oversight

Foreign Military Sales: Navy's Accounting for Sales to Foreign Customers Needs Improvement

Published by the Government Accountability Office on 1999-08-24.

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

                  United States General Accounting Office

GAO               Report to the Honorable
                  Charles E. Grassley,
                  U.S. Senate


August 1999
                  FOREIGN MILITARY
                  SALES

                  Navy’s Accounting for
                  Sales to Foreign
                  Customers Needs
                  Improvement




GAO/AIMD-99-213
United States General Accounting Office                                                              Accounting and Information
Washington, D.C. 20548                                                                                    Management Division



                                    B-281171                                                                                          Letter

                                    August 24, 1999

                                    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) accounting for and reporting on the costs of the foreign
                                    military sales (FMS) program.1 The report focuses specifically on whether
                                    the Navy has properly charged its FMS customers for goods and services
                                    already provided. As of September 30, 1998, Navy’s open FMS sales cases
                                    totaled a reported $60.1 billion. Of this amount, the Navy reported that it
                                    had $25 billion of undelivered orders representing goods and services that
                                    had not yet been delivered to FMS customers. As agreed with your office,
                                    we will subsequently review and report on whether the Army and Air Force
                                    are properly charging FMS customers for goods and services already
                                    provided.



Results in Brief                    The Navy did not always (1) charge FMS customer trust fund accounts
                                    when goods and services were delivered under the FMS program or
                                    (2) maintain accurate and reliable information on trust fund charges. As of
                                    October 1998, Navy’s FMS accounting records indicated that it had not
                                    charged FMS customer trust fund accounts for $582 million of delivered
                                    goods and services. According to our review of $75 million of this amount,
                                    FMS customer accounts had not been charged for $11.3 million for goods
                                    and services provided between April 1987 and December 1997.2

                                    For example, in 1996, the Navy provided support services valued at
                                    $1.1 million for Canada’s Navy Patrol Frigate Harpoon Shipboard
                                    Command and Launch System. Instead of charging Canada’s trust fund


                                    1
                                     In response to this request, we have also issued two reports that identified a total of over $335 million
                                    of nonrecurring research, development, and production costs for major defense equipment that had not
                                    been charged to FMS customer trust fund accounts. See Foreign Military Sales: Millions of Dollars of
                                    Nonrecurring Research and Development Costs Have Not Been Recovered (GAO/AIMD-99-11, October
                                    20, 1998) and Foreign Military Sales: Recovery of Nonrecurring Research, Development, and
                                    Production Costs (GAO/AIMD-99-148R, May 19, 1999).
                                    2
                                     The Navy’s accounting system inaccurately reported this amount as $12.9 million.




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        B-281171




        account for the $1.1 million, the Navy incorrectly charged (1) $636,123 to
        its appropriations and (2) $450,882 to the trust fund accounts of Greece and
        Japan. Further, although the remaining $18,507 was charged to Canada’s
        account, it was recorded incorrectly in the Navy’s system. Navy officials
        agreed with our findings and told us that they plan to correct the erroneous
        charges to the Greece and Japan accounts and will also charge Canada’s
        account in order to reimburse the Navy appropriation for the $636,123.

        For the remaining $62 million of balances in our sample, we found that the
        Navy’s accounting records included inaccurate data on the status of
        charges to FMS customer trust fund accounts, making it difficult for Navy
        managers to accurately account for and report on the FMS program. For
        example, Navy’s accounting records showed that Kuwait’s trust fund
        account had not been charged $54 million for three F-18 aircraft it received
        in 1993. However, we found that Kuwait’s trust fund account had, in fact,
        been charged for the full amount and that the Navy’s accounting system did
        not reflect the charges because erroneous data had been entered in the
        system.

        We are recommending that the Navy (1) recover the amounts we identified
        as owed by FMS customers and (2) correct errors in its accounting system.
        We are also recommending that the Navy work with the DOD Comptroller
        to develop and implement a plan to review the remaining $507 million of
        transactions recorded in the Navy’s system that were reportedly not
        charged to foreign customer trust fund accounts and (1) charge FMS
        customer accounts for goods and services already provided, (2) correct
        erroneous transactions, and (3) address the problems causing these errors
        to occur.

        In commenting on a draft of our report, the Defense Deputy Chief Financial
        Officer generally concurred with our findings and recommendations. He
        stated that the Navy and the Defense Finance and Accounting Service
        (DFAS) have taken significant steps in correcting the situation we
        identified. For example, he pointed out that they have taken steps to
        properly charge the FMS trust fund accounts for $8.8 million of the
        $11.3 million identified in this report as not properly charged to FMS
        customer accounts. He said that the processing of the remaining
        $2.5 million will be completed by October 1999. He also described several
        other current or planned initiatives that will result in the implementation of
        our recommendations.




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Background              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 Cooperation Agency (DSCA)
                        has overall responsibility for administering the FMS program, the Army,
                        Navy, and Air Force generally execute the sales agreements, which are
                        commonly referred to as sales cases.

                        Foreign military sales are made on an individual case basis. A foreign
                        country representative initiates a case by sending a letter of request to DOD
                        asking for information such as the price and availability of goods and
                        services, training, technical assistance, and follow-on support. 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 items and
                        services being provided. After the LOA is accepted, the FMS customer is
                        generally required to pay, in advance, amounts necessary to cover costs
                        associated with the services or items purchased from DOD. The
                        Department of the Treasury holds these advance payments in an FMS trust
                        fund. DOD then uses these funds to pay private contractors--commonly
                        referred to as direct cite payment transactions--and/or reimburse DOD
                        activities for the costs of goods and services provided and other costs
                        related to executing and administering the FMS sales agreement,
                        commonly referred to as reimbursable payment transactions. If for some
                        reason DOD fails to process the appropriate charges against the FMS trust
                        fund accounts, amounts FMS customers paid in advance to cover the costs
                        of goods and services could eventually be returned to them.



Objective, Scope, and   The objective of this review was to determine whether the Navy was
                        charging FMS customer trust fund accounts for goods and services already
Methodology             provided. To determine the requirements and procedures for charging the
                        FMS trust fund for goods and services, we obtained and reviewed
                        applicable laws, regulations, policies, and procedures. During our visits to
                        DOD locations, we gathered and analyzed financial information from
                        pertinent accounting records and reports to identify data on deliveries of
                        goods and services and related charges to the FMS trust fund accounts.

                        To select transactions for detailed review, we obtained a database from the
                        Navy’s Management Information System International Logistics (MISIL)
                        which included 25,993 delivery transactions totaling $582 million for which
                        there were no corresponding charges to the FMS customer trust fund
                        accounts to show that the customers had been charged for the goods and



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services provided. Our analysis showed that there were 14,173
reimbursable and 11,820 direct cite transactions totaling $71,092,232 and
$510,837,316, respectively.3 We judgmentally selected 20 of the 25,993
transactions for detailed review based primarily on (1) large dollar
amounts and (2) the type of financing involved to ensure that both
reimbursable and direct cite transactions were included. We did not
independently verify the integrity of the MISIL database. The 20
transactions are listed in appendix I.

To determine whether an FMS customer had received the goods and
services and its trust fund account had been charged, we contacted the
staff responsible for managing the FMS case and/or other officials
knowledgeable about the case to identify the (1) number, type, and value of
goods and services the FMS customer received, (2) date the FMS customer
received the goods or services, and (3) amount that the FMS customer’s
trust fund account had been charged for the goods and services. We also
asked the officials to independently calculate how much the FMS customer
should have been charged, compared it with our calculated amounts, and
resolved any differences. In those instances where it was determined that
the FMS customer’s trust fund account had not been charged, we asked
responsible FMS program officials to provide an explanation.

We performed our work at and obtained documents from headquarters of
the Defense Security Cooperation Agency, Office of the Under Secretary of
Defense (Comptroller), and the Naval Sea Systems Command, Arlington,
Virginia; Naval Air Systems Command, Patuxent River, Maryland; Naval
Inventory Control Point, Philadelphia, Pennsylvania; Naval Ordnance
Command, Indian Head, Maryland; and Defense Finance and Accounting
Service locations in Denver, Colorado; Columbus and Cleveland, Ohio; and
Charleston, South Carolina. We performed our work between September
1998 and June 1999 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 Deputy Chief Financial Officer provided



3
 Under the reimbursable method, the Navy uses its own appropriation to initially purchase the goods or
services being provided. Upon sale to an FMS customer, the FMS customer’s trust fund account is
charged for the value of the goods and services and the Navy appropriation is reimbursed. Conversely,
under the direct cite method, reimbursement is not required because the FMS customer’s trust fund
account is used as the source of funding to pay the vendor who provided the goods and services.




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                         B-281171




                         written comments, which are discussed in the “Agency Comments and Our
                         Evaluation” section and are reprinted in appendix II.



The Navy Has             The Navy did not always promptly charge foreign customer trust fund
                         accounts when goods and services were delivered under the FMS program.
Experienced Problems     In addition, the Navy’s accounting system contained inaccurate data on the
in Accounting for and    status of charges to the FMS customer trust fund accounts, making it
                         difficult for Navy managers to monitor the status of the FMS program. As
Charging FMS             of October 1998, the Navy’s MISIL accounting records indicated that FMS
Customers for Goods      customer trust fund accounts had not been charged for goods and services
and Services             amounting to $582 million—79 percent of which had been reported as
                         delivered over 3 years ago. Table 1 provides additional details.



                         Table 1: Aging Schedule for Delivered Goods and Services Reportedly Not Charged
                         to FMS Customer Trust Fund Accounts
                                                                                                        Number of
                         Time period                                   Delivered dollar amount        transactions
                         Up to 1 year                                                $56,761,184           12,832
                         1 to 2 years                                                 31,812,557             1,865
                         2 to 3 years                                                 32,360,014             2,787
                         More than 3 years                                           460,995,793             8,509
                         Total                                                     $581,929,548            25,993
                         Source: Navy’s MISIL accounting records data as of October 1998.




FMS Customer Accounts    Volume 15 of DOD’s Financial Management Regulation 7000.14-R, entitled
Are to Be Charged Upon   Security Assistance Policy and Procedures, states that implementing
                         agencies shall report accrued expenditures and physical deliveries to the
Receipt of Goods or
                         DFAS Denver Center within 30 days of date of shipment or performance.
Services                 The regulation also requires the Center to charge the FMS customer’s trust
                         fund account within 20 days after receiving notification that the goods or
                         services have been delivered. The following describes what generally
                         should be a typical transaction flow to report the delivery of items and
                         services and to charge FMS customer trust fund accounts.

                         Navy program and logistical offices responsible for managing and reporting
                         on the delivery of items and services generally receive shipping documents




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                            from those activities providing the items and services to FMS customers.4
                            As expenditures against the trust fund accounts are accrued and the goods
                            and services are delivered, this information is to be recorded in MISIL.
                            MISIL then transmits the expenditure and delivery information to the DFAS
                            Denver Center, which maintains the records on each country’s trust fund
                            balance and issues quarterly statements to FMS customers summarizing
                            amounts charged to their cases. If the goods and services were paid for
                            using the reimbursable method, the Center will process vouchers charging
                            the FMS customer’s trust fund account and reimbursing the Navy’s
                            appropriation account. If the goods and services were paid for using the
                            direct cite method, which does not require a reimbursement, the Center
                            only has to record the charges against the appropriate FMS customer’s
                            trust fund account.


Charges Are Not Processed   Navy did not always promptly charge FMS customers for goods and
Promptly                    services already provided. We found that FMS customer trust fund
                            accounts had not been charged $11.3 million for the goods and services
                            provided under all 14 of the reimbursable-type transactions in our sample
                            and for 1 of the 6 direct cite transactions. The following are examples of
                            transactions where FMS customer trust fund accounts had not been
                            charged for the goods and services already provided.

                            Navy reported that one of its inventory stock points shipped a total of
                            280,000 rounds of 20 millimeter ammunition to Canada in 1997. Since this
                            was a reimbursable transaction, Canada’s trust fund account should have
                            been charged $3,393,600 for the costs of the ammunition and the Navy’s
                            appropriation account should have been reimbursed for the same amount.
                            However, our review disclosed that Canada’s trust fund account had not
                            been charged for these items as of February 1999. While Navy program
                            officials agreed with our finding, they could not explain why Canada’s trust
                            fund account had not been charged. They added that they were not aware
                            of the problem until we brought it to their attention and now plan to take
                            the necessary actions to charge Canada’s trust fund account for the amount
                            owed.

                            Navy’s MISIL system indicated that seven helicopters from Navy’s
                            inventory of excess defense articles had been shipped to New Zealand


                            4
                            Activities providing items and services can consist of Army, Navy, and Air Force locations, or other
                            DOD locations, as well as private sector contractors doing business in the FMS program.




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between January 1997 and December 1997. Our review of these seven
reimbursable transactions disclosed that the Navy should have charged
New Zealand’s trust fund account a total of $4,184,733, or $597,819 for each
helicopter. We found, however, that New Zealand’s trust fund had not been
charged. The FMS case manager acknowledged that New Zealand’s
account had not been charged for the seven helicopters but could not tell
us why. After we brought the situation to the Navy’s attention, Navy
officials told us they plan to charge New Zealand’s trust fund account for
the amount owed.

In 1996, the Navy provided support services valued at $1.1 million for
Canada’s Navy Patrol Frigate Harpoon Shipboard Command and Launch
System. Our review of this direct cite transaction found a combination of
errors resulting in undercharges and incorrect postings to the MISIL
accounting records. For example, instead of charging Canada’s trust fund
account for the $1.1 million of services, the Navy incorrectly charged
$636,123 to its appropriations and $450,882 to the trust fund accounts of
Greece and Japan. Further, although the remaining $18,507 was charged to
Canada’s trust fund, it was recorded incorrectly in MISIL. According to the
Navy program manager, errors in entering two contract modifications
affected the obligation and expenditure balances in MISIL. As a result of
these errors, actual charges to Canada’s trust fund account were reduced
and the Navy, Greece, and Japan accounts were charged by mistake. Navy
officials agreed with our finding and told us that they plan to correct the
erroneous charges to the Greece and Japan accounts. They also agreed to
correct the erroneous charge to the Navy appropriation account by
correctly charging Canada and reimbursing the Navy appropriation for
$636,123.

The results of the 15 transactions where FMS customers’ accounts were
not properly charged are summarized in table 2.




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                         B-281171




                         Table 2: Amounts Not Properly Charged to FMS Customer Trust Fund Accounts
                         Country and case            Goods and services                       Amount not charged to FMS
                         code                        delivered to customers                                  trust funds
                         Canada-ANB                  Ammunition                                               $3,393,600
                         Pakistan-ABU                Rocket motors                                             1,628,305
                         Greece-GCV                  Packing, crating, handling                                  414,781
                         Greece-GCV                  Transportation                                              444,408
                         Egypt-ABN                   Ammunition                                                    3,026
                         New Zealand-SAA             Helicopter                                                  597,819
                         New Zealand-SAA             Helicopter                                                  597,819
                         New Zealand-SAA             Helicopter                                                  597,819
                         New Zealand-SAA             Helicopter                                                  597,819
                         New Zealand-SAA             Helicopter                                                  597,819
                         New Zealand-SAA             Helicopter                                                  597,819
                         New Zealand-SAA             Helicopter                                                  597,819
                         Philippines-LBX             Ground handling equipment                                   336,000
                         Turkey-AGJ                  Projectiles 5 inch                                          243,936
                         Canada-GKJ                  Harpoon system services                                     636,123
                         Total                                                                               $11,284,912a
                         a
                         Navy’s MISIL incorrectly reported that the 15 transactions totaled $12.9 million.




Some MISIL Information   Our analysis and discussions with program officials for the remaining five
Was Incorrect            direct cite transactions in our sample totaling $62 million found that FMS
                         customer trust fund accounts had, in fact, been charged. However, because
                         of various accounting errors, the Navy’s MISIL system did not accurately
                         reflect the charges. As a result, MISIL was not providing accurate and
                         reliable information for managers to use when monitoring delivery and
                         billing transactions. The following example involves three direct cite
                         transactions where the MISIL system did not accurately reflect a charge to
                         the customer’s account.

                         MISIL showed that in 1993 Kuwait received three separate deliveries of
                         F-18 aircraft, each valued at $18,127,142, for a total of over $54 million.
                         While we found that the Navy had in fact charged Kuwait’s account for this
                         amount, the MISIL system did not reflect the charges as of October 1998.
                         After we brought this to the attention of Navy officials, they told us that
                         their research showed that the failure to record the charges to the trust
                         fund account occurred because the contractor submitted incorrect delivery



                         Page 8                                                       GAO/AIMD-99-213 FMS Expenditures
                  B-281171




                  reports to the Navy that contained accounting errors and were rejected by
                  the accounting system. However, they could not tell us why the 5-year-old
                  rejected transactions had not been corrected. They told us that they now
                  plan to correct the information in MISIL.



Conclusion        The Navy is not always charging FMS customers in a timely manner to
                  recover its costs for delivered goods and services. Without ensuring that
                  accounts are promptly charged and that the MISIL system accurately
                  reflects charges, the Navy will not be able to effectively ensure that FMS
                  customers are paying the full cost for goods and services, as required by
                  the Arms Export Control Act. Furthermore, because our review focused on
                  only 13 percent of the $582 million reported as not charged to FMS
                  customer trust fund accounts, it is important that the remaining balances
                  be reviewed and that amounts still owed be promptly collected.



Recommendations   We recommend that the Secretary of Defense direct the Secretary of the
                  Navy to (1) collect from the FMS trust fund accounts the $11.3 million
                  identified in this report that has not been charged to FMS customer trust
                  fund accounts for goods and services already provided and (2) place
                  increased management emphasis on monitoring and follow-up efforts to
                  ensure that foreign customer trust fund accounts are promptly charged for
                  all goods and services and errors recorded in MISIL are promptly identified
                  and corrected.

                  We also recommend that the Secretary of Defense direct the Secretary of
                  the Navy and the Under Secretary of Defense (Comptroller) to develop and
                  implement a plan to review the remaining $507 million of transactions
                  recorded in the Navy’s MISIL system to (1) identify and collect amounts
                  FMS customers owe for goods and services already provided, (2) correct
                  erroneous transactions in MISIL, and (3) determine the causes for these
                  type of errors and take action to eliminate similar errors in the future.

                  With respect to the remaining $507 million of MISIL transactions, the
                  review could initially focus on the reimbursable transactions since we
                  found that 100 percent of the reimbursable transactions in our limited
                  sample represented amounts where FMS customer accounts had not been
                  charged for the goods and services already provided.




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Agency Comments and   In commenting on a draft of this report, the Defense Deputy Chief Financial
                      Officer (CFO) generally concurred with our findings and
Our Evaluation        recommendations. He stated that the Navy and DFAS have initiated
                      actions to address our findings and recommendations. For example, the
                      Deputy CFO commented that Navy and DFAS have already taken steps to
                      charge the FMS trust fund accounts for $8.8 million of the $11.3 million this
                      review found had not been properly charged. He stated that the processing
                      of the remaining $2.5 million to properly charge the FMS trust fund
                      accounts is expected to be completed by October 1999. He also stated that
                      the Navy and DFAS have made significant progress in developing and
                      implementing a plan to review the remaining $507 million of MISIL
                      transactions. Finally, he stated that the Navy and DFAS have already
                      implemented several measures designed to ensure that foreign customer
                      trust fund accounts are promptly charged for goods and services when
                      received.


                      We are sending copies of this report to Senator Robert C. Byrd, Senator
                      Carl Levin, Senator Joseph I. Lieberman, Senator Ted Stevens, Senator
                      Fred Thompson, Senator John W. Warner, Representative Dan Burton,
                      Representative Benjamin A. Gilman, Representative Stephen Horn,
                      Representative David R. Obey, Representative Ike Skelton, Representative
                      Floyd D. Spence, Representative Jim Turner, Representative Henry A.
                      Waxman, and Representative C. W. Bill Young in their capacities as Chair or
                      Ranking Minority Member of Senate and House Committees and
                      Subcommittees. We are also sending copies of this report to the Honorable
                      William S. Cohen, Secretary of Defense; the Honorable Richard Danzig,
                      Secretary of the Navy; and the Honorable Jacob J. Lew, Director, Office of
                      Management and Budget. We will make copies available to others upon
                      request.




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If you have any questions regarding this report, please contact me at
(202) 512-6240 or Larry W. Logsdon at (703) 695-7510. Other key
contributors to this report were Harold P. Santarelli and John A. Spence.

Sincerely yours,




Jack L. Brock, Jr.
Director, Governmentwide and Defense
 Information Systems Issues




Page 11                                     GAO/AIMD-99-213 FMS Expenditures
Contents



Letter                                                                                           1


Appendix I                                                                                      14
List of Selected
Transactions

Appendix II                                                                                     15
Comments From the
Department of Defense

Tables                  Table 1: Aging Schedule for Delivered Goods and Services
                          Reportedly Not Charged to FMS Customer Trust Fund
                          Accounts                                                               5
                        Table 2: Amounts Not Properly Charged to FMS Customer
                          Trust Fund Accounts                                                    8




                        Abbreviations

                        CFO       chief financial officer
                        DFAS      Defense Finance and Accounting Service
                        DOD       Department of Defense
                        DSCA      Defense Security Cooperation Agency
                        FMS       foreign military sales
                        LOA       Letter of Offer and Acceptance
                        MISIL     Management Information System International Logistics


                        Page 12                                    GAO/AIMD-99-213 FMS Expenditures
Page 13   GAO/AIMD-99-213 FMS Expenditures
Appendix I

List of Selected Transactions                                                      Appenx
                                                                                        Idi




Country and case code   Type of transaction   Estimated item value recorded in MISIL
Canada-ANB              Reimbursable                                     $3,337,600
Pakistan-ABU            Reimbursable                                      1,628,305
Greece-GCV              Reimbursable                                        693,311
Greece-GCV              Reimbursable                                        742,829
Egypt-ABN               Reimbursable                                        605,200
New Zealand-SAA         Reimbursable                                        597,820
New Zealand-SAA         Reimbursable                                        597,820
New Zealand-SAA         Reimbursable                                        597,820
New Zealand-SAA         Reimbursable                                        597,820
New Zealand-SAA         Reimbursable                                        597,820
New Zealand-SAA         Reimbursable                                        597,820
New Zealand-SAA         Reimbursable                                        597,820
Philippines-LBX         Reimbursable                                        336,000
Turkey-AGJ              Reimbursable                                        268,330
Finland-SAA             Direct cite                                       1,000,000
Canada-GKJ              Direct cite                                       1,105,512
Kuwait-SAO              Direct cite                                       6,630,000
Kuwait-SAO              Direct cite                                      18,127,142
Kuwait-SAO              Direct cite                                      18,127,142
Kuwait-SAO              Direct cite                                      18,127,142
Total                                                                   $74,913,253




                               Page 14            GAO/AIMD-99-213 FMS Expenditures
Appendix II

Comments From the Department of Defense                               AppenIx
                                                                            di




Note: GAO comment
supplementing those in the
report text appears at the
end of this appendix.




                             Page 15   GAO/AIMD-99-213 FMS Expenditures
                 Appendix II
                 Comments From the Department of Defense




See comment 1.




                 Page 16                                   GAO/AIMD-99-213 FMS Expenditures
Appendix II
Comments From the Department of Defense




Page 17                                   GAO/AIMD-99-213 FMS Expenditures
                  Appendix II
                  Comments From the Department of Defense




                  The following is GAO’s comment on the Department of Defense’s letter
                  dated July 29, 1999.



GAO Comment       1. In many of the transactions we reviewed, we found that the Navy was
                  not aware that funds had not been transferred from the FMS customer trust
                  fund accounts to the Navy accounts to pay for the goods and services they
                  had received. This oversight represents poor financial management
                  practices that resulted in long periods of time when the Navy used its own
                  funds to finance sales to foreign customers. It also significantly increased
                  the risk that amounts will never be charged to the FMS trust fund accounts
                  and that the earlier collections, deposited in advance into the FMS trust
                  fund for the purpose of paying for goods and services, will be erroneously
                  returned to foreign customers.




(511649)   Letr   Page 18                                      GAO/AIMD-99-213 FMS Expenditures
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