GAO

United States General Accounting Office

Report to the Chairman, Subcommittee 

on Military Readiness, Committee on 

Armed Services, House of 

Representatives

December 1999 AIR FORCE DEPOT 

MAINTENANCE

Analysis of Its 

Financial Operations

GAO/AIMD/NSIAD-00-38

Page 1 GAO/AIMD/NSIAD-00-38 Air Force Depot Maintenance

United States General Accounting Office

Washington, D.C. 20548

Accounting and Information

Management Division

B-283840 Letr

December 10, 1999

The Honorable Herbert H. Bateman

Chairman

Subcommittee on Military Readiness

Committee on Armed Services

House of Representatives

Dear Mr. Chairman:

The Air Force depot maintenance activity group supports combat readiness 

by providing the depot repair services necessary to keep Air Force units 

operating worldwide. The group repairs and overhauls a wide range of 

assets including aircraft, missiles, aircraft engines, electronics, avionics, 

software, and repairable inventory items for military services, other 

government agencies, and foreign governments. For example, in fiscal year 

1998, the Air Force reported that the depot maintenance activity group 

performed major overhauls on about 670 aircraft, overhauled about 

980 engines, and repaired more than 800,000 inventory items. The group 

generates about $5 billion in annual revenue of which about $3.5 billion 

comes from in-house repair and services and about $1.5 billion comes from 

its contract repair operations.

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 depot maintenance activity group. This group operates under the 

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

anticipated actual costs of providing goods and services to them. 

As requested, this report discusses (1) the Air Force depot maintenance 

activity group’s price increase between fiscal year 1994 and fiscal year 1999 

and the primary reasons for it, (2) the activity group’s financial losses 

during fiscal year 1994 through fiscal year 1998 and the primary reasons for 

them, and (3) the Air Force’s methods for recovering these losses. We 

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) and two reports on the 

Air Force Supply Management Activity Group (GAO/AIMD/NSIAD-98-118, June 8, 1998, and 

GAO/NSIAD/AIMD-99-77, April 29, 1999).
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briefed your office on the results of our work on September 15, 1999. As 

agreed, we are continuing our work and will evaluate the Air Force’s ability 

to develop accurate estimates for work to be accomplished, material costs, 

and anticipated savings that were used in developing depot maintenance 

prices.

Results in Brief The Air Force depot maintenance activity group’s prices increased from an 

average of $92.60 per direct labor hour (DLH) in fiscal year 1994 to 

$128.43 per DLH in fiscal year 1999—a 39 percent increase.2

 The price 

increase occurred primarily because (1) the direct material cost per direct 

labor hour increased, (2) workload declined faster than overhead costs, 

and (3) the average cost of civilian labor increased.

Even though the prices increased 39 percent, the Air Force reported that 

the depot maintenance activity group lost about $623 million3

 during fiscal 

years 1994 through 1998 on total sales of about $21.8 billion. Our analysis 

indicates that these losses occurred primarily because the activity group 

(1) did not accomplish as much work as expected, (2) had material costs 

that were higher than budget estimates, (3) developed prices based on 

anticipated savings that were not realized, and (4) incurred losses on its 

contract repair operations during fiscal years 1996, 1997, and 1998.

Since fiscal year 1995, the Air Force has tried different methods to recover 

the depot maintenance activity group’s losses with varying success. For 

fiscal years 1995 through 1997, the Air Force increased prices and 

requested a direct appropriation. However, neither of these methods was 

successful in recouping losses. Beginning in fiscal year 1998, the Air Force 

used the following two other methods, which were more successful in 

recovering losses.

• First, the Air Force developed the depot maintenance activity group’s 

fiscal years 1998 and 1999 prices based on the group’s cost of operations 

plus an amount to recover $310 million in prior year losses. The Air 

Force then separated the approved fiscal years 1998 and 1999 prices into 

2

If the fiscal year 1994 price is converted to fiscal year 1999 dollars, it would be $106.58 per 

DLH. This would reduce the increase to 20.5 percent.

3

The $623 million loss includes a $98.8 million accounting adjustment that does not need to 

be recovered.
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two pieces. The first piece was the amount the activity group charged 

individual customers for current year work. The second piece was to 

recover the $310 million in prior year losses. 

• Second, pursuant to a new DOD policy that directs depot maintenance 

activities to recover losses that occurred during the year of execution, 

the Air Force (1) reprogrammed funds and (2) used other available 

customer appropriated funds to recover the depot maintenance activity 

group’s losses. As a result, the Air Force recovered or plans to recover 

$313.4 million in losses that occurred in fiscal years 1998 and 1999. 

Background The Air Force depot maintenance activity 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 revenue 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.

The activity group generates revenue by billing customers at 

predetermined, fixed prices as it performs specifically agreed-upon work 

for those customers. The prices are to be based upon anticipated actual 

costs. DOD customers primarily use operations and maintenance 

appropriations to pay for the work. Payments from customers replenish the 

Air Force Working Capital Fund’s working capital, which is used to finance 

subsequent operations. The activity group is expected to operate within the 

revenue it generates. Conceptually, this provides an incentive to control 

costs and maximizes efficiency. It is essential that the activity group 

operates efficiently since every dollar spent inefficiently results in fewer 

funds available for other defense spending priorities. 

Developing accurate prices is challenging since the prices are developed 

about 2 years in advance of when the work is actually received and 

performed. In essence, the activity group’s budget development has to 

coincide with the development of its group’s customers’ budgets so that 

they both use the same set of assumptions. To develop prices, the activity 

group estimates (1) labor, material, overhead, and other costs based on 

anticipated demand for work as projected by customers, (2) total direct 

labor hours for each type of work to be performed, such as aircraft, 

engines, and repairable items, (3) the workforce’s productivity, and 

(4) savings due to productivity and other cost avoidance initiatives.
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Since the early 1990s, the depot maintenance activity group has undergone 

downsizing, accomplished through annual reductions-in-force and “early 

outs.” For instance, from fiscal years 1992 through 1999, the Air Force cut 

the activity group’s workforce by 23 percent (7,000 workers). The activity 

group was further affected by the work of the 1993 and 1995 Base 

Realignment and Closure Commissions, which resulted in decisions to 

close two of the Air Force’s five air logistics centers and the Aerospace 

Guidance and Metrology Center.

DOD and the Air Force have also made several major policy and other 

changes that affected the depot maintenance activity group’s costs, prices, 

and work performed since the early 1990s. Air Force officials stated that 

(1) both costs and the prices set to recover those costs have been 

significantly affected by changes in the scope and mix of workload to be 

performed and (2) the depot maintenance activity group’s costs have 

increased due to the aging of the aircraft and engines. Table 1 shows these 

changes have occurred throughout the 1990s.
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Table 1: Policy and Other Changes Affecting the Depot Maintenance Activity Group’s Prices, Costs, and Workload

Scope and 

Methodology

To determine what factors caused the prices to increase between fiscal 

year 1994 and fiscal year 1999, we obtained and analyzed budget 

documents that provided information on cost factors, such as material 

costs, overhead costs, and salaries used in developing the prices. We 

discussed the reasons for the price increases with Air Force officials 

located at headquarters and the Air Force Materiel Command.

To determine what factors caused the activity group to incur losses from 

fiscal year 1994 through fiscal year 1998, we obtained and analyzed budget 

documents and accounting information that provided information on 

budgeted and actual direct costs, overhead costs, workload expressed in 

direct labor hours (DLH), and productivity. When variances occurred 

between budgeted and actual reported information, we met with 

responsible budgeting and accounting officials to ascertain why there were 

differences and how the differences resulted in losses. To determine how 

the Air Force recovered the activity group’s reported losses, we obtained 

budget and accounting information on the amount of the losses and 

Fiscal year Policy and other changes

1992 Establishment of the Defense Business Operations Fund required recovery of full costs in the activity group’s 

prices.

1992 and 1993 The financing of repairable inventory items in the stock fund increased the activity group’s material costs 

because the group did not pay for these items prior to this change.

1992 through 1999 In response to the declining force structure and the increasing amount of work that is being contracted out, the 

Air Force reduced the number of activity group employees from about 31,000 in fiscal year 1992 to about 

24,000 in fiscal year 1998. This affected the experience and skills of workers as well as the amount of work that 

could be performed by the depots. 

1993 to 1997 The Air Force converted its existing three level depot maintenance operations (organization, intermediate, and 

depot) to two levels (organization and depot) for selected avionics and engine items. Since the engine work was 

very material intensive, the average material cost per hour and the average customer price per hour both 

increased.

1993 to present The process of closing two air logistics centers and the Aerospace Guidance and Metrology Center and 

transferring their work to other sources of repair reduced both the amount of work performed and the 

productivity of the workforce at these activities.

1998 The Air Force changed the method of pricing inventory items sold to customers, including the depot 

maintenance activity group, which affected the group’s material costs.

1998 and 1999 About one-third of the group’s workload was scheduled to be competed or realigned, which affected the 

location and the amount of work performed by the depots and resulted in a major hiring and training 

requirement at the gaining activities.
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analyzed the methods used by the Air Force to finance those losses. We 

discussed the different methods for recovering losses with Air Force 

officials located at headquarters and the Air Force Materiel Command to 

determine why they used several different methods.

We did not verify the accuracy of the accounting and budget information 

used in the tables and charts in this report, all of which was provided by the 

Air Force in then-year dollars. We are continuing our work and will report 

separately on the Air Force’s ability to develop accurate estimates of 

workload, material costs, and anticipated savings that were used in 

developing depot maintenance prices.

We performed our work at the headquarters, Office of the Under Secretary 

of Defense (Comptroller) and the Office of the Secretary of the Air Force, 

Washington, D.C.; Air Force Materiel Command, Dayton, Ohio; the 

Oklahoma City Air Logistics Center, Tinker Air Force Base, Oklahoma; the 

Ogden Air Logistics Center, Hill Air Force Base, Utah; the San Antonio Air 

Logistics Center, Kelly Air Force Base, Texas; the Sacramento Air Logistics 

Center, McClellan Air Force Base, California; the Warner Robins Air 

Logistics Center, Robins Air Force Base, Georgia; and the Defense Finance 

and Accounting Service, Arlington, Virginia. 

Our work was performed from May 1999 through October 1999 in 

accordance with generally accepted government auditing standards. We 

requested comments on a draft of this report from the Secretary of the Air 

Force or his designee. On November 10, 1999, the Depot Maintenance 

Program Manager provided us with oral comments. These comments are 

discussed in the “Agency Comments” section of this report.

Factors Causing Prices 

to Increase

The depot maintenance activity group’s composite sales price4 increased 

from $92.60 per DLH in fiscal year 1994 to $128.43 per DLH in fiscal year 

1999, an increase of about 39 percent.5

 As shown in table 2 and discussed 

below, almost all of this price increase can be attributed to three factors: 

(1) direct material costs per DLH increased, (2) workload declined more 

4

The composite sales price is the average price that customers must pay for a DLH of work.

5

The fiscal year 1994 information is in then-year dollars. If the fiscal year 1994 price is 

converted to fiscal year 1999 dollars, it would be $106.58 per DLH. This would reduce the 

increase to 20.5 percent.
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rapidly than overhead costs and, as a result, more overhead costs had to be 

allocated to each DLH of work accomplished, and (3) the average cost of 

civilian labor increased.

Table 2: Primary Reasons for the Air Force Depot Maintenance Activity Group’s 

Fiscal Years 1994 and 1999 Sales Price Increase

a

The actual increase was $16.04 per hour, but $3.03 is not included because it resulted from an 

increase in the average cost of civilian labor (which is a separate reason).

Direct Material Costs Have 

Increased

Our analysis showed that the depot maintenance activity group’s budgeted 

direct material costs have declined much less than its budgeted workload. 

Specifically, the activity group’s workload (expressed in DLHs) declined 

nearly 35 percent between fiscal year 1994 and fiscal year 1999 due to 

reductions in the Air Force’s force structure, along with other factors such 

as the increased use of contractors. However, its direct material costs 

declined less than 4 percent. As a result and as shown in table 3, direct 

material costs per DLH increased $14.28, about 48 percent.

Reason

Increase in the

price per DLH

Percent of

total

Direct material cost per DLH increased $14.28 39.8

Workload declined faster than overhead 

costs

$13.01a 36.3

Average cost of civilian labor increased $7.76 21.7

Other $.78 2.2

Total $35.83 100.0
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Table 3: Budgeted Direct Material Costs per DLH for Fiscal Year 1994 and Fiscal Year 

1999

Air Force depot maintenance officials stated that the increase in budgeted 

direct material costs per DLH can be attributed to (1) higher material costs 

and (2) increased material usage. Further, they stated that there is more 

than one underlying cause for both of these factors. Part of the cost 

increase can be attributed to inflation. Most of it, however, is attributable to 

the fact that, in 1998, the Air Force supply management activity group 

began charging specific customers the full cost of replacing condemned 

inventory items (broken items that cost more to fix than to replace). In the 

past, these costs were spread evenly to all customers. According to 

Air Force officials, the net effect of this change was that some costs shifted 

from other supply management activity group customers, such as Air Force 

units, to the depot maintenance activity group. 

Air Force depot maintenance officials also stated that material usage has 

increased because (1) the workload mix now includes more work that has 

relatively high material costs6

 and (2) factors such as the aging of the 

aircraft and engine inventory is causing them to replace more component 

parts when repairs are accomplished. However, these depot maintenance 

officials acknowledge that they (1) do not yet fully understand the effect of 

the various factors that have affected their material costs in recent years 

and (2) need to develop a better understanding of these factors if they are 

to effectively manage their material costs. They also said that the Air Force 

is making a concerted effort to develop this better understanding.

Fiscal year Change

Description 1994 1999 Amount Percent

Direct material costs (in millions) $1,029.7 $992.2 $(37.50) (3.6)

DLHs (in millions) 34.421 22.451 (11.97) (34.8)

Direct material costs/DLH $29.91 $44.19 $14.28 47.7

6

For example, engine work, which has higher material costs than most workloads, increased 

from 5.6 percent of the budgeted total in fiscal year 1994 to 12.5 percent in fiscal year 1999.
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Workload Decline Has 

Outpaced Overhead 

Reduction

Reductions in the Air Force’s force structure, along with other factors such 

as increased use of contractors, have reduced the amount of work 

accomplished by the depot maintenance activity group’s depots. However, 

the depots’ overhead costs have not decreased proportionately to the 

decline in the workload. As a result, the depots have had to allocate more 

overhead costs to each DLH of work they accomplished. Specifically, as 

summarized in table 4, the need to allocate overhead costs over a steadily 

declining workload base has caused the amount of budgeted overhead 

costs allocated to each budgeted DLH of work accomplished to increase 

from $33.38 in fiscal year 1994 to $49.42 in fiscal year 1999, an increase of 

about 48 percent.

Table 4: Budgeted Overhead Cost per DLH for Fiscal Year 1994 and Fiscal Year 1999

According to Air Force depot maintenance officials, prices in general and 

overhead cost in particular should decline after July 2001, when the 

Air Force expects to finish closing two depots and transferring their 

workload to other depots and contractors.

Average Cost of Civilian 

Labor Has Increased 

An increase in the average cost of civilian labor increased the depot 

maintenance activity group’s prices by $7.76 per DLH for fiscal year 1994 

through fiscal year 1999, about $3.03 for overhead labor and $4.73 for direct 

labor. This increase was due to higher costs for both salaries and benefits. 

Specifically, as shown in table 5,

• budget estimates for the average annual cost of employee compensation 

(for basic salary and such variable costs as holiday and overtime pay) 

increased by $5,752 per work year per employee, 15.5 percent over 

5 years and

Change

Description

Fiscal year

1994

Fiscal year

1999 Amount Percent

Overhead costs (in millions) $1,149.1 $1,109.5 $(39.60) (3.4)

DLHs (in millions) 34.421 22.451 (11.97) (34.8)

Overhead cost/DLH $33.38 $49.42 $16.04 48.1
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• budget estimates for the average annual cost of employee benefits 

(employer contributions for such things as health and life insurance) 

increased by $2,147, or 29.1 percent over 5 years.

Table 5: Average Budgeted Cost of Civilian Labor for Fiscal Year 1994 and Fiscal 

Year 1999

Factors Contributing to 

the Activity Group’s 

Financial Losses

The Air Force depot maintenance activity group reported that it lost about 

$623 million from fiscal years 1994 through 1998. Although many factors 

contributed to these financial losses, our analysis indicates that they 

occurred primarily because (1) the activity group did not accomplish as 

much work as expected (budgeted) and was, therefore, unable to fully 

recover its fixed overhead costs, (2) material costs were higher than budget 

estimates, (3) prices were based on anticipated savings that were 

subsequently determined by the Air Force to be overly optimistic, and 

(4) the activity group incurred losses on its contract repair operations 

during fiscal years 1996, 1997, and 1998.

Change

Description

Fiscal year

1994

Fiscal year

1999

Amount Percent

Average employee 

compensation

$37,175 $42,927 $5,752 15.5

Average employee benefits $7,375 $9,522 $2,147 29.1

Average compensation and 

benefits

$44,550 $52,449 $7,899 17.7
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Projected Operating Results 

Have Consistently Been 

Overly Optimistic

DOD policy requires that the depot maintenance activity group operate on 

a break-even basis over time. However, from fiscal year 1994 through fiscal 

year 1998, the activity group incurred losses every year. The activity group 

did not achieve its goal of operating on a break-even basis during this 

period chiefly because it consistently developed overly optimistic 

estimates for the activity group’s net operating results. For example, the 

activity group was budgeted to earn a profit of about $200.1 million in fiscal 

year 1998.7

 However, instead of making a profit, the activity group reported 

that it lost about $35 million during the year. Figure 1 shows the activity 

group’s reported net operating results for fiscal years 1994 through 1998.

7

This budget was submitted to the Congress in February 1997.
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Figure 1: Air Force Depot Maintenance Activity Group’s Reported Actual Net 

Operating Results for Fiscal Years 1994 Through 1998

Lower Than Budgeted 

Production Levels 

Prevented Full Recovery of 

Overhead Costs

The Air Force depot maintenance activity group lost about $374 million 

from fiscal years 1994 through 1998 because its workers accomplished 

fewer DLHs of work than budgeted and because this, in turn, prevented it 

from fully recovering its overhead costs. Air Force depot maintenance 

officials stated the following.

• Overhead costs for such things as the salaries of administrative 

personnel are generally fixed costs in the year of execution and 

therefore do not vary significantly with the amount of work 

accomplished during the year.

• When prices are developed approximately 2 years in advance of actual 

work being accomplished, overhead costs are allocated on a prorated 

share to each DLH of work expected to be accomplished in the year of 

execution (i.e., in essence, each hour of work they accomplish pays for a 

certain amount of overhead costs). When workload does not 

materialize, regardless of the reason, DOD’s price stabilization policy 

($188)

($86) ($78)

($236)

($35)

($623)

($700)

($600)

($500)

($400)

($300)

($200)

($100)

$0

Dollars in millions

1994 1995 1996 1997 1998 94-98

Fiscal year
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prohibits the activity group from increasing prices to make up for the 

shortfall.

Figure 2 shows that the number of budgeted DLHs declined from 

34.4 million in fiscal year 1994 to 25.3 million in fiscal year 1998—a 

9.1 million (26 percent) DLH reduction. Even though the Air Force reduced 

the budgeted DLHs each year from fiscal year 1994 through fiscal year 

1998, our analysis showed that the amount of work actually accomplished 

during this 5 year period was still 10.1 million DLHs less than the budgeted 

amount. Figure 2 shows the budgeted and actual DLHs for the 5-year 

period.
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Figure 2: Depot Maintenance Activity Group’s Budgeted and Actual Production for 

Fiscal Years 1994 Through 1998

Activity Group Had Higher 

Than Budgeted Material 

Costs

The activity group’s reported actual material cost per DLH was 

$16.61, about 38 percent higher in fiscal year 1998 than the previous fiscal 

year. Further, as shown in figure 3: (1) in fiscal year 1998, the reported 

actual material cost per DLH was $12.40, about 26 percent higher than the 

budgeted amount and (2) although the Air Force increased the budget 

estimate for material cost per DLH by $5.96 in fiscal year 1999, the reported 

actual costs have been even higher.8

 According to Air Force officials, these 

increases were driven by a number of changes in the Air Force’s pricing 

policy for depot-level repairables in order to more accurately distribute 

costs to customers. The changes had the net effect of distributing a larger 

share of material cost to depot maintenance and a smaller share to other 

Air Force activities.

20,000

25,000

30,000

35,000

1994 1995 1996 1997 1998

Fiscal year

Budget

Actual

34,421

30,252

32,517

29,585

31,543

29,022

28,297

27,075

25,317

26,094

Hours in thousands

8

Actual fiscal year 1999 data are a straight-line projection of actual data for the first 

10 months.
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Figure 3: Air Force Depot Maintenance Activity Group’s Budgeted and Reported 

Actual Material Costs per DLH for Fiscal Years 1997 Through 1999

The higher than budgeted material cost per DLH caused the activity group’s 

fiscal year 1998 material costs to be $324 million higher than budget 

estimates.9

 However, material costs per DLH of work accomplished vary 

significantly from one workload to another, and a determination of the 

effect of these higher material costs on the activity group’s financial 

operating results would require a detailed analysis of individual workloads.

Recognizing that this is an area that needs more management attention, the 

Air Force Materiel Command is beginning to implement metrics to develop 

a better understanding of why material costs are increasing and how the 

Command can better control and reduce material costs. This is a good step 

9

Reported actual material costs were $360.8 million higher than the budgeted amount, but 

part of the difference was due to higher than budgeted production.

$30

$35

$40

$45

$50

$55

$60

$65 Per DLH

1997 1998 1999

Fiscal year

Budget

Actual

$42.57 $43.62

$47.83

$60.23

$53.79

$60.85
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toward ensuring that decisionmakers have the information they need to 

manage the activity group as a business operation. 

Anticipated Budget Savings 

Did Not Materialize

Another major contributor to the activity group’s financial losses has been 

its failure to achieve cost reduction and productivity improvement goals 

that were incorporated into budget estimates. We could not determine how 

much the activity group actually saved on individual initiatives because 

activity group managers do not track and document actual savings.10

However, a comparison of initial budget estimates for savings (which are 

used to develop prices) and revised budget estimates provides a good 

indication that the savings are not being achieved. Specifically, as shown in 

figure 4, in recent years, the initial budget estimate for savings has 

repeatedly been reduced in the revised budget estimate, which is 

developed the following year based on updated information.

10Our report, entitled Air Force Depot Maintenance: Management Changes Would Improve 

Implementation of Reform Initiatives (GAO/NSIAD-99-63, June 25, 1999), discussed that 

the Air Force does not have a system for tracking savings.
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Figure 4: Comparison of Initial and Revised Budget Estimates for the Air Force 

Depot Maintenance Activity Group’s Savings for Fiscal Years 1996 Through 1998

Contract Operations Have 

Lost Money in Recent Years

As shown in figure 5, the activity group’s contract operations reported a net 

operating loss of about $210 million during fiscal years 1994 through 1998, a 

profit of about $21 million during the first 2 fiscal years, and a loss of 

$231 million during the last 3 fiscal years.

$151

$55

$35

$241

$65

$4 $10

$79

$0

$50

$100

$150

$200

$250

$300

1996 1997 1998 96-98

Fiscal year

Dollars in millions

Original budget

Revised budget
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Figure 5: Air Force Depot Maintenance Activity Group’s Reported Actual Net 

Operating Results From Its Contract Operations for Fiscal Years 1994 Through 1998

Although figure 5 indicates that the activity group’s financial performance 

on its contract operations has declined steadily since fiscal year 1995, the 

results are distorted by a $98.8 million “accounting” loss in fiscal year 1998. 

This loss occurred because the Air Force changed its accounting policy on 

valuing inventory located at contractor plants and inventory in transit from 

the contractors to the Air Force.11 Since this loss was due to the revaluation 

of inventory and not due to actual losses resulting from operations, the Air 

Force, with Office of the Under Secretary of Defense (Comptroller) 

approval, did not recover this loss in its prices. Without this change in 

accounting policy, the reported fiscal year 1998 loss would have been 

$22.8 million rather than $121.6 million.

11Prior to 1998 (1) the activity group paid the full (standard) price for repairable items 

provided to contractors, (2) items at contractor plants were valued at standard prices, and 

(3) the activity group was credited for the carcass value (standard price less exchange 

price) when broken items were returned to supply. Under the new policy (1) the activity 

group pays the exchange price (standard price less carcass value) for items provided to 

contractors, (2) the value of items at contractor plants is based on exchange prices, and 

(3) the activity group receives no credit when contractors return broken items to supply.

$1.0

$20.1

-$36.0 -$73.3 -$121.6

-$140

-$120

-$100

-$80

-$60

-$40

-$20

$0

$20

$40 Millions of dollars

1994 1995 1996 1997 1998

Fiscal year
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Most of the activity group’s other contract losses were caused by problems 

related to the management and control of government-furnished material 

provided to contractors. For example, one air logistics center lost about 

$18.8 million on a single contract because of numerous material-related 

control problems, including (1) Air Force records showed that more 

material was shipped to a contractor than was received by the contractor 

and (2) material that was supposed to be on hand at the contractor’s 

facilities was not found.

Air Force Has Tried 

Different Methods to 

Recover Activity Group 

Losses

Over the last 5 years, the Air Force has tried four different methods to 

recover the activity group’s losses. For fiscal years 1995 and 1996, prices 

the group charged individual customers for work were increased to recover 

losses. For fiscal year 1997, rather than increase prices, the Air Force 

requested an appropriation to recover losses but the request was denied by 

the Congress. In fiscal years 1998 and 1999, the Air Force used two 

different methods to recover the activity group’s losses. First, the Air Force 

separated approved customer prices into two pieces: an amount charged 

individual customers for work performed in the current year and an 

amount used to recover $310 million in prior year losses. Under the second 

method, the activity group recovered or plans to recover $313.4 million in 

losses in the fiscal year they occurred. Air Force officials told us that the 

activity group will have about $30.5 million in accumulated operating 

losses at the end of fiscal year 1999. These losses occurred during fiscal 

year 1999 (primarily in the last quarter) and the Air Force plans to recover 

them during fiscal year 2000.

Fiscal Years 1995 and 1996 

Prices Increased to Recover 

Losses

DOD policy12 requires depot maintenance activities, as well as other 

working capital fund activities, to operate on a break-even basis over time. 

To do this, working capital funds are to establish prices that would allow 

them to recover from their customers the expected costs of operations, as 

well as any prior years’ losses. In accordance with this policy, the Air Force 

increased the activity group’s fiscal years 1995 and 1996 customer prices in 

an attempt to recover prior year losses. However, even though the prices 

were increased, the activity group reported losses of about $86 million and 

$78 million in fiscal years 1995 and 1996, respectively.

12DOD’s Financial Management Regulation, Volume 11B, Reimbursable Operations, 

Policy and Procedures—Defense Business Operations Fund, Chapter 50, page 50-2.
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Page 20 GAO/AIMD/NSIAD-00-38 Air Force Depot Maintenance

Appropriation of $194.5 

Million Requested in Fiscal 

Year 1997 to Recover Losses

Although the general practice has been to recover losses through 

increasing the prices charged customers, DOD policy also allows losses to 

occasionally be recovered by a direct appropriation. In its fiscal year 1997 

budget submission to the Congress, rather than increasing prices, the 

Air Force requested that $194.5 million be appropriated to its Operations 

and Maintenance account to specifically recover the activity group’s 

accumulated operating losses. The Operations and Maintenance funds 

were then to be transferred (called a pass through) to the activity group.

In its budget submission to the Congress, the Air Force stated that the 

requested appropriation was necessary to reduce the impact of external 

events that were beyond its control on the activity group’s prices. The 

Air Force stated that the DOD force structure reduction initiatives caused 

workforce turmoil (unexpected workload losses, skilled labor imbalances, 

and multiple job changes) that undercut budgeted productivity and 

efficiency goals. The Air Force further stated that the $194.5 million pass 

through was essential to the liquidity of its working capital fund and 

protected customers from unacceptable future price increases.

The Congress denied the Air Force’s request for the pass through. In 

reviewing the request, the House Appropriations Committee stated that 

DOD has had a policy of recovering prior year operational losses through 

adjustments (increases) in prices. The Committee further stated that it 

generally supported the policy of recovering losses through prices, and 

since DOD requested a pass through to recover losses, the Committee was 

concerned that DOD may be making a significant shift in policy. The 

Congress subsequently reduced the Air Force’s fiscal year 1997 budget 

submission by the $194.5 million requested.

Prior Year Losses Recovered 

by Separating Fiscal Years 

1998 and 1999 Prices Into 

Two Pieces

Activity group customer prices that were approved by DOD for fiscal years 

1998 and 1999 and submitted to the Congress in the Air Force’s budget 

justification books included an amount to recover $310 million in prior year 

losses. According to Air Force officials and budget documents, these losses 

were related to the closing of two depot maintenance activities 

(San Antonio and Sacramento) and force structure reductions. To ensure 

that the prior year losses were recovered, the Air Force separated the 

group’s approved prices into two pieces. The first piece was the amount or 

price the group charged customers for current year work. The second 

piece—the difference between the approved price and the actual price 

charged customers—was the amount to be used to recover the $310 million 

in prior year losses in fiscal years 1998 and 1999.
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Page 21 GAO/AIMD/NSIAD-00-38 Air Force Depot Maintenance

The funds representing the difference between the approved prices and the 

prices actually charged customers—$176 million to be recovered in fiscal 

year 1998 and $134 million to be recovered in fiscal year 1999—were 

accounted for at Air Force headquarters and have been or will be provided 

to the depot maintenance activity group. The Air Force sent project orders 

to the activity group to recover these losses. By using this method, the Air 

Force was able to help ensure that the activity group received or will 

receive the funds to recover the prior year losses.

Losses Recovered in the 

Fiscal Year They Occurred

For many years, DOD has had a policy of recovering prior year losses 

through increased customer prices for future work. Starting in fiscal year 

1998, DOD changed this policy for its depot maintenance activities. DOD 

now requires unbudgeted losses to be recovered in the year they occur by 

adding a surcharge to individual customer’s bills. An unbudgeted loss is the 

difference between a depot maintenance activity’s net operating results 

that were estimated in its budget and the actual net operating results 

experienced in the current year.

DOD changed its policy because it believed this would (1) encourage 

depots to initiate cost controls more rapidly, (2) provide the right 

incentives to set prices correctly, and (3) eliminate the routine use of 

advance billing to cover execution losses.13 This policy helps to control 

costs because it puts pressure on the Air Force to ensure that the depot 

maintenance activity group sets prices correctly. 

The Air Force followed DOD’s policy change in fiscal years 1998 and 1999, 

and as a result, its depot maintenance activity group collected or plans to 

collect $313.4 million from customers to recover unbudgeted losses during 

these 2 fiscal years—$182.6 million and $130.8 million in fiscal years 1998 

and 1999, respectively. However, rather than adding a surcharge to 

customers’ bills as required by DOD’s new policy, the Air Force used 

project orders to specifically recover the losses. Customers (major 

commands) sent project orders to the depot maintenance activity group 

which then, in turn, billed for the amount on the orders to recover the 

losses.

13Since 1993, the defense working capital funds have experienced a cash shortage and have 

had to advance bill customers for work not yet performed in order to ensure that the funds’ 

cash balances remained positive.
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Page 22 GAO/AIMD/NSIAD-00-38 Air Force Depot Maintenance

To help Air Force customers pay the activity group their portion of the 

losses related to current year work orders, the Air Force transferred 

$134.6 million in fiscal year 1998 and $80.5 million in fiscal year 1999 from 

its Procurement, Military Personnel and/or Research, Development, Test 

and Evaluation appropriations to Air Force customers’ Operations and 

Maintenance appropriation. According to Air Force officials, the remaining 

$98.3 million in unbudgeted losses was related to prior year orders, the 

work for which was performed in the current year. To pay the activity 

group for these losses, Air Force customers used prior year funds that 

financed the orders that were still available for obligation.

Conclusions Over the past 5 years, the Air Force depot maintenance activity group has 

not been able to meet its financial goal of operating on a break-even basis. 

Even though the activity group increased its prices 39 percent, the activity 

group reported losses of $623 million. These losses primarily occurred 

because the Air Force did not develop accurate estimates of its expected 

material costs, direct labor hours to be performed, and anticipated savings 

that were used in developing prices. Beginning in fiscal year 1998, the 

Air Force began recovering losses in the year that they occurred. As a 

result, the activity group will be closer to breaking even at the end of fiscal 

year 1999 than it has in the past 5 years. 

The Air Force is also beginning to implement management metrics to 

develop a better understanding of why material costs are increasing and 

how they can be better controlled. While this is a good step toward 

ensuring that decisionmakers have the information they need to manage 

the activity group as a business operation, it will be important for the group 

to also develop metrics for other key factors such as workload, overhead 

costs, and anticipated savings. Our subsequent review will assess the 

effectiveness of existing metrics and provide additional perspective on the 

need for other measures.

Agency Comments Air Force officials provided comments on previous briefings on the results 

of our work. These comments were incorporated in this report as 

appropriate. In providing oral comments on this report, Air Force officials 

agreed with our findings and conclusions.
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Page 23 GAO/AIMD/NSIAD-00-38 Air Force Depot Maintenance

We are sending copies of this report to Representative Solomon P. Ortiz, 

Ranking Minority Member, Subcommittee on Military Readiness, House 

Committee on Armed Services; Senator John Warner, Chairman, and 

Senator Carl Levin, Ranking Minority Member, Senate Committee on 

Armed Services; Senator Ted Stevens, Chairman, and Senator Daniel K. 

Inouye, Ranking Minority Member, Subcommittee on Defense, Senate 

Committee on Appropriations; and Representative Jerry Lewis, Chairman, 

and Representative John P. Murtha, Ranking Minority Member, 

Subcommittee on Defense, House Committee on Appropriations. We are 

also sending copies of this report to the Honorable William S. Cohen, 

Secretary of Defense, and the Honorable F. Whitten Peters, Secretary of the 

Air Force. Copies will also be made available to others upon request. If you 

have any questions about this report, please call Mr. Greg Pugnetti, 

Assistant Director, at (202) 512-6240. Other key contributors to this report 

are listed in appendix I.

Sincerely yours,

Jack L. Brock, Jr.

Director, Governmentwide and Defense Information Systems

Accounting and Information Management Division

David R. Warren

Director, Defense Management Issues

National Security and International Affairs Division
Page 24 GAO/AIMD/NSIAD-00-38 Air Force Depot Maintenance

Appendix I

GAO Staff Acknowledgements ApendxiI

Cristina Chaplain, Karl J. Gustafson, William A. Hill, Ron L. Tobias, and 

Eddie W. Uyekawa made key contributions to this report.

(511663 and 709418) Letr
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