Foreign Military Sales: Millions of Dollars of Nonrecurring Research and Development Costs Have Not Been Recovered (Letter Report, 10/20/98, GAO/AIMD-99-11)
Pursuant to a congressional request, GAO reviewed the Department of
Defense's (DOD) ability to account for and report on the full costs of
the foreign military sales (FMS) program, focusing on DOD's: (1)
recoupment of monies owed by FMS customers for the U.S. government's
research, development, and production costs of major defense equipment;
and (2) accountability over expenditures of FMS customers' funds. GAO
focused on Air Force and Navy activities.
GAO noted that: (1) the Air Force and Navy were not always recovering
nonrecurring research, development, and production costs from the FMS
trust fund as major defense equipment items were delivered to the FMS
customer; (2) specifically, GAO identified over $183 million of
nonrecurring costs related to items that were delivered--some as long
ago as 1989--that had not been charged to the FMS customers' trust fund
account; (3) for example, between July 1993 and November 1995, South
Korea received 48 F-16 aircraft on a FMS case managed by the Air Force;
(4) GAO's review of the case disclosed that no deliveries had been
reported for the purpose of recovering nonrecurring research,
development, and production costs; (5) had the Air Force followed DOD's
procedures and reported the deliveries and recouped the nonrecurring
costs within 30 days of physical delivery of the aircraft, it would have
already charged South Korea's trust fund account for over $49 million of
nonrecurring research, development, and production costs; and (6) Air
Force and Navy officials agreed that FMS customers were not being
properly charged for millions of dollars of nonrecurring costs for major
defense equipment items they had received and have begun to take actions
to recover the outstanding amounts.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: AIMD-99-11
TITLE: Foreign Military Sales: Millions of Dollars of Nonrecurring
Research and Development Costs Have Not Been
Recovered
DATE: 10/20/98
SUBJECT: Military aircraft
Weapons systems
Foreign military sales
Foreign military sales policies
Military cost control
Research and development costs
Trust funds
IDENTIFIER: Foreign Military Sales Program
F-16 Aircraft
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Cover
================================================================ COVER
Report to the Honorable
Charles E. Grassley,
U.S. Senate
October 1998
FOREIGN MILITARY SALES - MILLIONS
OF DOLLARS OF NONRECURRING
RESEARCH AND DEVELOPMENT COSTS
HAVE NOT BEEN RECOVERED
GAO/AIMD-99-11
FMS Nonrecurring Costs
(511640)
DOD@Department of Defense DFAS@Defense Finance and Accounting Service
DSAA@Defense Security Assistance Agency FMS@Foreign Military Sales
LOA@Letter of Offer and Acceptance
Letter
=============================================================== LETTER
B-280771
October 20, 1998
The Honorable Charles E. Grassley
United States Senate
Dear Senator Grassley:
This report responds to your request that we review the Department of
Defense's (DOD) ability to account for and report on the full costs
of the foreign military sales (FMS) program. It was agreed with your
office that we would take a two-step approach in responding to your
request. First, we agreed to evaluate DOD's recoupment of monies
owed by FMS customers for the U.S. government's research,
development, and production costs of major defense equipment.
Second, we agreed to evaluate DOD's accountability over expenditures
of FMS customers' funds. This report, which discusses the first of
these efforts, focuses on Air Force and Navy activities. As agreed
with your office, we did not review the Army-managed cases because
the U.S. Army Audit Agency is currently completing an audit of the
Army's recoupment of nonrecurring costs. We will respond to the
other segment of your request in a subsequent report.
BACKGROUND
------------------------------------------------------------ Letter :1
The Arms Export Control Act gives the President authority to sell
defense articles and services to eligible foreign countries,
generally at no cost to the U.S. government. While the Defense
Security Assistance Agency (DSAA) has overall responsibility for
administering the FMS program, the Army, Navy, and Air Force normally
execute the sales agreements--commonly referred to as sales cases.
Foreign military sales are made on an individual case basis. The
cases are initiated by a foreign country representative sending a
letter of request to DOD asking for various information, such as
precise price data. Once the customer decides to proceed with the
purchase, DOD prepares a Letter of Offer and Acceptance (LOA) stating
the terms of the sale for the goods and services being provided. The
Arms Export Control Act requires that, after September 30, 1976,
letters of offer for the sale of major defense equipment shall
include a proportionate amount of nonrecurring costs related to the
research, development, and production of major defense equipment.
DOD interpreted the act as requiring the recovery of these costs on a
pro rata basis. The military services calculate the pro rata rate by
dividing the total research and development and other one-time
production costs by the anticipated total number of units to be
produced for both domestic and foreign use. A separate charge is
calculated for each item of major defense equipment and is included
in the LOA as part of the price that FMS customers are to pay for the
purchase of major defense equipment.
After the LOA is accepted, the FMS customer is generally required to
pay, in advance, amounts necessary to cover costs associated with the
sales agreement, including any nonrecurring costs. These advance
payments are held in an FMS trust fund by the Department of the
Treasury. DOD then uses these funds to pay private contractors and
reimburse DOD activities for the costs of executing and administering
the FMS agreement.
In addition, as deliveries of major defense equipment occur, the
military services are to prepare delivery reports and related cost
statements which, among other things, are used as support to charge
FMS customers' trust fund accounts for applicable nonrecurring
research, development, and production costs. Nonrecurring costs
collected from the FMS trust funds are to be deposited into the
general fund of the Treasury. The funds are returned to the Treasury
instead of to DOD since the Congress had previously provided DOD with
appropriated funds to pay for the research, development, and
production costs of major defense equipment. If, for some reason,
DOD fails to process the charges to recover applicable nonrecurring
costs from the FMS customers' trust fund, amounts paid in advance to
reimburse the U.S. government for nonrecurring costs would
eventually be returned to the FMS customer.
As deliveries of major defense equipment are made, the military
services are to report the detailed delivery and recovery of
nonrecurring costs within 30 days to a central accounting
activity--the Defense Finance and Accounting Service (DFAS), Denver
Center--which maintains records of each country's trust fund balance
and issues quarterly statements to foreign customers summarizing
deliveries and amounts charged to their cases.
RESULTS IN BRIEF
------------------------------------------------------------ Letter :2
We found that the Air Force and Navy were not always recovering
nonrecurring research, development, and production costs from the FMS
trust fund as major defense equipment items were delivered to the FMS
customer. Specifically, we identified over $183 million of
nonrecurring costs related to items that were delivered--some as long
ago as 1989--that had not been charged to the FMS customers' trust
fund account.
For example, between July 1993 and November 1995, South Korea
received 48 F-16 aircraft on an FMS case managed by the Air Force.
Our review of the case disclosed that no deliveries had been reported
for the purpose of recovering nonrecurring research, development, and
production costs. Had the Air Force followed DOD's procedures and
reported the deliveries and recouped the nonrecurring costs within 30
days of physical delivery of the aircraft, it would have already
charged South Korea's trust fund account for over $49 million of
nonrecurring research, development, and production costs. Air Force
and Navy officials agreed that FMS customers were not being properly
charged for millions of dollars of nonrecurring costs for major
defense equipment items they had received and have begun to take
actions to recover the outstanding amounts.
OBJECTIVE, SCOPE, AND
METHODOLOGY
------------------------------------------------------------ Letter :3
The objective of this assignment was to determine if the Air Force
and Navy were correctly recovering nonrecurring research,
development, and production costs owed by FMS customers for purchases
of major defense equipment. To determine the regulatory requirements
for charging and collecting these nonrecurring costs from FMS
customers, we obtained and reviewed applicable laws, policies,
procedures, regulations, and guidance. During our visits to DOD
locations, we gathered and analyzed financial information from
pertinent accounting reports and records to identify data on reported
deliveries of major defense equipment items and related charges for
nonrecurring research, development, and production costs.
We judgmentally selected 30 FMS cases for detailed review from a
total of 93 Air Force and Navy FMS sales cases listed on their March
1998 reports entitled Recoupment of Nonrecurring Costs on Sales of
USG Products and Technology (RCS DSAA (Q) 1112). According to DOD
accounting officials, the quarterly reports are to include only
ongoing current FMS cases since all nonrecurring costs should be
recovered and transferred to the general fund of the Treasury before
a case is completed and closed. The reports generally included the
country, case, item description, quantity of items to be sold,
scheduled delivery dates, quantity of items delivered to date, amount
of nonrecurring research, development, and production costs to be
collected, and amount of nonrecurring research, development, and
production costs collected to date.
We selected the 30 FMS cases for detailed review based on whether the
unrecovered amount of nonrecurring research, development, and
production costs was large and whether the report showed, among other
things, that (1) items had been delivered to the customers, but that
there had been little or no recovery of nonrecurring costs or (2)
scheduled delivery dates were for March 1998 or earlier and no or few
deliveries had been made. The 30 FMS cases accounted for about $266
million (40 percent) of the two services' total unrecovered
nonrecurring research, development, and production costs of over $655
million. For the selected cases, we contacted the staff responsible
for managing the case or other responsible officials knowledgeable
about the case, to determine the (1) quantity of items to be
delivered, (2) quantity of items delivered to date, (3) total amount
of nonrecurring costs to be recovered, and (4) total amount of
nonrecurring costs recovered to date. We also asked the staff to
provide an explanation for why nonrecurring research, development,
and production costs that should have been recovered earlier had not
yet been recovered. The dollar values of nonrecurring research,
development, and production costs related to major defense equipment
items discussed in this report were obtained from DOD reports or
responsible program officials. We did not independently verify these
costs.
We performed our work at the headquarters, departments of the Navy
and Air Force; Defense Security Assistance Agency; Office of the
Under Secretary of Defense (Comptroller), Washington, D.C.; Naval Air
Systems Command, Patuxent River, Maryland; Naval Sea Systems Command,
Arlington, Virginia; Air Force Aeronautical Systems Center and Air
Force Security Assistance Center, Wright Patterson Air Force Base,
Dayton, Ohio; and the Defense Finance and Accounting Service centers
in Denver, Colorado, and Columbus, Ohio.
We performed our work between February 1998 and August 1998 in
accordance with generally accepted government auditing standards. We
requested written comments on a draft of this report from the
Secretary of Defense or his designee. The Under Secretary of Defense
(Comptroller) provided written comments. These comments are
discussed in the "Agency Comments and Our Evaluation" section and
throughout the report where appropriate and are reprinted in appendix
I.
ACTIVITIES NOT CHARGING
CUSTOMERS' ACCOUNTS FOR
NONRECURRING RESEARCH,
DEVELOPMENT, AND PRODUCTION
COSTS
------------------------------------------------------------ Letter :4
We found that the Air Force and Navy were not following prescribed
policies and procedures for reporting the delivery of items to FMS
customers in order to recover the nonrecurring research, development,
and production costs. As a result, FMS customers' trust fund
accounts were not being charged for millions of dollars of these
costs for major defense equipment items they had received.
FMS CUSTOMER ACCOUNTS ARE TO
BE CHARGED FOR NONRECURRING
COSTS AS ITEMS ARE DELIVERED
---------------------------------------------------------- Letter :4.1
Volume 15 of DOD's Financial Management Regulation 7000.14-R,
entitled Security Assistance Policy and Procedures, states that
"Charges for nonrecurring costs are earned as items are physically
delivered to the FMS customer." It also requires that deliveries be
reported to DFAS Denver within 30 days of shipment. While the DOD
policy is not specific about the length of time after delivery during
which an activity is to charge an FMS customer's trust fund account
for the nonrecurring costs, responsible DOD accounting officials told
us that the nonrecurring costs should be recouped as items are
delivered. According to the DOD accounting officials, DOD activities
should prepare the delivery report, recover the nonrecurring costs,
and submit both the delivery and recovery of costs data to DFAS
Denver within 30 days of shipment of the items. Therefore, DOD
policy recognizes delivery reporting as a key step toward initiating
the charges to recover nonrecurring costs from FMS customers' trust
funds.
The following describes what generally should be a typical
transaction flow to report the delivery of major defense equipment
and recovery of nonrecurring research, development, and production
costs.
-- The military service program office is generally responsible for
reporting the delivery of items as they are made. It also
prepares a cost statement, which serves as the supporting
documentation for recording earnings, and forwards these data
along with the delivery report to its budget or finance office.
-- The budget or finance office reviews the information and reports
the delivery to DFAS Denver. The budget or finance office also
attaches a letter to the cost statement requesting that the area
accounting office prepare a voucher to collect the nonrecurring
costs. The letter and cost statement are then forwarded to the
area accounting office for processing.\1
-- The area accounting office processes the transaction to charge
the FMS trust fund and transfer the amount to the general fund
of the Treasury and reports the transaction to DFAS Denver,
which records the charge against the FMS customer's trust fund
account.
--------------------
\1 At some activities, the program office may bypass the budget or
finance office and forward the documents directly to the appropriate
area accounting office. In these instances, the program office would
be responsible for reporting the delivery of items to DFAS Denver.
MILLIONS OF DOLLARS NOT
RECOVERED
---------------------------------------------------------- Letter :4.2
DOD's reports on nonrecurring costs for current sales cases show that
as of March 1998, the Air Force and Navy had over $655 million of
nonrecurring research, development, and production costs for major
defense equipment sales that had not been recovered from FMS
customers. Our analysis and discussions with program officials
concerning $266 million of this amount found that at least $183
million of the reported outstanding nonrecurring costs was related to
equipment that had been delivered, and therefore, should have already
been recovered from the FMS customers' trust fund accounts and
deposited in the general fund of the Treasury. In most cases where
nonrecurring costs had not been recovered, we found that the military
activities' program offices generally had failed to provide the
budget or finance office or appropriate accounting station with the
proper delivery or cost documentation to support the recoupment of
the nonrecurring costs. Following are several examples of FMS cases
where nonrecurring research, development, and production costs were
not recovered.
-- From July 1993 through November 1995, 48 F-16 aircraft were
delivered to South Korea. While DOD's accounting records showed
that the FMS customer's account had been charged for over $1.3
billion to pay the contractor and DOD activities for their
costs, the Air Force program office had not completed the
necessary delivery and cost reports in order to recover the U.S.
government's nonrecurring costs of $1,018,050 per aircraft. As
a result, as of May 1998, 5 years after the first aircraft had
been delivered and over 2 years after the delivery of the 48th
aircraft, nearly $49 million of nonrecurring research,
development, and production costs, which should have been
charged against South Korea's trust fund account and transferred
to the general fund of the Treasury, was still outstanding. The
program official responsible for preparing the delivery reports
could not explain why he had not reported the deliveries of the
aircraft. Air Force officials agreed that they had not prepared
the delivery reports to recoup the nonrecurring costs and told
us that, in response to our finding, they were in the process of
preparing the necessary delivery reports and cost statements in
order to recover the nearly $49 million from South Korea's trust
fund account.
-- Between April 1996 and March 1998, the Air Force reported that
it had delivered a total of 78 F-16 aircraft to Taiwan. Based
on these reported deliveries, the Air Force should have charged
Taiwan's trust fund account $49,920,000 for nonrecurring
research, development, and production costs--$640,000 for each
delivered aircraft.\2 We found, however, that while Taiwan's
trust fund account had been charged over $2.3 billion to pay the
contractor and other costs, only $1,574,366 of nonrecurring
research, development, and production costs had been charged
against the trust fund account. In discussing this case with
officials in the program and budget offices, we found that the
program office had reported the delivery of the items to the
budget office and DFAS Denver but that the delivery report did
not include the cost statement, which the budget office required
for processing nonrecurring costs charges. As a result, over
$48 million of nonrecurring costs had not been charged to
Taiwan's trust fund account and transferred to the general fund
of the Treasury. Air Force officials agreed with our finding
and told us that they have instructed the program office to
include the cost statement with the delivery report so that this
does not happen again, and that they have begun the process of
preparing the necessary cost statements for the aircraft that
have already been delivered. The officials anticipate that they
will recover the $48 million from Taiwan's trust fund account.
-- A review of the nonrecurring costs report for another Taiwan
case, this one managed by the Navy, showed that between June
1993 and February 1998, Taiwan had received 43 attack
helicopters, 53 night target systems, and 20 spare engines.
Based on these reported deliveries, the Navy should have charged
Taiwan's trust fund account for $19,819,858 of nonrecurring
research, development, and production costs. While our review
of financial records disclosed that Taiwan's trust fund account
had over $600 million recorded against it for contractor
payments and other miscellaneous charges, we found that none of
the over $19 million of nonrecurring costs had been charged to
Taiwan's account. Navy program officials responsible for
reporting the delivery of the items agreed that Taiwan's trust
fund account had not been charged for nonrecurring costs but
could not explain why this was allowed to happen. They added
that they were not aware of this problem until we brought it to
their attention. They now plan to take the necessary actions to
charge Taiwan's trust fund account for the over $19 million of
outstanding nonrecurring costs.
-- A review of the nonrecurring costs report for a Navy sale of 482
target detectors to Japan showed that all of the items had been
delivered as of 1989. However, the report showed that only
$163,398 of the $557,444 of the nonrecurring research,
development, and production costs associated with the items had
been recovered. At our request, the Navy program official
reviewed the case and told us that the original amount had been
miscalculated and should have been $376,442, not the $557,444
shown on the report. He told us that based on his new
calculations, an additional $213,044 of nonrecurring costs
should have been charged to Japan's trust fund account; but he
could not tell us why this amount had not been recovered
earlier. He told us that the Navy plans to recoup the $213,044
of outstanding nonrecurring costs from Japan's trust fund
account.
As noted earlier, our review focused only on 30 of the 93 FMS cases
that were included in the March 1998 reports, which should only
include current ongoing cases, of DOD recoupment of nonrecurring
costs of U.S. government products and technology. Over the years
DOD has routinely closed FMS cases as they were completed. In
response to our request for nonrecurring cost data on these closed
cases, DOD officials told us that a query of their FMS system's
database disclosed that over 11,000 cases, involving major defense
equipment, had been closed since 1976. However, their database did
not include information on the total amounts of nonrecurring costs
owed or collected. The officials did acknowledge, however, that
there would have been hundreds of millions of dollars of nonrecurring
research, development, and production costs associated with these
closed cases.
Because of the magnitude of nonrecurring research, development, and
production costs we identified that had not been charged to FMS
customers' trust fund accounts as a result of the services'
noncompliance with established DOD policies and procedures for
recovering these costs, some FMS cases may have been erroneously
closed before all nonrecurring costs were recovered from FMS
customers' trust fund accounts. A responsible DOD accounting
official agreed that this was a major concern and acknowledged that,
given the level of the services' noncompliance with DOD's policies
and procedures for reporting the deliveries of items and recovery of
applicable nonrecurring costs, FMS cases could have easily been
closed before all nonrecurring costs were recovered.
--------------------
\2 The F-16 aircraft sold to Taiwan was a different model than the
F-16 sold to South Korea. This resulted in different nonrecurring
costs.
CONCLUSIONS
------------------------------------------------------------ Letter :5
Not recovering nonrecurring research, development, and production
costs from the FMS trust fund promptly after major defense equipment
is delivered to the FMS customer represents a poor financial
management practice that delays the transfer of millions of dollars
into the general fund of the Treasury. Also, it raises the risk that
amounts will never be recovered and that these funds, deposited in
advance into the FMS trust fund for this purpose, will erroneously be
returned to customers. The Air Force and Navy should begin to comply
with DOD's established policies and procedures for reporting the
delivery of major defense equipment and recouping applicable
nonrecurring research, development, and production costs. This will
help ensure that all amounts of nonrecurring research, development,
and production costs associated with the sale of major defense
equipment are promptly recovered and deposited in the general fund of
the Treasury and that no FMS cases are erroneously closed before all
costs are recovered.
RECOMMENDATIONS
------------------------------------------------------------ Letter :6
We recommend the Secretary of Defense direct the Under Secretary of
Defense (Comptroller) to require the Air Force and Navy to
-- recover the over $183 million identified in this report as
nonrecurring research, development, and production costs that
have not been charged to FMS customers' trust fund accounts for
major defense equipment that has already been delivered,
-- review all the other open FMS cases that require FMS customers
to pay a proportionate amount of nonrecurring research,
development, and production costs for major defense equipment
and recoup nonrecurring costs that have not yet been recovered
for items that have already been delivered to FMS customers, and
-- follow DOD policies and procedures for reporting the delivery of
major defense equipment so that the FMS customers' accounts can
be charged with nonrecurring research, development, and
production costs and amounts transferred to the general fund of
the Treasury within the 30 days required by DOD policy.
We also recommend that the Secretary of Defense direct the Under
Secretary of Defense (Comptroller) to direct the Air Force and Navy
to review closed FMS cases to ensure that all nonrecurring research,
development, and production costs for delivered major defense
equipment have been recouped. Initially, this review of closed cases
could be limited to a specific period. For example, the review could
include FMS cases that were closed during the last 5 fiscal years.
If this review discloses that there have been FMS cases closed before
all nonrecurring research, development, and production costs were
recouped, (1) any amounts due the U.S. government should be
recovered from the FMS customer and (2) the review should be expanded
to include closed cases for additional fiscal years.
AGENCY COMMENTS AND OUR
EVALUATION
------------------------------------------------------------ Letter :7
The Under Secretary of Defense (Comptroller) agreed to instruct the
Navy and Air Force to recover all applicable nonrecurring costs we
identified as not billed to FMS customers. The Comptroller also
agreed to require the Navy and Air Force to review all other open
cases for outstanding nonrecurring costs and to instruct them to
follow DOD policies and procedures for reporting the delivery of
defense articles and the collection of applicable nonrecurring costs.
He also agreed with our recommendation that a review be conducted of
closed foreign military sales cases to determine if any cases were
closed before all nonrecurring costs were recovered. However, he
pointed out that since the Air Force and Navy retain their respective
records for the closed foreign military sales cases, it would be
appropriate that they conduct those reviews rather than the Defense
Security Assistance Agency. We have revised our recommendation
accordingly.
We are sending copies of this report to the Chairmen and Ranking
Minority Members of the Senate Committee on Armed Services, the
Senate Committee on Governmental Affairs, the House Committee on
Government Reform and Oversight, the House and Senate Committees on
Appropriations, and the House Subcommittee on Government Management,
Information and Technology; the Secretary of Defense; the Secretary
of the Navy; the Acting Secretary of the Air Force; the Director of
the Office of Management and Budget; and other interested parties.
We will make copies available to others upon request.
Please contact me at (202) 512-6240 if you or your staff have any
questions concerning this report. Major contributors to this report
are listed in appendix II.
Sincerely yours,
Jack L. Brock, Jr.
Director, Governmentwide and Defense
Information Systems Issues
(See figure in printed edition.)Appendix I
COMMENTS FROM THE DEPARTMENT OF
DEFENSE
============================================================== Letter
(See figure in printed edition.)
(See figure in printed edition.)
MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix II
ACCOUNTING AND INFORMATION
MANAGEMENT DIVISION, WASHINGTON,
D.C.
Larry W. Logsdon, Assistant Director
Harold P. Santarelli, Senior Auditor-in-Charge
Cristina Chaplain, Communications Analyst
DENVER REGIONAL OFFICE
John A. Spence, Senior Evaluator
OFFICE OF GENERAL COUNSEL
Frank Maguire, Senior Attorney
*** End of document. ***
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