oversight

Evaluation of the Management of Exchange and Motion Picture Services

Published by the Government Accountability Office on 1971-03-25.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

--' .     :
         REPORT
              - TO THE
         COMMITTEE ON APPROPRIATIONS
%, ,'-   HOUSE OF REPRESENTATIVES
                                       F   L_
                                           1.    _
                                                LS




         Evaluation Of The
         Management Of Exchange And
         Motion Picture Services .748587
         Department of Defense




         BY THE COMPTROLLER GENERAL
         OF THE UNITED STATES



                                 HARCH 25, 1 9 7 1
                     '/S'-'/FW7
.'   ;           COMPTROLLER GENERAL OF THE UNITED STATES
                            WASHINGTON, D.C.   20548




B- 148581




Dear Mr. Chairman:

      In your letter of January 26, 1970, you asked us to make a
comprehensive review and evaluation of the operation and manage-
ment of nonappropriated fund activities in the Department of Defense.
The results of our review and evaluation of the management of the ex-
change and motion picture services of the Army, Air Force, Navy, and
Marine Corps are set forth in this report.

      Although observations included in the report were discussed with
exchange and other responsible officials, we did not request written
comments from the Department of Defense. Because the report con-
tains suggestions for actions which should be taken by the Department
of Defense to improve its management of the exchange and motion pic-
ture services, you may wish to review these matters with Department
of Defense officials.

      We plan no further distribution of this report unless copies are
specifically requested, and then we shall make distribution only after
your agreement has been obtained.

                                           Sincerely yours,




                                           Comptroller General
                                           of the United States

The Honorable George H. Mahon
Chairman, Committee on Appropriations
House of Representatives



               50TH ANNIVERSARY      1921-1971
  COMPTROLLER GENERAL'S                         EVALUATION OF THE MANAGEMENT OF
 REPORT TO                                      EXCHANGE AND MOTION PICTURE
 THE ,COMMITTEE ON APPROPRIATIONS               SERVICES
 HOUSE OF REPRESENTATIVES                       Department of Defense B-148581

  DIGEST


  WHY THE REVIEW WAS MADE

         On January 26, 1970, the Chairman, Committee on Appropriations, House
         of Representatives, requested that the General Accounting Office (GAO)
         make a comprehensive review and evaluation of the operation and manage-
         ment of nonappropriated fund activities in the Department of Defense
         (DOD). This is GAO's report on its review and evaluation of the manage-
         ment of the exchange and motion picture services of the Army, Air Force,
         Navy, and Marine Corps.
         Individual reports have been submitted previously by GAO to the Commit-
         tee covering the results of GAO's inquiries into various club, morale,
         and recreational activities at selected locations in the United States,
         Europe, and the Far East.

 FINDINGS AND CONCLUSIONS

        Appropriated fund support exceeds profits distributed for morale purposes.
             --The military exchanges are established to sell consumer goods and
               services at DOD installations and to provide revenue to supplement
               appropriated funds for the support of welfare and recreation pro-
               grams. In fulfilling these two purposes, the exchanges received
               appropriated fund support of at least $140 million and provided
               dividends of about $130 million to the military departments for
               welfare and recreation programs during fiscal year 1970.
                (See p. 8.)
             --Data maintained by DOD are inadequate for identifying the full
               amount of appropriated fund support of exchanges and theaters.
               GAO believes that such identification is necessary for DOD and
               the Congress to consider the reasonableness of such support.
               (See pp. 9 and 10.)
        The exchanges lack many of the profit-oriented controls exerted in a
        commercial environment and many of the normal systemic controls exerted
        in the Government environment. (See p. 12.)
        The exchanges determine the location and type of their facilities and
        services. The resulting location and nature of exchange and recreation

Tear Sheet


                                         1            MARCH 25,1971
resources do not achieve an equitable distribution among active duty
military personnel and between active duty and retired military person-
nel. (See p. 13.)
Large loans and investment funds are handled at exchange and theater
headquarters.
  --About $100 million in cash that is not needed for current opera-
    tions is invested by the exchange systems and by the Army and Air
    Force Motion Picture Service. (See p. 15.)
  --The Army and Air Force Exchange Service has established a $65 mil-
    lion line of credit with commercial banks, which has been utilized
    many times in the last 3 years but which is currently inactive.
    (See p. 15.)
Exchanges give inadequate recognition to competition in procurement.
  --Many opportunities to utilize competition in contracting have been
    ignored by the Army and Air Force Exchange Service and by the
    Marine Corps Exchange Service. Price agreements are negotiated
    without competition and are used as the bases for certain future
    procurements by the central exchanges and by area exchange procure-
    ment offices. (See p. 18.) Contracts are negotiated, rather than
    opened for competition, even for such standard items as spark plugs,
    automobile antifreeze, paper cups, and other products. (See p. 19.)
  --None of the exchange systems maintain appropriate surveillance over
    contractors or require documentation of contractors' certifications
    in price agreements that prices do not exceed those offered to other
    customers. (See p. 18.)
  --The Marine Corps Exchange Service does not permit all qualified
    suppliers an equal opportunity to meet with exchange department
    managers and to write up orders. (See p. 19.)
Cash and other resources are inadequately controlled.
  --Control over cash at individual exchanges and theaters is not
    adequate. Cash audits are not performed as scheduled, and
    concessionaires at exchanges are rarely required to document
    their reports of sales and of cash collected. (See p. 20.)
  --Inventory shortages have been increasing annually in the Army and
    Air Force Exchange Service. (See p. 21.)
Improved auditing procedures are needed.
  --Scope of work agreements between certified public accountants and
    exchange and theater management need revision because, although
    certified statements are prepared annually, the exchanges and

                             2
             theaters do not receive the benefits that might be obtained from
             inquiries into management policies and practices and into the
             operation of internal controls. (See p. 23.)
         --The internal auditing organization of the Army and Air Force Ex-
           change Service does not, in GAO's opinion, sufficiently emphasize
           evaluating management techniques. (See p. 24.)

RECOMMENDATIONS OR SUGGESTIONS

      GAO believes that improvement in the management of the exchanges and
      theaters would result from:
         --Developing cost data by the military departments showing the value
           of appropriated fund support provided by the departments to the
           exchanges and theaters. (See p. 10.)
         --Meeting the needs of the servicemen for exchange facilities with
           a more equitable distribution among active duty personnel and be-
           tween active duty and retired personnel. (See p. 14.)
         --Obtaining maximum competition in exchange procurements and, where
           negotiation is necessary, exercising surveillance over contractors'
           pricing. (See p. 19.)
         --Giving special attention to existing requirements for controls
           over cash and inventories in the exchanges and theaters.
           (See p. 22.)
         --Developing agreements with certified public accountants for a scope
           of work emphasizing improved management controls. (See p. 25.)
         --Assigning, developing, and supervising internal audit staffs so
           that they meet the standards of professional auditing in the
           purpose, techniques, and scope of work. (See p. 25.)
      --Coordinating work of certified public accountants and internal audit
        staffs to ensure sufficiently detailed evaluations of management
        practices without unnecessary duplication of effort. (See p. 25.)

MATTERS FOR CONSIDERATION BY THE COMMITTEE

      Since DOD has not had an opportunity to prepare formal comments on the
      suggestions presented in this report, the Chairman may wish to review
      these matters with DOD officials.
      The problems in identifying appropriated fund support discussed in this
      report give additional emphasis to the need for new procedures. As sug-
      gested in our earlier reports under this assignment, the Committee may
Tear Sheet

                                      3
wish to consider directing the military departments to establish a sys-
tem for identifying the costs of all types of appropriated fund support
given to nonappropriated fund activities.
                           Contents
                                                          Page

DIGEST                                                      1

CHAPTER

      1       HOW THE MILITARY EXCHANGES AND THEATERS
              OPERATE                                       5

      2       APPROPRIATED FUND SUPPORT                     8
                  Conclusion                               10
                  Matters for consideration by the Com-
                    mittee                                 10

      3       ALLOCATION AND REPORTING OF REVENUE          11
                  Conclusion                               14

  4           INVESTMENTS AND LOANS AT EXCHANGE AND
              THEATER HEADQUARTERS                         15

      5       PROCUREMENT PRACTICES                        18
                  Conclusion                               19

      6       CONTROLS OVER CASH AND INVENTORIES           20
                  Conclusion                               22

      7       INTERNAL AND EXTERNAL AUDITS                 23
                  Conclusion                               24

      8       SCOPE OF REVIEW                              26

APPENDIX

          I   Letter dated January 26, 1970, to the
                Comptroller General from the Chairman,
                Committee on Appropriations, House of
                Representatives                            31

                            ABBREVIATIONS

GAO           General Accounting Office
DOD           Department of Defense
COMPTROLLER GENERAL'S                     EVALUATION OF THE MANAGEMENT OF
REPORT TO                                 EXCHANGE AND MOTION PICTURE
THE COMMITTEE ON APPROPRIATIONS           SERVICES
HOUSE OF REPRESENTATIVES                  Department of Defense B-148581


DIGEST

WHY THE REVIEW WAS MADE

     On January 26, 1970, the Chairman, Committee on Appropriations, House
     of Representatives, requested that the General Accounting Office (GAO)
     make a comprehensive review and evaluation of the operation and manage-
     ment of nonappropriated fund activities in the Department of Defense
     (DOD). This is GAO's report on its review and evaluation of the manage-
     ment of the exchange and motion picture services of the Army, Air Force,
     Navy, and Marine Corps.
     Individual reports have been submitted previously by GAO to the Commit-
     tee covering the results of GAO's inquiries into various club, morale,
     and recreational activities at selected locations in the United States,
     Europe, and the Far East.

FINDINGS AND CONCLUSIONS

     Appropriated fund support exceeds profits distributed for morale purposes.
       --The military exchanges are established to sell consumer goods and
         services at DOD installations and to provide revenue to supplement
         appropriated funds for the support of welfare and recreation pro-
         grams. In fulfilling these two purposes, the exchanges received
         appropriated fund support of at least $140 million and provided
         dividends of about $130 million to the military departments for
         welfare and recreation programs during fiscal year 1970.
          (See p. 8.)
       --Data maintained by DOD are inadequate for identifying the full
         amount of appropriated fund support of exchanges and theaters.
         GAO believes that such identification is necessary for DOD and
         the Congress to consider the reasonableness of such support.
         (See pp. 9 and 10.)
     The exchanges lack many of the profit-oriented controls exerted in a
     commercial environment and many of the normal systemic controls exerted
     in the Government environment. (See p. 12.)
     The exchanges determine the location and type of their facilities and
     services. The resulting location and nature of exchange and recreation



                                   1
resources do not achieve an equitable distribution among active duty
military personnel and between active duty and retired military person-
nel. (See p. 13.)
Large loans and investment funds are handled at exchange and theater
headquarters.
  --About $100 million in cash that is not needed for current opera-
    tions is invested by the exchange systems and by the Army and Air
    Force Motion Picture Service. (See p. 15.)
  --The Army and Air Force Exchange Service has established a $65 mil-
    lion line of credit with commercial banks, which has been utilized
    many times in the last 3 years but which is currently inactive.
    (See p. 15.)
Exchanges give inadequate recognition to competition in procurement.
  --Many opportunities to utilize competition in contracting have been
    ignored by the Army and Air Force Exchange Service and by the
    Marine Corps Exchange Service. Price agreements are negotiated
    without competition and are used as the bases for certain future
    procurements by the central exchanges and by area exchange procure-
    ment offices. (See p. 18.) Contracts are negotiated, rather than
    opened for competition, even for such standard items as spark plugs,
    automobile antifreeze, paper cups, and other products. (See p. 19.)
  --None of the exchange systems maintain appropriate surveillance over
    contractors or require documentation of contractors' certifications
    in price agreements that prices do not exceed those offered to other
    customers. (See p. 18.)
  --The Marine Corps Exchange Service does not permit all qualified
    suppliers an equal opportunity to meet with exchange department
    managers and to write up orders. (See p. 19.)
Cash and other resources are inadequately controlled.
  --Control over cash at individual exchanges and theaters is not
    adequate. Cash audits are not performed as scheduled, and
    concessionaires at exchanges are rarely required to document
    their reports of sales and of cash collected. (See p. 20.)
  --Inventory shortages have been increasing annually in the Army and
    Air Force Exchange Service. (See p. 21.)
Improved auditing procedures are needed.
  --Scope of work agreements between certified public accountants and
    exchange and theater management need revision because, although
    certified statements are prepared annually, the exchanges and

                             2
         theaters do not receive the benefits that might be obtained from
         inquiries into management policies and practices and into the
         operation of internal controls. (See p. 23.)
       --The internal auditing organization of the Army and Air Force Ex-
         change Service does not, in GAO's opinion, sufficiently emphasize
         evaluating management techniques. (See p. 24.)

RECOMMENDATIONS OR SUGGESTIONS

     GAO believes that improvement in the management of the exchanges and
     theaters would result from:
       --Developing cost data by the military departments showing the value
         of appropriated fund support provided by the departments to the
         exchanges and theaters. (See p. 10.)
       --Meeting the needs of the servicemen for exchange facilities with
         a more equitable distribution among active duty personnel and be-
         tween active duty and retired personnel. (See p. 14.)
       --Obtaining maximum competition in exchange procurements and, where
         negotiation is necessary, exercising surveillance over contractors'
         pricing. (See p. 19.)
       --Giving special attention to existing requirements for controls
         over cash and inventories in the exchanges and theaters.
         (See p. 22.)
       --Developing agreements with certified public accountants for a scope
         of work emphasizing improved management controls. (See p. 25.)
       --Assigning, developing, and supervising internal audit staffs so
         that they meet the standards of professional auditing in the
         purpose, techniques, and scope of work. (See p. 25.)
     --Coordinating work of certified public accountants and internal audit
       staffs to ensure sufficiently detailed evaluations of management
       practices without unnecessary duplication of effort. (See p. 25.)

MATTERS FOR CONSIDERATION BY THE COMMITTEE

     Since DOD has not had an opportunity to prepare formal comments on the
     suggestions presented in this report, the Chairman may wish to review
     these matters with DOD officials.
     The problems in identifying appropriated fund support discussed in this
     report give additional emphasis to the need for new procedures. As sug-
     gested in our earlier reports under this assignment, the Committee may


                                  3
wish to consider directing the military departments to establish a sys-
tem for identifying the costs of all types of appropriated fund support
given to nonappropriated fund activities.
                         CHAPTER 1

      HOW THE MILITARY EXCHANGES AND THEATERS OPERATE

     For many years the military services permitted sutlers
and traders to provide for servicemen's needs, other than
those supplied through congressional appropriations. To
prevent certain abuses of these operations, the services in
1889 established post canteens and later replaced them with
post exchanges. The stated purposes of these early canteens
and exchanges were to sell ordinary articles to the service-
men and to afford them a means of entertainment.

     Some earnings from the sales of the sutlers, traders,
canteens, and exchanges were used by individual commanders
for the welfare of military personnel.  Similarly, today's
exchanges and theaters generate revenue which, under proce-
dures established by each of the military services, provide
morale and recreational resources supplementing those derived
from appropriated funds for military personnel.

     Currently, the following three large-scale exchange
organizations operate within DOD, and each performs world-
wide financing, purchasing, storage, distribution, and re-
tail functions as a Government instrumentality.

     -- The Army and Air Force Exchange Service
     -- The Navy Resale System Office
     -- The Marine Corps Exchange Service

     The Army and Air Force Exchange Service is by far the
largest of the three organizations. During fiscal year
1970, that exchange service reported sales of $2 billion
and net earnings of $120 million.

     The Secretary of Defense has vested in the Secretaries
of the Army and Air Force, jointly and coequally, all func-
tions, powers and duties relating to the exchange service.
The chief of the exchange service, acting on behalf of a
14-member board of directors consisting primarily of mili-
tary personnel, administers the operations of the exchange
service from its headquarters in Dallas, Texas. Currently,
the exchange service is comprised of 130 exchanges under
12 area support centers in the continental United States,

                              5
an offshore exchange system, the Pacific Exchange System,
the European Exchange System, and the Alaskan Exchange
System.

     The Navy Resale System Office is the central office for
Navy exchanges, commissary stores, ship's stores afloat,
and exchanges of the Military Sea Transportation Service.
The responsibilities of the system office involve a complex
mixture of appropriated and nonappropriated fund support.
While each of the activities receives a degree of appro-
priated fund support, the major appropriated fund activities
are the commissary stores and ship's stores afloat.

     The major nonappropriated fund activity under the sys-
tem office is the Navy exchange which, for the year ended
February 23, 1970, reported sales of $754 million and net
earnings of $57 million. Among other activities, the Navy
exchange is responsible for the operation of enlisted men's
clubs.

     The Secretary of the Navy administers the Navy exchange
through a chain of command extending from the Chief of Naval
Operations, the Chief of Naval Material, and the Naval Sup-
ply Systems Command to the Navy Resale System Office in
New York City. A group of educators and businessmen form
an advisory committee to the,;Commanding Officer of the Navy
Resale System Office. Currently, the Navy exchange system
is composed of 169 main and supporting exchanges under the
headquarters and West Coast Branch.

     The Exchange Service Division of the Marine Corps
Quartermaster General is responsible for the general super-
vision of the Marine Corps Exchange Service but exercises
no command authority over the exchanges. The Commandant of
the Marine Corps exercises command authority over the ex-
changes directly through each installation commander to the
base exchange officer. For the year ended January 25, 1970,
the exchanges reported consolidated sales of $159 million
and net earnings of $11 million. The Corps operates a to-
tal of 27 exchanges.

THEATERS

     The Army and Air Force Motion Picture Service is a
revenue-producing, self-supporting, nonappropriated fund
                              6
activity which was established in 1920 to furnish recreation
to Army, and later Air Force, personnel through the medium
of entertainment motion pictures. For fiscal year 1969 the
motion picture service reported revenue of $29 million and
net earnings of $6 million. The motion picture service is
under the surveillance of the same board of directors as
the Army and Air Force Exchange Service.

     The Navy Motion Picture Service is operated under an
annual $5 million grant from the Central Recreation Fund
maintained by the Bureau of Naval Personnel by assessments
against Navy exchanges and other Navy nonappropriated fund
activities. The film shows on board ships and at Navy over-
seas installations are given without charge. The stateside
Navy film expenses are covered by an average charge of 25
cents for each attendee.




                             7
                            CHAPTER 2

                    APPROPRIATED FUND SUPPORT

     The exchanges in DOD received appropriated fund support
of at least $140 million and provided dividends of about
$130 million to the military departments for welfare and
recreation programs during fiscal year 1970. The appropri-
ated fund support is discussed below, and the dividends are
discussed in chapter 3.

     DOD does not maintain accounting systems that identify
the amount of appropriated fund support furnished to the ex-
changes. As a result, a proper accounting for operations
and resources is not made, in our opinion, in the nonappro-
priated fund statements of the exchanges because revenue is
shown to be generated without an adequate portrayal of the
resources applied. In addition, the statements of military
commands' use of appropriated funds do not give sufficient
disclosure of the use of appropriated fund resources.

     Exchange officials furnished us with the following es-
timates of fiscal year 1970 appropriated fund support pro-
vided to the exchanges for which they were not billed.
Other appropriated fund support had been provided to the
exchanges for which they had'reimbursed the appropriations.

                                    Army and             Marine
                            Total   Air Force    Navy     Corps

                                     (000,000 omitted)

Overseas
  transportation             $ 83       $ 76     $ 7       $-
Military pay                  25          14       8        3
Facilities rental             10           5       5        -
Utilities                       9          7       2        -
Maintenance and other
  services                      9          7       2        -
Construction                    4          2       2        -

                             $140       $111     $26       $3



                                8
     We believe that the information shown above understates
by many million dollars the amount of appropriated fund sup-
port furnished to the exchanges in fiscal year 1970, because
the management systems used by the services were inadequate
for identifying the complete amount of the types of costs
shown in that:

     -- Rates billed to the exchanges for utilities and for
        many other Government-provided stateside and overseas
        services were not sufficient to recover the Govern-
        ment's cost to furnish these services.

     -- Most of the costs of transportation of merchandise
        from one overseas area to another were not billed or
        identified as appropriated fund support to the ex-
        changes, although the exchanges are permitted free
        transportation only from stateside ports.

     -- A broad range of other types of services, such as
        management planning, inspecting, auditing, and engi-
        neering, were not billed or identified as appropriated
        fund support for the exchanges. The Navy exchange
        reimburses the Government for some, but not all, the
        Navy engineering services it receives; other exchanges
        make no reimbursement for the Government-performed
        engineering services they receive.

     The Congress has permitted the regulations of DOD com-
ponents to have the force of law in the area of nonappropri-
ated fund activities operated within DOD. DOD components
have established through various regulations that the ex-
changes may receive almost any type of appropriated fund sup-
port necessary to provide exchange opportunities to the ser-
vicemen.

THEATERS

     The Army and Air Force Motion Picture Service receives
its major appropriated fund support from the use of theater
facilities and from transportation of films between state-
side and overseas locations. Adequate data are not available
for an estimate of these costs. Over the past 4 fiscal years,
only three theaters have been built with appropriated funds.
Although existing worldwide theaters are being used, present

                              9
DOD policy is for theater construction and renovation to be
financed with nonappropriated funds. The Army and Air Force
Motion Picture Service has suspended dividend payments for
a 5-year period beginning in 1970 to provide funds to fulfill
this policy.

     The Navy Motion Picture Service operates in a manner
somewhat different than the Army and Air Force Motion Picture
Service. Although the Navy utilizes a few land-based the-
aters built with appropriated funds, most of the Navy films
are rotated among ships in a planned program for motion pic-
tures to be shown at sea as often as possible. The total
amount of appropriated fund support for the Navy Motion Pic-
ture Service is, in our opinion, negligible.

CONCLUS ION

      On the basis of presently available cost data, we con-
clude that annual appropriated fund support, as a minimum,
regularly exceeds the annual dividends paid by the exchanges
and theaters for the servicemen's welfare. Operating and
cost data showing the value of appropriated fund support
provided to the exchanges and theaters are not maintained by
the military departments or by the exchange and theater ser-
vices. We suggest that these data be developed by DOD, be-
cause we believe that such data are necessary for DOD and
the Congress to determine the reasonableness of the appro-
priated fund support provided and to consider the possible
desirability of the exchange and theater services making
full reimbursement to the military departments for such sup-
port.

MATTERS FOR CONSIDERATION BY THE COMMITTEE

     The problems in identifying appropriated fund support
discussed in this report give additional emphasis to the
need for new procedures. As suggested in our earlier re-
ports under this assignment, the Committee may wish to con-
sider directing the military departments to establish a sys-
tem for identifying the costs of all types of appropriated
fund support given to nonappropriated fund activities.




                             10
                         CHAPTER 3

            ALLOCATION AND REPORTING OF REVENUE

     The Army and Air Force exchange and the Navy exchange
use significantly different procedures to allocate and re-
port their revenues. Each of these two major exchange ser-
vices generates sufficient funds to maintain complex orga-
nizational headquarters and subheadquarters, manage
multimillion-dollar cash investment accounts, support im-
pressive programs for construction and renovation of stores
and warehouses, and provide dividends for servicemen's rec-
reational facilities. The Marine Corps exchange operation
is significantly smaller and more decentralized than the
operations of the other services.

ARMY AND AIR FORCE

     In fiscal year 1970 the Army and Air Force exchange,
after providing $26 million for depreciation, reported
earnings of $120 million and paid dividends of $85 million.
On the basis of military strength, the Army Central Welfare
Fund received $53.5 million of the dividends and the Air
Force Central Welfare Fund received $31.5 million.

     The dividends paid to the central welfare funds repre-
sented about 70 percent of the exchange earnings. The re-
maining 30 percent was retained for future improvements.
During the 7 -year fiscal period 1959-65, the exchange dis-
tributed about 94 percent of earnings, as dividends but
during the next 5 years it reduced the dividend rate to an
average 68 percent. Exchange officials said that they re-
duced the rate because:

     -- In late 1965 the exchange acquired the Navy Vietnam
        exchange system and started a growth period requiring
        a considerable amount of capital expenditures.

     -- In the absence of appropriated fund support for con-
        struction of new facilities and improvements, the ex-
        change had initiated an accelerated capital improve-
       ments program.

     -- Inflation had increased requirements for capital.
     More fundamentally, however, exchange officials have
advised us that they do not expect to return to the higher
dividend rate, because they believe that it is not good
business to distribute nearly 95 percent of earnings as
dividends.

NAVY

     In fiscal year 1970 the Navy exchange, after providing
about $6 million for depreciation, reported earnings of
$57 million and paid dividends of $39 million, as follows:

                                             Amount
                                       (000,000 omitted)

           Field installations                 $30
           Bureau of Naval Personnel             9

                                               $39

     The Navy exchange earnings distribution was similar to
that of the Army and Air Force exchange. Dividends repre-
sented about 70 percent of earnings and the remaining 30
percent was retained for future improvements and for enter-
tainment in the enlisted men!s clubs.

     During the 5-year fiscal period 1965-69, the Navy ex-
change distributed about 71 percent of earnings.

CONTROLS

     The Army and Air Force exchange and the Navy exchange
have unique responsibilities in the generation of revenue
and the allocation of resources. These exchanges lack many
of the profit-oriented controls exerted in a commercial en-
vironment and many of the normal systemic controls exerted
in the Government environment. Although the exchanges are
centrally directed within their own organizations, they are
quasi-independent of the military departments.

     The exchanges, in addition to receiving the appropri-
ated fund support discussed in chapter 2, have been granted
a virtual monopoly to a broad base of ready consumers, and

                               12
in dealings with commercial enterprises they receive bene-
fits as part of the Federal Government. In 1942 the Su-
preme Court held, in the case of Standard Oil v. Johnson,
that the exchange services are instrumentalities of the
Federal Government and thus are entitled to sovereign priv-
ileges and immunities.

     Yet the exchanges are not required to be bound by the
budgetary, supply, procurement, personnel, and other man-
agement systems that are established for other organiza-
tions in DOD. The exchanges receive advice, and often many
of the services available, from these systems, without the
usual limitations imposed by these systems.

     The exchanges determine the location and type of their
facilities and services to be established; as a result,
these facilities and services vary significantly from in-
stallation to installation. It is possible that many ser-
vicemen spend2-or 3-year tours of duty without having ready
access to the better exchange facilities. Under the Navy
system, such a situation is worsened, because each instal-
lation receives exchange dividends to apply to recreational
purposes on the basis of its local exchange profit. In
contrast, the Army and Air Force exchange profits are dis-
tributed by the respective departments to suborganizations
on the basis of military strength.

     The number of retired military personnel available in
an area to use exchange facilities strongly influences the
establishment of the more desirable types of facilities,
because the exchanges establish facilities on the basis of
expected sales.

MARINE CORPS

     In fiscal year 1970 the decentralized Marine Corps ex-
change operations, after providing about $1.8 million for
additions to capital, reported earnings of about $11.1 mil-
lion and paid dividends of $6.1 million directly to rec-
reation funds at installations.
     The Marine Corps exchange dividends represented about
54 percent of earnings, and 46 percent was retained for fu-
ture improvements.

                            13
THEATERS

      The Army and Air Force Motion Picture Service has sus-
pended dividends for the next 5 years, as noted on page 10,
and will apply the money to the theater construction pro-
gram.

CONCLUSION

     The location and nature of exchange resources do not
always achieve an equitable distribution among active duty
Army, Navy and Air Force personnel or between active duty
and retired personnel. Although we recognize that many lo-
gistical and other management problems must be faced, we
believe that priority attention should be directed to meet-
ing the needs of the active duty servicemen on a more equi-
table basis.




                            14
                        CHAPTER 4

                INVESTMENTS AND LOANS AT

           EXCHANGE AND THEATER HEADQUARTERS

     About $100 million in cash that was not directed to
current operations was invested by the exchanges and the
Army and Air Force Motion Picture Service. As of early
1970 the Army and Air Force exchange had invested about
$49.5 million of this amount, the Navy exchange had invested
about $34.2 million, the Marine Corps exchange had invested
about $4.5 million and the Army and Air Force Motion Picture
Service had invested about $11.2 million.

     During fiscal year 1970 the Army and Air Force exchange
earned about $2.9 million in interest from these investments
which consisted of U.S. government securities.

     The Army and Air Force exchange has established ac-
counts with four banks which advise the exchange by tele-
phone each morning of its currently recorded cash balance.
After the exchange considers outstanding checks, anticipated
receipts, and other items, investments of excess cash are
negotiated with the four banks and with other banks. If
required, funds are transferred between banks by wire. All
investments are made by telephone and are confirmed in writ-
ing, normally by the executive director and the comptroller
of the exchange.

     The exchange has determined that there is an average
time lag of 7 days between the date the check is written
and the date the check clears the bank. This time lag es-
tablishes a fund float which is invested by the exchange.
On the January 26, 1970, balance sheet date, cash invest-
ments not used in operations amounted to $49.5 million,
$44.7 million of which was the fund float.

     The exchange has established a $65 million line of
credit with the banks, which serves, in general, as a buffer
against overdrafts. The line of credit was used regularly
from May 1966 to January 1970 to buy the Navy Vietnam ex-
change system, to establish an inventory in Southeast Asia,
and to fill the merchandise pipeline. The maximum amount
                             15
payable against this line of credit was $57 million on De-
cember 1, 1967. The line of credit currently is not being
used.

     Included in this financial structure was a series of
loans from the Army and Air Force Motion Picture Service,
Since 1966 the exchange has borrowed about $34 million from
the motion picture service with the largest balance payable
being $7 million. Since May 1966 the exchange has paid ac-
cumulated interest of $4.7 million on all of its loans, of
which $892,000 was paid to the motion picture service.

     Although the Board of Directors of the Army and Air
Force Exchange Service has sufficient authority to authorize
the exchange to borrow money, these loans, in our opinion,
have not been and must not be on the credit of the United
States.

PURCHASE OF NAVY VIETNAM EXCHANGE

     Since the majority of the U.S. personnel increases in
Vietnam were in the Army and the Air Force, DOD designated
that the Army and Air Force exchange provide all exchange
services in that country. In December 1965 the Army and
Air Force exchange paid $18.6 million to the U.S. Navy
Ship's Stores Office, a nonappropriated fund activity, for
the Navy's Vietnam exchange merchandise and equipment.

     Also, the Army and Air Force exchange paid $18 million
to the Navy Commissary, an appropriated fund activity, for
its exchange-type merchandise located on Saigon wharves, in
warehouses, and in the Navy pipeline. Under the Navy sys-
tem all exchange merchandise is purchased and stored by the
commissary until sold to the exchange.

OTHER INVESTMENTS

     At February 23, 1970, the Navy exchange's investments,
other than for self-insurance and certain reserves,
amounted to $34.2 million in bank notes, Federal intermedi-
ate credit bank debentures, and bankers' acceptance notes.
Investment transactions, which are made at frequent inter-
vals, are executed by the bank as directed by an official
of the Controller's Division of the Navy--Resale System
Office.
                              16
     At January 25, 1970, the Marine Corps Exchange Fund in-
vestments amounted to about $4.5 million in U.S. securities
and in savings accounts.

     At March 31, 1970, the Army and Air Force Motion Pic-
ture Service investments amounted to $11.2 million in U.S.
securities and in bank certificates.




                            17
                         CHAPTER 5

                   PROCUREMENT PRACTICES

     During a limited review of procurement practices of the
exchanges, we encountered many instances where the Army and
Air Force exchange and the Marine Corps exchange had ignored
opportunities to utilize competition in contracting for mer-
chandise. In addition, we believe that neither the Army and
Air Force, nor the Navy, nor the Marine Corps exchanges
maintained appropriate surveillance over contractors' pric-
ing and related contract terms.

     On June 30, 1970, the Army and Air Force exchange had
about 1,700 active price agreements which were negotiated
with selected vendors by the exchange without competition.
Stateside Area Support Centers for the exchange determine
the requirements of the individual exchanges under their ju-
risdictions and issue purchase orders against the price
agreements listed in Price Agreement Bulletins. In certain
circumstances purchase orders are also issued by the head-
quarters against these price agreements.

     Vendors were required to certify in the price agree-
ments that the prices and terms offered to the exchange were
as favorable as those offered to other customers. Exchange
officials advised us, however, that they had never requested
access to the vendors' customer files or seen documentation
to support the certification. The exchange attempted to de-
termine the reasonableness of the certification by comparing
the certified prices with those offered to other Government
agencies and with those shown on manufacturers' price lists.

     When we visited the Army and Air Force exchange's Alamo
Area Support Center in Texas, we learned that more advanta-
geous prices could be obtained than those in the price agree-
ments. The procurement staff at the center negotiated with
the vendors and obtained better terms than those in the
price agreements. The discounts ranged up to 6 percent of
the prices.

     Elsewhere we observed contracts for delivery at the
price agreement terms. Although we would like to see the

                             18
maximum application of renegotiation of price agreements
with vendors, we believe that purely competitive procurement
would better serve the Government's interest, especially for
items such as spark plugs, automobile antifreeze, paper cups,
and other products now purchased by negotiation, although
brand is not a significant factor.

MARINE CORPS

     In its decentralized operations the Marine Corps ex-
change has not provided procedures adequate for permitting
all qualified suppliers equal sales opportunities. At Camp
Lejeune, North Carolina, a select group of suppliers had the
privilege of visiting exchange sales locations, talking to
department managers, and writing up orders for approval by
the purchasing department. The remainder of the suppliers
were required to present their goods to the purchasing de-
partment for consideration and, if purchases were to be made,
the department prepared purchase orders for the desired
goods.

     Also, the purchasing department had awarded a major
contract for renting television sets to military personnel
without obtaining competitive bids.

CONCLUSION

     Although we have performed a limited review of purchas-
ing procedures, it is evident that the exchange systems do
not provide for sufficient competition in contracting or for
adequate surveillance over contractors' negotiated pricing.
We suggest that maximum competition in procurement be ob-
tained and that, where negotiation is necessary, surveillance
over contractors' pricing be exercised.




                             19
                         CHAPTER 6

            CONTROLS OVER CASH AND INVENTORIES

     In many instances the controls exercised over cash and
inventories by individual exchanges and theaters were inef-
fective.

      From our observations and from the reports of the Army
and Air Force exchange internal auditors, unsatisfactory
cash controls have existed in various stateside and Far East
exchanges. Typical violations of prescribed procedures
were:

     -- Cash shortages at individual exchanges exceeded
        $3,000.

     -- Receipts for petty cash or working funds were not
        obtained.

     -- Petty cash was reimbursed prior to approval of
        vouchers.

     -- Cash receipts were not deposited promptly.

     -- Expenditures of petty cash exceeded authorized
        amounts.

     -- Unannounced cash counts were not performed as pre-
        scribed.

     -- Contrary to the provisions of concessionaire con-
        tracts, operations of concessionaires were not au-
        dited periodically to verify commissions received by
        the exchanges.

     The controls over cash in the Navy exchange had been
clearly improved as a result of a November 1968 report is-
sued by a certified public accounting firm on a special
study of cash systems in the Navy exchange. The report con-
tained numerous recommendations applicable to the individ-
ual exchanges and to the Navy exchange headquarters. The



                            20
exchange had initiated corrective action on all the recom-
mendations, except those dealing with weak controls over
cash received by mail and over dishonored checks.

     The Marine Corps exchange exercised controls over cash
that, in general, were satisfactory, except for vending
machine receipts. We noted that the only machines which
had coin counters were those serving coffee and soft drinks
in cups. Inasmuch as the remainder of the machines lacked
counters, we believe that the exchange should arrange for
its employees to be present whenever contractors' staffs
collect money from these machines.

     In our review of the Army and Air Force Motion Picture
Service in Europe, we noted that the service reports had
overstated cash and understated expenses. Part of the prob-
lem was the delay in forwarding data from the individual
theaters and part was the improper reporting of cash by cer-
tain theaters brought on by discrepancies in ticket controls.

INVENTORY

     Each of the exchange services provides for complete
annual inventories of its stock and for investigations of
significant shortages. The largest shortages, as well as
an unfavorable trend of increasing shortages, have been ex-
perienced by the Army and Air Force exchange, as shown be-
low.

               Exchange Inventory Shortage

                      Navy               Army and Air Force
Fiscal        Amount         Percent      Amount     Percent
 year       (millions)       of sales   (millions)   of sales

 1968          $4.2            0.67       $17.8        1.15
 1969          $5.6            0.80       $22.3        1.38
 1970          $5.3            0.70       $25.6        1.47

     Although the Marine Corps exchange has experienced
significantly smaller shortages than those shown above, it
does not have storage and distribution facilities comparable
to those of the other exchange services and often uses the
other services' facilities.

                                21
     We reviewed shortage investigation reports of the Army
and Air Force exchange and found that they generally were
inconclusive and showed no evidence of gross negligence,
fraud, dishonesty, or willful misconduct on the part of em-
ployees. Exchange officials are placing new emphasis on
warehouse controls and on shortage investigations by a newly
established special staff from the exchange headquarters.

CONCLUSION

     The deficiencies in controls over cash and inventories
described in this chapter represent violations of the ex-
change and theater manuals and regulations of the military
departments. Thus we suggest that special attention be
given by the three exchange systems and by the Army and Air
Force Motion Picture Service to ensure that existing re-
quirements are met. The steps initiated by the Army and
Air Force exchange to reduce inventory shortages appear
necessary and appropriate.




                            22
                         CHAPTER 7

               INTERNAL AND EXTERNAL AUDITS

     The three military exchange systems are audited regu-
larly by internal auditors and are audited annually by
firms of independent certified public accountants. In ad-
dition, inspection teams representing various military
headquarters' offices regularly perform audits of selected
exchange operations.

     The Army and Air Force Motion Picture Service is au-
dited annually by a firm of independent certified public
accountants and by a joint Army and Air Force Inspector
General Team.

     Despite this audit coverage we believe that improvements
in the auditing work are necessary to improve the internal
controls over the exchanges and theaters.

     A change in the type of work performed by certified
public accountants for the exchanges would, in our opinion,
be beneficial. Although certified statements are prepared
annually, the exchange and theater systems place insuffi-
cient emphasis on inquiries into management policies and
controls. The brief letters commenting on internal con-
trols provided by the certified public accountants, to-
gether with certified statements, generally include only
limited references to the improvements possible in the com-
plex procedures that implement management policies.

     On the other hand a special study into a limited area
by one of these firms can prove very worthwhile. For ex-
ample, the Navy exchange engaged a firm of certified public
accountants to perform a special study of the exchange's
cash receipts and sales recording systems as discussed on
page 20. The report from the firm resulted in the numerous
improvements in the Navy exchange procedures which were
evident during our review.

     The exchange and theater services should emphasize not
only annual certifications but also special studies of con-
trols when they are needed. The time for establishing the


                            23
priority of work, in our opinion, is before and during the
initial agreement discussions with the certified public
accountants.

INTERNAL AUDITING

     The Navy exchange is audited by the Naval Audit Ser-
vice, which is the central internal auditing organization
for the Navy. In contrast, the Army and Air Force exchange
and the Marine Corps exchange have established internal
audit staffs within their own organizations. Although we
noted no basic reason for favoring the use of a central
audit staff or a separate exchange internal audit staff, we
noted several significant weaknesses in the policies for
the use of separate internal audit staff.

     -- Internal audit work in the Army and Air Force ex-
        change has been limited to reviews of operations
        without evaluating policies and other management
        actions. The audit working papers have been pre-
        pared cursorily on an exception basis and have not
        clearly established the scope of work performed.

     -- The Marine Corps exchange established its own inter-
        nal audit staff in January 1968 but authorized in-
        sufficient staff. The audit responsibilities for
        the exchanges are divided among three area audit of-
        fices under the control of the chief auditor at Ma-
        rine Corps headquarters. There are only 10 auditors
        authorized to staff these offices and to conduct
        semiannual audits of the central exchange fund and
        the 27 exchanges. As a result the scope or work, in
        our opinion, is too severely reduced to provide the
        minimum coverage needed. The accuracy of individual
        exchange financial statements often has not been
        verified, and exchange officials and base commanders
        at times have refused to follow the recommendations
        of the auditors on grounds, basically, that the rec-
        ommendations were not adequately supported.
CONCLUSION
     Auditing is an important part of the internal control
over exchange and theater operations and resources. We



                             24
suggest that the reports by certified public accountants on
audits of exchanges and theaters could be of far greater
usefulness if better agreements were developed with the ac-
counting firms on the scope of work to be performed. Far
greater emphasis should be placed on improving the policies,
procedures, and practices of internal control.

     We suggest that internal audit staffs be assigned, de-
veloped, and supervised in such a manner that the staffs
meet the standards of professional auditing in the purpose,
techniques, and reporting of their work. The work of the
internal audit staffs should be coordinated with that of
the public accountants to ensure sufficiently detailed
evaluations of management practices without unnecessary du-
plication of effort.




                            25
                          CHAPTER 8

                       SCOPE OF REVIEW

     Our review was conducted at the headquarters of the
Army, Navy, Air Force, Marine Corps, Army and Air Force Ex-
change Service, Marine Corps Exchange Service, and Army and
Air Force Motion Picture Service and at the Navy Resale Sys-
tem Office. We reviewed exchange management, storage, dis-
tribution, and retailing operations at the following sites.

ARMY AND AIR FORCE EXCHANGE SERVICE

     Headquarters, Pacific Exchange System, Hawaii
     Headquarters, European Exchange Service, Munich, Ger-
       many
     Alamo Area Support Center, Texas
     Clark Air Base, Philippines
     Fort Lewis, Washington
     Lackland Air Force Base, Texas
     Ramstein Air Base, Germany
     Retail Outlet, Frankfurt, Germany

NAVY EXCHANGE SYSTEM

     Newport Naval Station, Rhode Island
     Rota Naval Station, Spain
     Subic Bay Naval Station, Philippines

MARINE CORPS EXCHANGE SERVICE

     Camp Lejeune, North Carolina

ARMY AND AIR FORCE MOTION PICTURE SERVICE

    Headquarters, Europe, Mainz-Kastel, Germany
    Selected theaters




                                26
     Our review was directed primarily toward the evaluation
of systems of internal control and audit and the identifica-
tion of management policies and practices for controlling
appropriated and nonappropriated fund expenditures on be-
half of the exchanges. We also traced the distribution of
exchange revenues and profits.

     All these matters and related management considera-
tions were discussed with exchange officials at various
echelons and with administrative military officials.




                             27
APPENDIX




   29
I
                                                                                  APPENDIX I
                                                                                      Page 1


                                                                                          MINORITY MEMOS
    MAJORITY MEMBERS                                                                   FrANK T. mO10
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          B.    COL.
DAVID R. OMEY,WIS.




                      Honorable Elmer B. Staats
                      Comptroller General of the United States
                      General Accounting Office
                      Washington, D. C. 20548

                      Dear Mr. Staats:

                           The Committee is concerned with the management and
                      operation of non-appropriated fund activities operated by the
                      Department of Defense. In reporting the Department of
                      Defense and Military Construction Appropriation Bills for
                      1970, the Committee voiced its concern with the policies and
                      practices of the military services for the reporting and
                      use of non-appropriated funds. The Committee is also interested
                      in the support furnished non-appropriated fund activities from
                      appropriated funds and in whether these activities are being
                      properly managed to insure that there is no waste or other
                      inappropriate use of such funds.

                           Accordingly, the Committee requests that the General
                      Accounting Office make a comprehensive review and evaluation
                      of the operation and management of non-appropriated 'fund
                      activities. The review should include an investigation of the
                      services' operating practices, procedures and management
                      controls.

                            The Committee would appreciate a complete report as soon
                       as possible. However, in view of the various types of non-
                       appropriated activities and the extensive operations of the
                       larger ones, individual reports may be submitted as the work




                                                            31
APPENDIX I
    Page 2



    on each type of activity selected is    cQmpleted.

          The review should include, but not necessarily be limited
    to:

          1.   The extent to which various types of non-appropriated
               fund activities rely on support from appropriated
               funds, including such areas as personnel, facilities,
               transportation, and supply. The information obtained
               should be used as the basis for further detailed
               studies into selected areas to determine whether
               such support is necessary and should be more
               closely delineated in budget requests.

          2.   The procedures, guidelines, and controls established
               by each of the military services and the Department
               of Defense to insure that the collection of funds
               from various non-appropriated fund activities and
               the reallocation of these funds are in the best
               interest of the military personnel involved.

          3.   The adequacy of procurement practices and policies
               for the acquisition of facilities, materials, goods,
               and services.

          4.   The custody and control of all assets including
               facilities.

          5.   The control of the sale, donation, award, or other
               distribution of materials, goods, services, assistance,
               or other property acquired with non-appropriated
               funds.

          6.   The reporting of financial results of operations of
               non-appropriated fund activities to various levels
               of command in each of the military departments.




                                                   aU.S.                     GA Wa




                                                                         U.S. GAO Wash.. D.C3


                                           32