oversight

Financial Management: Army Stock Fund Pricing and Refund Practices

Published by the Government Accountability Office on 1990-05-09.

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

_-_-l---l_..       l..l-l”-“..” _““_                                ITllittvI
                                   .--.- I_..^--.-.---.-..-----__.-._--_-__._ States   (;t~trt~w.l
                                                                                           ---       Awount.iIlg       Ol’l’iw
                                                                                                                   --~-----------




--..-._l-----l.---...~ ..-._.--_.   ..--..
May I!l!tO
                                                             FINANCIAL
                                                             MANAGEMENT
                                                             Army Stock Fund
                                                             Pricing and Refund
                                                             Practices


                                                                                                                                             %i




                                                                                                                                    141527




(;AO,'AVMI)-W-f;8
      .



                     United States
GAO                  General Accounting Office
                     Washington, D.C. 20648

                     Accounting and Financial
                     Management Division

                     B-238448
                     May 9,199O

                     The Honorable John P. Murtha
                     Chairman, Subcommittee on Defense
                     Committee on Appropriations
                     House of Representatives
                     Dear Mr. Chairman:

                     In an April 11, 1989, letter, you requested that we review and prepare
                     separate reports on certain Army, Navy, and DefenseLogistics Agency
                     stock fund pricing and refund practices. You made this request follow-
                     ing our April 1989 report’ to you on the Air Force stock fund, which
                     discussesthe budgetary impact of reducing the operating cash balance
                     of that stock fund. In responding to your most recent request, we
                     reviewed the operating cash balancesof the Army, Navy, and Defense
                     Logistics Agency and briefed your staff on the status of our work. This,
                     the third in our series of reports on stock fund cash balances,presents
                     information on (1) whether the Army stock fund can operate with less
                   . than an 1l-day operating cash balance, (2) how refunds made to stock
                     fund customers affected the 1l-day cash balance, and (3) how stock
                     fund customers used the refunds. Cur reports on the Navy and the
                     DefenseLogistics Agency’s stock funds will be issued separately.


Results in Brief    We found that from 1987 through 1989, the stock funds average month-
                    end operating cash balanceshave ranged from 1.3 to 9 days of cash. We
                    believe, similar to our earlier position regarding the Air Force, that the
                    Army stock fund has shown it can operate with less than 11 days of
                    cash. The Department of Defense,considering what it believes to be nor-
                    mal fluctuations in income received from customers and payments made
                    to suppliers, established an 1l-day requirement to ensure that a suffi-
                    cient amount of cash was available to pay bills from suppliers. However,
                    our analysis of the Army’s operating cash balancesfrom fiscal years
                    1986 through 1989 showed that the average fluctuation in the cash bal-
                    ancesfrom one month to the next was only 1.8 days.
                    In addition, for the past 6 years, the stock fund has refunded $736 mil-
                    lion to selectedcustomers. By making these refunds, the Army reduced
                    the operating cash level below 11 days. We were unable, just as the

                    lFinancial Management: Operating Cash Requirement for Air Force Stock Fund Can Be Reduced
                    @W--60            , April 7,lQSQ).



                    Page 1                                                    GAO/AF’MBW         Army Stock Fund
                                                                               ,



             B-233443




             Army was unable, to determine the ultimate disposition of over
             $600 million of these refunds becausethey were merged into other
             accounts.Of the remaining refunds, officials told us that about $88 mil-
             lion were used to improve readiness,support training, and purchase
             supplies in two of the Army’s nine retail divisions. In addition, an Army
             National Guard official responsible for operations and maintenance
             activities told us that $28 million of the refunds were used for clothing,
             repair parts, and equipment purchases.

             The Department of the Army stock fund provides for the financial man-
Background   agement, inventory control, and distribution of consumablesupply items
             to support Army peacetime and wartime operations. At the end of fiscal
             year 1989, the stock fund had a total reported inventory value of
             $8.9 billion and annual salesof $7.3 billion. The total assetsheld by the
             stock fund, consisting of inventory and cash, are referred to as the stock
             fund corpus.

             The stock fund operates under a revolving fund concept, whereby it
             buys and holds inventory for sale to authorized customers, such as
             activities funded by the Army’s Operation and Maintenance appropria-
             tion. Salesof stock fund inventory generate cash that is used to replen-
             ish inventory levels.

             To ensure that sufficient cash is available to pay incoming bills from
             suppliers, Department of DefenseRegulation 7420.13-Rrequires that
             the stock fund maintain a certain level of funds with Treasury. Until
             November 1989, when the House and SenateAppropriations Commit-
             tees recommendedthat this balance be reduced to 5 days, Defensehad
             used 11 days of operating cash to accommodatefluctuations in revenue
             received from customers and payments made to vendors. Such a cash
             level is achieved by adding a surcharge to the acquisition cost of inven-
             tory items when setting prices charged customers. For the Army stock
             fund, the disbursements for 1 day are currently worth about $18.4 mil-
             lion, for an 11-day total of $202.4 million.
             While the stock fund obtains most of its funds by selling inventory items
             to its customers, it also receives appropriations from the Congress.The
             congressionalcommittees indicated that these funds are intended to
             purchase war reserve material and inventory items to support weapon
             system modernization and modification. By designating funds for these
             items, the congressionalcommittees attempted to gain a degreeof



             Page 2                                        GAO/AFMD-90-63 Amy Stock Fund




                                                ,
                        budget visibility over certain stock fund purchases.These appropria-
                        tions increase the corpus of the stock fund and are available to cover
                        stock fund cash needs.For fiscal year 1989, the Army stock fund
                        received $292 million in appropriated funds.

                        The stock fund has only a single cash balance consisting of both the
                        operating and appropriated cash amounts. Therefore, when calculating
                        the fund balance that is available to cover stock fund cash needs,
                        Department of Defenseofficials can use the appropriated funds, to the
                        extent they are available, to cover temporary cash shortages in the
                        operating portion of the stock fund.

                        Basedon our April 1989 report on the Air Force stock fund, which dis-
Objectives, Scope,and   cussesthe budgetary impact of reducing the operating cash balance of
Methodology             the stock fund, you requested that we review certain Army, Navy, and
                        DefenseLogistics Agency stock fund pricing and refund practices. In
                        responding to your request, we reviewed the operating cash balancesof
                        these stock funds and briefed your staff on the status of our work. The
                        objectives of this review were to determine (1) whether the Army stock
                        fund can operate at less than an 1l-day operating cash balance, (2) how
                        refunds made to stock fund customers affected the 1l-day cash balance,
                        and (3) how stock fund customers used the refunds. Our reports on the
                        Navy and the DefenseLogistics Agency’s stock funds will be issued to
                        you separately.
                        You also asked us to provide certain information regarding the use of
                        refunds. In this report, the term “refund” describestwo kinds of pay-
                        ments: (1) payments made under various statutory transfer authorities
                        and (2) payments made to adjust the original price charged stock fund
                        users. Although different legal authorities govern these two types of
                        payments, we have used the sameterm to cover both.
                        To accomplish these objectives, we discussedwith the Office of the Sec-
                        retary of Defenseand Army officials how stock fund (1) inventory
                        prices and surcharges are determined, (2) operating cash balancesare
                        calculated, and (3) cash is returned to customers.We examined Army
                        stock fund budget documents and related accounting records. We
                        reviewed congressionalreports and legislation as well as Department of
                        Defenseand Army regulations concerning stock fund cash balancesand
                        refund policies. In addition, to determine if any material weaknesseshad




                        Page 8                                       GAO/AFMD-BME   Army Stock Fund
                                         B-238448




                                         previously been reported on Army stock fund pricing and refund prac-
                                         tices, we reviewed the Army’s Federal Managers’ Financial Integrity Act
                                         reports.
                                         Army officials could only provide us with year-end data on appropri-
                                         ated and operating cash balancesfor fiscal years 1984 and 1986 and
                                         monthly data for fiscal years 1986 through 1989. We did not verify the
                                         accuracy of the budgetary data, but we did analyze the monthly Army
                                         stock fund cash balances.We performed our work at the Office of the
                                         Secretary of Defense;Headquarters, U.S. Army; the Army Materiel Com-
                                         mand; and the Army Accounting and Finance Center. We conducted our
                                         work from June 1989 to March 1990 in accordancewith generally
                                         acceptedgovernment auditing standards.

                                         The Army stock fund has functioned with less than an 1l-day operating
Stock Fund Operated                      cash balance. Army information shows that since 1987, stock fund fiscal
at Less Than an ll-                      year-end operating balanceshave been equivalent to or less than 8.4
Day Operating Cash                       days of cash. Furthermore, our analysis of the operating cash balances
                                         from fiscal year 1986 through fiscal year 1989 showed that the average
Balance                                  month-end fluctuation was only 1.8 days. In essence,the cash balances
                                         changed,on average,no more than 2 days from one month to the next,
                                         which was less than the &day cash target recommendedby the House
                                         and SenateAppropriations Committees.


Four-Year 1balvsis
                u ---
                             of
                             --
                                the
                                ----
                                         From our analysis of Army stock fund cash, we determined that the
Stock Fund Operating                     Army’s fiscal year-end operating cash balanceshave been less than 11
                                         days since 1986. Table 1 displays the fiscal year-end balances,the aver-
Cash Balance                             age month-end balances,and the range of the operating month-end cash
                                         balancesfrom 1986 through 1989.
Table 1: Stock Fund Operatlng Cash
Balances for Fiscal Years 1988 Through   Dollars in millions
1989                                                                                                   Range of month-end
                                                               Fiscal y;~;;z;q    Average month-end         balances
                                         Fiscal Year                                        balance        Hiah        Low
                                         1986     -                      $110.3               $304.8      $659.8     $78.1
                                         1987                             102.0                108.1       151.0       57.1
                                         1988                              13.1                 24.6        92.1     (38.0)
                                         1989                             153.9                164.6       274.4      '22.4'




                                         Page 4                                            GAO/AFMD-go-88 Army Stock F’und
                                         B-228448




                                         Table 1 shows that from 1986 through 1988, the fiscal year-end and
                                         average month-end cash balancesdecreasedwhile the balances
                                         increased in 1989. To relate this information to the 1l-day requirement,
                                         table 2 provides the samedata as shown in table 1, but converts the
                                         dollar information to equivalent days. To determine the equivalent days
                                         of cash for each fiscal year, we used the Department of Defenseformula
                                         of total stock fund operating expenditures divided by 360 days. The l-
                                         day disbursement rate for fiscal years 1986 through 1989 was $18.2 mil-
                                         lion, $18.9 million, $18.4 million, and $18.4 million, respectively.
Table 2: Stock Fund Operating Cash
Balances for Fiscal Years 1986 Through                                                                     Range of month-end
1989 Converted to Equivalent Day8                            Fircal y;i;;;wt         Average month-end          balances
                                         Fiscal year                                           balance         High        Low
                                         1986                                  6.1                  16.8        36.3           4.3
                                         1987                                  5.4                   5.7         8.0           3.0
                                         1988                                  0.7                   1.3         5.0           (2.1)
                                         1989                                  8.4                   9.0        14.9            1.2


                                         Table 2 shows that in 1986, the average month-end operating cash bal-
                                         ance exceededthe 1l-day operating cash target. However, since 1986,
                                         the averagemonth-end and fiscal year-end operating cash balanceshave
                                         both been less than 11 days of cash.

                                         In our April 1989 report, we stated that the Air Force stock fund operat-
                                         ing cash balance could be substantially reduced. By reducing the cash
                                         target below 11 days, the surcharge added to the selling price of inven-
                                         tory items could be reduced, thus lowering the prices the stock fund
                                         charges its customers by a,corresponding amount. This, in turn, could
                                         result in a reduction to Defensebudget authority.
                                         Acting on our recommendation, in November 1989, the House and Sen-
                                         ate Appropriations Committees recommendedlowering the stock fund
                                         operating cash requirement from 11 days to 6 days which resulted in
                                         the Congressreducing the fiscal year 1990 Department of Defense
                                         budget by $707.2 million. Further, becausestock fund customers should
                                         theoretically be able to purchase the samequantity of items at reduced
                                         prices, the customers’ ability to perform their missions should not be
                                         adversely affected.




                                         Page 6                                               GAO/AF’MD-90-68   ARny IsltocL; Pud
                                                                                                                  ,
I


                                             B-228446




    Changesin Stock Fund                     The fluctuation in the monthly cash balancesis a key measure in analyz-
    Month-end Cash Balances                  ing the neededlevel of the stock fund cash balance. In analyzing the
                                             monthly fluctuations in the operating cash balances,we adjusted the
    Have Been Less Than 6                    operating cash balancesfor refunds. As agreed with the Office of the
    Days                                     Secretary of Defenseand Army officials, refunds need to be added back
                                             to the operating cash balancesbecausethey are not part of the normal
                                             stock fund processof income received from customers and payments
                                             made to vendors.
                                             Our analysis showed that for the 4-year period there were minor fluctu-
                                             ations or changesin operating cash balances.For example, of the 47
                                             months of data available, the average operating cash fluctuation was 1.8
                                             days. In addition, of the 47 months of data, there were 24 months in
                                             which cash increased and 23 months in which cash decreased,with only
                                             1 of these fluctuations exceeding6 days. Neither we nor Army head-
                                             quarters officials were able to determine the reason for this fluctuation.


                                             The Army has made substantial amounts of refunds from the stock fund
    Refunds Total $736                       operating cash to its customers- $736 million since fiscal year 1986.
    Million in I.&St 5 ‘Years                Table 3 shows the refunds made during the year as well as the fiscal
                                             year-end operating cash balancesafter refunds, in dollars and
                                             equivalent days.
    Table 3: Stock Fund Refund8 and Year-
    end Operating Carh Balances for Fircal   Dollars in millions
    Year8 1985 Through 1889                                                                         Operatii ,;;:h after
                                                                                 Refunds                     B
                                                                                      Equivalent                 Equivalent
                                             Fibcal year                     Amount         days    Amount             days
                                             1985                             $102.3          5.7     $596.1           33.5
                                             1986                              389.5         21.4      110.3            6.1
                                             1987                               28.9          1.5      102.0            5.4
                                             1988                               70.0          3.8       13.1            0.7
                                             1989                              145.4          7.9      153.9            8.4
                                             Total                            $730.1


                                             As table 3 shows, in 1986, after the refunds were made, the stock fund
                                             maintained 33.6 days of cash. However, in fiscal years 1986 through
                                             1989, after the refunds were made, the level of cash was reduced below
                                             11 days. In July 1989, the Office of the Secretary of Defensenotified the
                                             House and SenateCommittees on Armed Servicesand on Appropriations
                                             that it intended to transfer $196 million from stock fund operating cash


                                             Page 6                                       GAO/AFMD-9686 Army Stock F’und
                                        to the Army appropriation for Operations and Maintenance activities.
                                        On April 30,1989, the stock fund balance was $228.6 million, or 12 days
                                        of cash. This transfer would have left the stock fund with 6 days of cash
                                        at the end of fiscal year 1989. However, the House Appropriations Com-
                                        mittee, Subcommittee on Defense,opposedportions of the transfer. Con-
                                        sequently, the Army transferred a total of only $146.4 million. As a
                                        result, at the end of fiscal year 1989, the stock fund operated at about 8
                                        days of cash.
                                        The $736 million in refunds were made with various levels of congres-
                                        sional involvement and approval. These refunds were generally
                                        intended to offset budget reductions in the customers’ accounts,which
                                        allowed Army units to have more money to spend for general operating
                                        and maintenance purposes. When we attempted to determine how the
                                        $736 million in refunds were used by customers, we found that over
                                        $600 million had been merged with customers’ appropriations and,
                                        therefore, could not be traced. As a result, neither we nor the Army
                                        could determine how these refunds were ultimately used other than for
                                        the general purposes of the appropriation which received the refund.

                                        Basedon what Army customers told us, of the remaining refunds, about
                                        $88 million were used to improve readiness,support training, and
                                        purchase supplies in two of the Army’s nine retail divisions. In addition,
                                        an Army National Guard official responsible for operation and mainte-
                                        nance activities told us that $28 million of the refunds were used for
                                        clothing, repair parts, and equipment purchases.

                                        While we were not able to determine the use of all refunds, table 4
                                        shows the amount of refunds major Army stock fund customers
                                        received by fiscal year from 1986 to 1989.
Table 4: Amount of Refunds Stock Fund
Customers Received From Operating       Dollars in millions
Funds
1989 for Fircal Year8 1985 Through                                               Fiscal year
                                        Customers              1985      1886            1987          1888           1989
                                        Operation and
                                        Maintenance,
                                        Army                  $102.3    $343.3         $28.9           $70.0         $145.4
                                        Operation and
                                        Maintenance,
                                        Army Reserve               0      18.2             0               0              0
                                        Operation and
                                        Maintenance,
                                        g”r;dNational              0      28.0             0               0              0




                                        Page 7                                           GAO/AF’MD-90438 Army liltoclr Fund
              B-222448




              Over the last 6 years, the majority of Army stock fund refunds have
              been received by Operations and Maintenance, Army, with a very small
              portion distributed to other stock fund customers.Specifically, Army
              operations and maintenance activities have received about $690 million
              or 94 percent of the $736 million in refunds from operating cash in the
              last 6 years.

              Since 1987, the Army stock fund operating cash balance has been less
Conclusions   than 11 days. During 1989, the House and SenateAppropriations Com-
              mittees recommendedthat Defensechangeits policy and lower the stock
              fund operating cash requirement from 11 days to 6 days. Our analysis
              shows that a &day cash supply is adequate and, as a result, we are not
              making any recommendations at this time.

              As requested by your Office, we did not obtain written comments on a
              draft of this report. We did, however, discussits contents with pertinent
              Defenseand Army officials and have incorporated their views where
              appropriate.
              Unless you publicly announcethe contents of this report earlier, we will
              not distribute it until 30 days from its date. At that time we will send
              copies to the Secretary of Defense,the Secretary of the Army, the Direc-
              tor of the Office of Management and Budget, and other interested par-
              ties. We will also make copies available to others upon request.
              Pleasecontact me at 276-9607,if you or your staff have any questions
              concerning this report. Other major contributors to this report are listed
              in appendix I.
              Sincerely yours,




              Jeffrey C, Steinhoff
              Director, Financial Management
                Systems and Audit Oversight




              Page I3                                       GAO/AFMD-QO-68   Army Stock Fund
Page 9   GAO/AFMDMMB   Army Stock Fund
Appendix I

Major Ckmtributorsto This Report


                        Joseph Potter, Assistant Director, (202) 696-6922
Accounting and          RosaL. Ricks, Accountant-in-Charge
Financial Management    Wilma G. Raymo, Accountant
Division, Washington,
DC.




(908109)                Page 10                                     GAO/~f)O43   Army Stock Fund