of cash to meet operational and

capital requirements. DOD’s cash management policy further requires that

projected collections and disbursements be monitored during execution in

order to assess operational and financial problems and take the necessary

actions to correct the problems. However, we found that SMAG did not

accurately project cash (1) collections from foreign military sales (FMS)

and (2) disbursements to be made to vendors for inventory items. In

addition, SMAG managers did not adequately monitor account balance data

on FMS collections and vendor disbursements.

Our analysis of SMAG’s cash plans and reports show that SMAG made a

reported $237.3 million in cash from fiscal year 1992 through fiscal year

1997. Our analysis also shows that SMAG made $683.3 million less than

projected in fiscal years 1996 and 1997. This is of particular concern since

SMAG disbursed more money than it collected at the same time the Air

Force Working Capital Fund was experiencing a cash shortage problem

and was advance billing customers.

Estimated Cash From

Foreign Military Sales

Overstated

From fiscal year 1993 through fiscal year 1996, AFMC did not accurately

project cash collections from FMS. AFMC erroneously estimated FMS revenue

based on charging FMS customers the standard price (acquisition cost of

the item plus surcharges) for depot level repairable inventory items rather

than the exchange price (repair price of the item plus surcharges) that FMS

customers actually paid. According to Air Force officials, AFMC budgeted

FMS revenue and collections based on the standard price because it

assumed that FMS customers would not be turning in broken inventory

items (referred to as carcasses) in exchange for good, “useable” items.

However, FMS customers turned in the carcasses. As a result, actual cash

collections were about $429 million less than budgeted from fiscal year

1993 through fiscal year 1996.

The difference between the standard price and exchange price that the FMS

customer paid was recorded in a receivable account called “other assets

accounts receivable—deliveries suspense.” As shown below, the amount

steadily grew from fiscal year 1993 through fiscal year 1996.

Page 39 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Chapter 4 

Air Force Working Capital Fund and SMAG

Cash Management Problems

Table 4.1: Dollar Amount Reported in

Account Called Other Asset Accounts

Receivable—Deliveries Suspense

(Dollars in millions)

Fiscal year Amount

1993 $208.2

1994 298.0

1995 527.1

1996 776.8

Source: SMAG general ledger. We did not independently verify this information.

Because AFMC personnel were not adequately monitoring account balance

information, they did not realize that FMS customers were turning in

broken items until SMAG started to experience cash problems in early fiscal

year 1996. This was soon after the Air Force received cash management

responsibilities for the working capital fund. Until that time, AFMC

managers were not monitoring the account’s balances because, from an

overall cash position, there were no adverse issues regarding SMAG’s cash.

AFMC has begun to resolve this problem. Beginning in fiscal year 1997,

revenue from FMS customers was budgeted at the exchange price.

Cash Outlay Rates Not

Accurately Projected

From a cash management standpoint, when SMAG orders inventory items

from vendors, it is critical that the Air Force accurately project the timing

of delivery since SMAG pays the vendors based on the delivery of the

inventory items. The time period used for projecting outlays depends on

the type of inventory items being purchased and can cover several years

starting from the time the items are ordered from vendors. AFMC officials

assumed that vendor deliveries, and thus cash outlays, would be greater in

the earlier years of the delivery period and less in the later years.

Accordingly, AFMC projected its cash outlays to fit this delivery pattern.

However, Air Force officials stated that AFMC’s projected outlays have not

materialized as expected. Cash outlays in the early years were significantly

less than expected, while outlays in the later years were more than

expected. According to Air Force supply management officials, until

recently, outlay rates for the Reparable Support Division inventory buys

were not being updated each year to better reflect vendor delivery

patterns. The following table illustrates the shift in projected outlay rates

over a 5-year outlay period. It also shows the (1) outlay rates that have

been used over the past several years and (2) revised outlay rates—based

on the Air Force’s analysis of current outlay pattern—used in developing

the Air Force’s fiscal year 1999 budget estimate submission for SMAG.

Page 40 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Chapter 4 

Air Force Working Capital Fund and SMAG

Cash Management Problems

Table 4.2: Reparable Support Division

Original and Revised Projected Outlay

Rates

Year of outlay

Original projected

outlay rates (percent)

Revised projected

outlay rates (percent)

Percentage change

from original to

revised

1st year 7.8 2.9 (62.8)

2nd year 24.9 17.0 (31.7)

3rd year 37.2 32.6 (12.4)

4th year 17.8 23.8 33.7

5th year 12.3 23.7 92.7

Source: Air Force projected outlay rate schedules.

AFMC managers did not realize that there was a problem with projected

cash outlays until SMAG started to experience cash problems in early fiscal

year 1996. According to AFMC officials, outlay rates were not monitored

because there were no adverse issues regarding SMAG’s cash.

AFMC officials told us that they do not have the basic information for

projecting cash outlays, such as item managers’ delivery projections or

good, historical data by fiscal year on vendor contracts. DOD’s

September 1997 report5

 also acknowledged that managers do not have the

necessary information nor an automated cash model to assist them in

predicting required cash levels, forecasting cash positions, or for

predicting end-of-period cash positions on a weekly, monthly, or annual

basis.

AFMC officials acknowledged that they need better management tools for

projecting cash outlays for all types of SMAG outlays. They noted that

projecting outlay rates is relatively easy for obligations and disbursements

that occur within the same year (such as paying salaries or accounting

services provided by the DFAS). However, this process becomes much

more complicated when it comes to disbursements that occur several

years after the obligation (such as purchases of repairable inventory items

from vendors), and thus there is a critical need for better information and

tools that can guide fund managers. Recognizing this, AFMC contracted

with a major public accounting firm to develop a cash forecasting model.

Conclusions The Air Force Working Capital Fund depends on its activity groups to

effectively manage their cash in order for the fund to have enough cash to

pay for day-to-day operating expenses. However, the activity groups have

5

The National Defense Authorization Act for Fiscal Year 1997 required DOD to prepare a report on

improving the management and performance of the working capital funds.

Page 41 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Chapter 4 

Air Force Working Capital Fund and SMAG

Cash Management Problems

not generated sufficient cash to eliminate the practice of advance billing

customers. With regard to SMAG, this activity group has made less cash

than estimated from fiscal year 1993 through fiscal year 1997. This

problem will undoubtedly persist until SMAG (1) develops and uses

management tools, such as cash forecasting models to project the amount

of collections to be received and disbursements to be made in future years

and (2) emphasizes the need to monitor account balances and takes steps

needed to identify and correct the problems.

Recommendations We recommend that the Secretary of the Air Force direct the Commander,

Air Force Materiel Command to

• ensure that the development of the cash forecasting model includes the

capabilities to forecast (1) required cash level, (2) end-of-period cash

positions on a weekly, monthly, or annual basis, (3) disbursements to be

made in future years based on when vendors are scheduled to deliver

items to SMAG and the prices charged by the vendors, and (4) receipts

based on SMAG’s sales; and

• monitor accounts receivable balances and cash outlay rates to identify

anomalies and their causes so that corrective actions can be taken.

Agency Comments In its comments, DOD concurred with our recommendation to ensure that

the development of the cash forecasting model includes the capabilities to

forecast (1) required cash levels, (2) cash balances, (3) disbursements, and

(4) receipts based on sales. DOD also concurred with our recommendation

to monitor accounts receivable balances and cash outlay rates to identify

anomalies and their causes so that corrective actions can be taken.

Page 42 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Page 43 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Appendix I 

Comments From the Department of Defense

Page 44 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Appendix I 

Comments From the Department of Defense

Page 45 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Appendix I 

Comments From the Department of Defense

Page 46 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
Appendix II 

Major Contributors to This Report

Accounting and

Information

Management Division,

Washington, D.C.

Gregory E. Pugnetti, Assistant Director

William A. Hill, Auditor-In-Charge

Ron L. Tobias, Senior Auditor

Cristina Chaplain, Communications Analyst

San Francisco

Regional Office

Karl J. Gustafson, Senior Evaluator

Eddie W. Uyekawa, Senior Evaluator

Christine D. Frye, Senior Evaluator

(511635 and 709293) Page 47 GAO/AIMD/NSIAD-98-118 Air Force Supply Management
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