Defense Budget: Actions Needed to Improve the Management of Foreign Currency Funds

DOD requested about $60 billion for fiscal years 2009 - 2017 to purchase goods and services overseas and reimburse service-members for costs incurred while stationed abroad. DOD uses foreign currency exchange rates to budget and pay (that is, disburse amounts) for these expenses. It also manages the FCFD account to mitigate a loss in buying power that results from foreign currency rate changes.

GAO was asked to examine DOD's processes to budget for and manage foreign currency fluctuations. This report (1) describes DOD's revision of its foreign currency budget rates since 2009 and the relationship between the revised rates and projected O&M and MILPERS funding needs; (2) evaluates the extent to which DOD has taken steps to reduce costs in selecting foreign currency rates to disburse funds to liquidate O&M obligations, and determined whether opportunities exist to gain additional savings; and (3) assesses the extent to which DOD has effectively managed the FCFD account balance. GAO analyzed data on foreign currency rates, DOD financial management regulations, a non-generalizable sample of foreign currency disbursement data, and FCFD account balances.

The Department of Defense (DOD) revised its foreign currency exchange rates (“budget rates”) during fiscal years 2014 through 2016 for each of the nine foreign currencies it uses to develop its Operation and Maintenance (O&M) and Military Personnel (MILPERS) budget request. These revisions decreased DOD's projected O&M and MILPERS funding needs. DOD's revision of the budget rates during these years also decreased the expected gains (that is, buying power) that would have resulted from an increase in the strength of the U.S. Dollar relative to other foreign currencies. DOD did not revise its budget rates in fiscal years 2009 through 2013. For fiscal year 2017, DOD changed its methodology for producing budget rates, resulting in rates that were more closely aligned with market rates. According to officials, that change made it unnecessary to revise the budget rates during the fiscal year.

DOD has taken some steps to reduce costs in selecting foreign currency rates used to pay (that is, disburse amounts) for goods and services, but DOD has not fully determined whether opportunities exist to achieve additional savings. The Army has estimated potential savings of up to $10 million annually by using a foreign currency rate available 3 days in advance of paying for goods or services rather than a more costly rate available up to 5 days in advance. The Army has converted to the use of a 3-day advanced rate. GAO's analysis suggests that DOD could achieve cost savings if the services reviewed and consistently selected the most cost-effective foreign currency rates when paying for their goods and services. Absent a review, DOD is at risk for paying more than it would otherwise be required to conduct its transactions.

DOD used the Foreign Currency Fluctuations, Defense (FCFD) account to cover losses (that is, less buying power) due to unfavorable foreign currency fluctuations in 6 of the 8 years GAO reviewed. Since 2012, DOD has maintained the FCFD account balance at the statutory limit of $970 million, largely by transferring unobligated balances before they are cancelled from certain DOD accounts into the FCFD. However, DOD has not identified the appropriate FCFD account balance needed to maintain program operations by routinely analyzing projected losses and basing any transfers into the account on those expected losses. Thus, DOD may be maintaining balances that are hundreds of millions of dollars higher than needed, and that could have been used for other purposes or returned to the Treasury Department (see figure).

GAO is making four recommendations, including that DOD review opportunities to achieve cost savings by more consistently selecting the most cost-effective foreign currency rates used for the payment of goods and services, and analyze projected losses to manage the FCFD account balance. DOD generally concurred with the recommendations.

The Department of Defense (DOD) requested about $60 billion for fiscal  years 2009 through 2017 in Operation and Maintenance (O&M) and  Military Personnel (MILPERS) appropriations to purchase foreign goods  and services overseas and to reimburse service-members for certain  costs incurred while stationed abroad. As part of the annual budget  formulation process, DOD selects exchange rates for each of the nine  foreign currencies it uses to develop its O&M and MILPERS funding  requirements. Budget formulation for a particular fiscal year starts  approximately 18 months prior to the beginning of that fiscal year. DOD refers to foreign currency exchange rates established during the budget  formulation process as the budget rates.

During each fiscal year, DOD’s O&M and MILPERS appropriations incur  new obligations for overseas expenditures at the budget rate for a  particular foreign currency. The fiscal year during which an appropriation  may incur new obligations is known as the period of availability. DOD  liquidates those obligations through disbursements at the foreign currency  market rates available at the time the disbursements are made. DOD  typically disburses funds to liquidate its MILPERS obligations during the  fiscal year of availability because MILPERS appropriations fund service- member salaries, which are paid on a regular basis throughout the fiscal  year. However, O&M appropriations are generally obligated for the  provision of goods and services, and the liquidation of those obligations  may not always occur within the fiscal year of availability. Disbursements  to liquidate O&M obligations also commonly occur during an  appropriation’s 5-year period of expiration, particularly during the first year  of expiration, during which amounts are available only for limited  purposes, such as disbursement (see figure 1). Differences between the  foreign currency budget rate applied when an obligation is incurred and  the foreign currency market rate applied at the time of disbursement will  result in either a gain or a loss in the amount of appropriations available  to DOD for its planned overseas expenditures.

In fiscal year 1979, Congress appropriated $500 million to establish the  Foreign Currency Fluctuations, Defense (FCFD) account for purposes of  maintaining the budgeted level of operations in the MILPERS and O&M  accounts by eliminating substantial gains or losses to the appropriations  caused by foreign currency rate fluctuations that vary from rates used in  preparing budget submissions. DOD may replenish FCFD amounts by  transferring MILPERS and O&M appropriations, under certain  circumstances. Congress has not provided the FCFD account with  annual appropriations since the account’s inception. Unobligated FCFD  account balances are available until expended, carrying over from one  fiscal year to the next. We have previously reported that an examination  of balances in federal accounts carried forward into future fiscal years  (carryover balances) provides an opportunity to identify areas where the  federal government can improve and maximize the use of its resources.

You asked us to examine DOD’s processes and methodologies to budget  for and manage foreign currency fluctuations. Specifically, this report (1)  describes DOD’s revision of its foreign currency budget rates since 2009  and the relationship between the revised budget rates and DOD’s  projected O&M and MILPERS funding needs; (2) evaluates the extent to  which DOD has taken steps to reduce costs in selecting foreign currency  rates to disburse funds to liquidate O&M obligations, and has determined  whether opportunities exist to gain additional savings; and (3) assesses  the extent to which DOD has effectively managed the FCFD account  balance to cover losses due to foreign currency fluctuations and  maintained quality information to manage these funds.

To address our first objective, we reviewed DOD’s foreign currency  budget rates for the period of fiscal years 2009 through 2017, and we  identified any years during which DOD revised the initial budget rates. We  discussed with DOD officials the process for reviewing the rates and the  factors considered in determining whether to revise the rates.  Additionally, to understand the effects that revising the budget rates had  on DOD’s O&M and MILPERS funding estimates, and the potential for  gains or losses due to foreign currency fluctuations, we compared DOD’s  initial foreign currency budget rates and revised foreign currency budget  rates against rates published by the U.S. Treasury Department (Treasury)  for fiscal years 2009 through 2017. This period corresponded with the  data available to us on DOD’s initial and revised rates, and it allowed for  use of the most current data available, because while we were conducting  our audit work DOD had not yet decided whether or not to revise the  fiscal year 2018 budget rates. We chose rates published by Treasury for  this comparison because Treasury has the sole authority to establish for  all foreign currencies or credits the exchange rates at which such  currencies are to be reported by all agencies of the government.

For our second objective, we reviewed accounting standards and  disbursement guidelines such as DOD’s Financial Management  Regulation, which mirrors the FCFD account’s statutory authority by  directing that MILPERS and O&M obligations be liquidated and amounts  be disbursed at the foreign currency market rate that is current at the  time. We discussed with DOD officials the foreign currency rates used  to liquidate DOD’s obligations; any analysis and ongoing efforts to identify  options for selecting more cost-effective disbursement rates; and whether  there is guidance that may be considered in selecting a disbursement  rate. We also analyzed a non-generalizable selection of data from  Treasury for disbursements made during the months of June and July  2017 to determine what foreign currency rates were used and what  savings may have been possible using alternate rates. We chose these  two months because they were the most recent data available on  disbursements at the time Treasury provided the data for our review.

For our third objective, we analyzed DOD data for fiscal years 2009  through 2016 on foreign currency gains and losses reported by each of  the services that resulted from differences between the foreign currency  budget rate applied when incurring obligations and the rates applied when  those obligations were liquidated; transfers of amounts between the  FCFD account and the services’ O&M and MILPERS appropriations  accounts; and the end-of-year FCFD account balances. We chose this  time period in order to capture years in which both gains and losses were  experienced, and for which DOD had complete data on gains and losses,  fund transfers, and end-of-year balances for the FCFD account. We  compared the end-of-year FCFD account balances and the use of the  FCFD account against guidelines on the importance of examining  unobligated carryover balances established in our prior work.  Additionally, we reviewed and analyzed DOD financial reports on foreign  currency gains or losses and compared the reports, including any  identified discrepancies, against standards for accurate reporting and  maintaining quality information, such as those identified in GAO’s  Standards for Internal Control in the Federal Government and the Federal  Accounting Standards Advisory Board’s Handbook of Federal Accounting  Standards and Other Pronouncements.

To determine the reliability of the data used in addressing these  objectives, we analyzed DOD and Treasury foreign currency rates, data  on DOD foreign currency disbursements, and DOD financial reporting  data on foreign currency gains and losses to identify any missing or  inaccurate information; and we discussed with agency officials any  identified data abnormalities and how the data were extracted from  systems, when appropriate. We found the data to be sufficiently reliable  for the purposes of our reporting objectives, with the exception of the  financial reporting on financial gains and losses. Specifically, based on  problems with the completeness and accuracy of DOD’s financial  reporting on foreign currency gains and losses, we found that these data  were not sufficiently reliable for the purpose of computing exact totals for  the gains and losses DOD experienced. However, because DOD uses  these data as the basis for decisions related to management of the FCFD  account, we included the data in our analysis to provide insight into the  general scope of gains and losses experienced. We also spoke with  Office of the Under Secretary of Defense (Comptroller) (OUSD(C)),  military service, and Treasury officials regarding the process and systems  used to input the data and generate the foreign currency reports we  reviewed. More details on our objectives, scope, and methodology can be  found in appendix I.

We conducted this performance audit from February 2017 to April 2018 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.

Establishing Foreign Currency Budget Rates

As part of the annual budget formulation process for each fiscal year,  DOD establishes for each of nine foreign currencies, a foreign currency  budget rate (units of foreign currency per one United States (U.S.) Dollar)  to use when developing O&M and MILPERS funding requirements for  overseas expenditures. Foreign currency budget rates for a particular  fiscal year are established approximately 18 months prior to the fiscal  year when overseas obligations will be incurred and disbursements  made. For example, in June 2015, OUSD(C) issued guidance to, in part,  instruct the services on the foreign currency rates to use in building their  fiscal year 2017 budgets. In February 2016, as part of the President’s  budget, DOD submitted its proposed fiscal year 2017 budget to  Congress, and it began incurring obligations against subsequently  appropriated amounts on October 1, 2016.

DOD has used various methodologies for establishing the foreign  currency budget rates. In 2005, we reviewed DOD’s methodology for  developing its foreign currency budget rates and reported that DOD’s  approach for estimating its foreign currency requirements for the fiscal  year 2006 budget was a reasonable approach for forecasting foreign  currency rates that could produce a more realistic estimate than its  historical approach. In its fiscal year 2006 through 2016 budget  requests, DOD used a centered weighted average model that combined  both a 5-year average of exchange rates and an average of the most  recently observed 12 months of exchange rates.

For its fiscal year 2017 request, DOD adjusted its methodology to  establish the foreign currency budget rates. Specifically, DOD established  its foreign currency rates by calculating a 6-month average of Wall Street  Journal rates published every Monday from May 25, 2015, to November  16, 2015. According to an OUSD(C) official, the 6-month average more  closely represented foreign currency exchange rates experienced by the  department during budget formulation, and it accounted for the strength of  the U.S. Dollar, which had increased as compared with its historical 5- year average. DOD’s analysis found that the use of the 5-year historical  average would have resulted in substantial gains when compared with  gains expected from application of the 6-month average. More  specifically, DOD projected gains of about $1 billion using the 5-year  average of rates.

Obligating and Disbursing Amounts Using Foreign Currency Rates

During the fiscal year for which a budget is developed, DOD incurs  obligations for its overseas O&M and MILPERS activities. Those  obligations are recorded using the foreign currency budget rates. DOD  uses various methods for selecting foreign currency rates to liquidate  those obligations through disbursements, which may differ from the  budget rates. DOD’s preferred payment method for foreign currency  transactions is the Department of Treasury’s (Treasury) comprehensive  international payment and collection system—the International Treasury  Services (ITS.gov) system—which serves federal agencies making  payments in nearly 200 countries. ITS.gov offers a number of rates,  including advanced rates available up to 5 days in advance of  disbursement, and the spot rate. The spot rate is the price for foreign  currencies for delivery in 2 business days. While advanced rates, like spot  rates, are based on the current market rate, advanced rates at the time  they are selected are generally higher than the spot rate, with the 5-day  advanced rate being the highest, because the rates are locked in ahead  of the actual value date. While the spot rate can be more cost-effective,  it requires immediate transaction processing, which may not be feasible  for all disbursements.

Differences between obligations incurred at the foreign currency budget  rates and the amounts that DOD actually disburses drive gains or losses  in the appropriated amounts DOD has available for its planned overseas  expenditures. For example, if DOD budgeted for the U.K. Pound at a rate  of .6289 (that is, 1 U.S. Dollar buys .6289 U.K. Pounds) as it did in fiscal  year 2016, and the rate experienced at the time of disbursement was  .6845, then DOD would have requested more funds than were actually  needed for transactions involving the U.K. Pound. That would have  resulted in a gain from the transaction—meaning that DOD would need  less funds than were budgeted for the transaction. Conversely, a current  rate that is lower than what was budgeted will result in a loss—and DOD  would require more funds than were budgeted for the transaction.

Within each of the services’ O&M and MILPERS appropriations accounts,  amounts are available for overseas activities. Amounts obligated for  overseas activities, along with associated foreign currency gains and  losses, are managed by the services as part of the overall management  of their O&M and MILPERS appropriations accounts. Service  components use foreign currency fluctuation accounts within their O&M  and MILPERs appropriations to manage realized gains and losses in  direct programs due to fluctuations in foreign exchange rates. The  service-level foreign currency fluctuation accounts are maintained at  various budgetary levels within the service components.

In fiscal year 1979, Congress appropriated $500 million to establish the  FCFD account for purposes of maintaining the budgeted level of  operations in the MILPERS and O&M appropriation accounts by  mitigating substantial gains or losses to those appropriations caused by  foreign currency rate fluctuations.

FCFD appropriations are different from the O&M and MILPERS  appropriations in two ways. First, FCFD account amounts are no-year  amounts, meaning that they are available until expended, while in  general, O&M and MILPERS appropriations are 1-year amounts and  expire at the end of the fiscal year for which they were appropriated.  Expired O&M and MILPERS amounts remain available only for limited  purposes for 5 additional fiscal years. At the end of the 5-year expired  period, any remaining O&M or MILPERS amounts, obligated or  unobligated, are canceled and returned to Treasury. Second, FCFD  account amounts may be used only to pay obligations incurred because  of fluctuations in currency exchange rates of foreign countries, while O&M  amounts are available for diverse expenses necessary for the operation  and maintenance of the services and MILPERS amounts are available for  service personnel-related expenses, such as pay, permanent changes of  station travel, and expenses of temporary duty travel, among other  purposes.

Amounts from the FCFD account may be transferred to service-level  foreign currency fluctuation accounts within O&M and MILPERS  appropriation accounts to offset losses in buying power due to  unfavorable differences between the budget rate and the foreign currency  exchange rate prevailing at the time of disbursement. The FCFD account  may be replenished in several ways. Amounts transferred from the FCFD  to O&M and MILPERS appropriations may be returned when not needed  to liquidate obligations because of subsequent favorable foreign currency  rates in relation to the budget rate, or because other amounts have  become available to cover obligations. A transfer back to the FCFD of  unneeded amounts must be made before the end of the second fiscal  year of expiration following the fiscal year of availability of the O&M or  MILPERS appropriation to which the funds were originally transferred.

Amounts may also be transferred to the FCFD account even if they did  not originate there. Specifically, DOD may transfer to the FCFD account  any unobligated O&M and MILPERS amounts unrelated to foreign  currency exchange fluctuations so long as the transfers are made not  later than the end of the second fiscal year of expiration of the  appropriation. While multiple transfers of these unobligated amounts may  be made during a fiscal year, any such transfer is limited so that the  amount in the FCFD account does not exceed the statutory maximum of  $970 million at the time of transfer. When the FCFD account balance is  at the maximum balance, the services normally retain in their service- level O&M and MILPERs foreign currency fluctuation accounts any gains  resulting from favorable foreign currency rates. Finally, any amounts  transferred, whether from the FCFD account to an O&M or MILPERS  account, or from an O&M or MILPERS account to the FCFD, are merged  with the account and assume the characteristics of that account, including  the period of availability of the funds contained in the account.

Visibility of service-level foreign currency fluctuation account and FCFD  transactions is maintained through the services’ accounting systems and  execution reports. DOD uses the following reports to track its foreign  currency funds:

Foreign Currency Fluctuations, Defense Report (O&M): provides data  on O&M foreign currency gains and losses for each service, by  currency, including data on projected gains or losses for any  remaining obligations that have not yet been liquidated and disbursed  at the time of the report.

Foreign Currency Fluctuation, Defense Report (MILPERS): provides  data on MILPERS foreign currency gains and losses for each service,  by currency, including data on projected gains or losses for any  remaining obligations that have not yet been disbursed at the time of  the report.

GAO’s Prior Work on Management of Federal Funds

In 2013 we analyzed and reported on carryover balances in federal  accounts, which amounted to $2.2 trillion in fiscal year 2012, and we  found that greater examination of carryover balances by an agency  provides opportunities for enhanced oversight of their management of  federal funds and may help identify opportunities for potential budgetary  savings. Carryover balances are composed of both obligated and  unobligated amounts. Only accounts with multi-year or no-year amounts,  such as the FCFD, may carry over amounts that remain legally available  for new obligations from one fiscal year to the next. DOD’s carryover  balances would include FCFD account balances carried from one year to  the next. DOD’s FCFD account is composed of unobligated carryover  amounts that accumulate when unneeded for transfer to O&M and  MILPERS accounts to cover foreign currency fluctuations. FCFD  unobligated carryover balances include any expired, unobligated  balances from the military services’ O&M and MILPERS accounts, which  can include any gains due to favorable foreign currency fluctuations that  are not used to cover other losses and that are transferred into the FCFD.

DOD Revised Its Foreign Currency Budget Rates in Fiscal Years 2014 through 2016, Decreasing Its Projected Funding Needs and Potential Foreign Currency Gains and Losses

DOD revised its foreign currency budget rates in fiscal years 2014  through 2016, which resulted in budget rates in these years that were  more closely aligned with rates published by Treasury. Furthermore, the  revised budget rates in fiscal years 2014 through 2016 decreased DOD’s  projected O&M and MILPERS funding needs. The revised budget rates  also decreased potential gains and losses in the amount of funds that  DOD had available for its planned overseas expenditures.

DOD Revised Its Foreign Currency Budget Rates in Fiscal Years 2014 through 2016, Resulting in Rates More Closely Aligned with Treasury Rates

DOD revised its foreign currency budget rates in fiscal year 2014 and  continued to do so in fiscal years 2015 and 2016 before making  adjustments to its methodology in fiscal year 2017. According to an  OUSD(C) official, the methodology developed in 2017 resulted in budget  rates that were more closely aligned with market rates than in previous  years, making revision of the 2017 budget rates unnecessary. DOD’s  revisions to its foreign currency budget rates in fiscal years 2014 through  2016 resulted in rates that more closely aligned with those published by  Treasury. Further, they decreased the expected gains that would have  otherwise resulted from a substantial increase in the strength of the U.S.  Dollar, in fiscal years 2014 through 2016, relative to other foreign  currencies from the time the budget rates were set as compared with the  rates available once the fiscal year began. Prior to fiscal year 2014,  DOD did not revise its foreign currency budget rates. DOD officials did not  provide an explanation for why the budget rates for fiscal years 2009  through 2013 were not revised.

DOD developed, in November 2015, a set of standard operating  procedures that describe the methodology it used for formulating budget  rates for the nine foreign currencies included in its budget submission.  These procedures also state that DOD is required to update the budget  rates once an appropriation is enacted for the fiscal year. For example, if  Congress reduces DOD’s appropriations due to favorable foreign  currency rates, such as the $1.5 billion reduction in DOD’s total fiscal year  2016 appropriations, OUSD(C) then revises the budget rates to absorb  the reduced funding levels.

OUSD(C) officials stated that other factors are also considered when  determining whether to revise the foreign currency budget rates, and that  the department communicates the revised budget rates to the DOD  components and Congress. For example, OUSD(C) assesses the value  of each of the nine foreign currencies used to develop the budget request  relative to the strength of the U.S. Dollar during the fiscal year. An  OUSD(C) official also noted that the effects that the rate changes would  have across these foreign currencies are also considered prior to  submitting recommended rate revisions to the OUSD(C) leadership for  approval. The official stated that one currency may be experiencing a  loss, while another is experiencing a gain, which can affect whether to  revise the rates and what those revisions should be.

Additionally, the OUSD(C) official stated that “significant” projected gains  or losses could drive a revision to the foreign currency budget rates, and  that an informal $10 million threshold for projected gains and losses is  used to determine when the foreign currency budget rates are revised.  According to OUSD(C) officials, DOD components and Congress were  notified when the budget rates were revised during fiscal years 2014  through 2016, including an explanation for why the rates were revised.  OUSD(C) also includes the budget rates for each of the nine foreign  currencies on its website and identifies any instances in which the budget  rates were revised with the effective date of any rate revisions.

Our analysis of DOD’s use of revised budget rates during fiscal years  2014 through 2016 found that the revised budget rates for those years  were more closely aligned with rates published by Treasury. More  specifically, for the nine foreign currencies included in DOD’s budget, our  analysis comparing DOD’s initial and revised budget rates for fiscal years  2009 through 2017 with average Treasury rates for these years found that  DOD’s budget rates differed from Treasury rates by less than 10 percent  in about 64 percent of the total 162 occurrences we examined. While we  are unaware of any criteria that suggest how closely DOD’s foreign  currency budget rates should align with market rates, we used 10 percent  as a basis for our analysis because Treasury’s guidance states that  amendments to its published exchange rates are required if rates differ  from current rates by 10 percent or more.

We further examined these occurrences to determine what the  differences were between the DOD and Treasury rates before and after DOD began revising its budget rates in fiscal year 2014. Of the 162  occurrences we reviewed, there were 90 occurrences included in our  comparison for fiscal years 2009 through 2013, and 72 occurrences were  included in our comparison for fiscal years 2014 through 2017. Our  analysis shows the following:

For fiscal years 2014 through 2017, DOD’s budget rates for its nine  foreign currencies differed from Treasury rates by less than 10  percent in about 71 percent of the occurrences. This increased from  about 59 percent of the occurrences for the period of fiscal years 2009  through 2013, before DOD began revising its rates after the fiscal year  began.

For fiscal years 2014 through 2017, DOD’s budget rates differed from  Treasury’s rates by 10 percent or more after DOD began revising its  rates in fiscal year 2014 in about 29 percent of the occurrences, which  is a decrease from about 41 percent of the occurrences prior to fiscal  year 2014.

Figure 2 below shows the number of occurrences in which DOD’s initial  and revised rates differed from Treasury rates by less than 10 percent,  and the occurrences in which DOD’s rates differed from Treasury rates by  10 percent or more. The occurrences that are less than 10 percent of  Treasury rates are most closely aligned with Treasury rates.

According to DOD officials, the differences between DOD’s foreign  currency budget rates and Treasury rates are driven primarily by market  volatility (that is, the differences in the foreign currency rates from when  DOD formulates its budget rates, prior to the fiscal year, and the foreign  currency rates determined by Treasury when obligated amounts are  liquidated through disbursements during the fiscal year). According to the  OUSD(C) official responsible for formulating and revising the foreign  currency budget rates, the delay that occurs between the time when a  budget rate is set (approximately 18 months prior to the beginning of a  particular fiscal year) and the actual fiscal year is a major factor for why  the budget rate may be revised. According to the official, the market rates  experienced during fiscal years 2014 through 2016 were substantially  different from those expected when the budget rates for those years were  developed. Therefore, DOD revised its budget rates during these years to  more closely align with market rates experienced.

Specifically, this official stated that DOD revised its budget rates during  fiscal years 2014 through 2016 to decrease the expected gains that would  have otherwise resulted during these fiscal years from a substantial  increase in the strength of the U.S. Dollar relative to other foreign  currencies from the time the budget rates were set as compared with  more favorable rates available once the fiscal year began. In order to  more closely align its budget rates with market rates, DOD introduced a  new methodology to establish the foreign currency budget rates for fiscal  year 2017 because DOD anticipated approximately $1 billion in projected  gains if it used the prior methodology. As a result of this change in the  methodology, according to the OUSD(C) official, DOD did not experience  substantial gains or losses in fiscal year 2017. Therefore, DOD did not  revise its foreign currency budget rates during fiscal year 2017. However,  as previously stated, the official did not provide an explanation as to why  the budget rates for fiscal years 2009 through 2013 were not revised.

Revised Foreign Currency Budget Rates Decreased the Estimate of DOD’s O&M and MILPERS Funding Needs and Potential Gains and Losses That Would Have Occurred Due to Foreign Currency Fluctuations

DOD’s use of revised foreign currency budget rates decreased DOD’s  projected O&M and MILPERS funding needs and any potential gains and  losses that would have occurred due to foreign currency fluctuations  during fiscal years 2014 through 2016. Because DOD uses its budget  rates to establish its projected annual O&M and MILPERS funding  requirements for planned overseas expenditures, any revisions to the  budget rates affect DOD’s estimate of its funding needs. For example, our  analysis shows that as a result of revising its budget rates during fiscal  years 2014 through 2016, DOD’s projected funding needs for the period  of fiscal years 2009 through 2017 decreased from about $60.2 billion to  about $57.5 billion—a decrease of about $2.7 billion.

To further show the effect that changing foreign currency rates could have  on DOD’s projected funding for planned overseas expenditures for fiscal  years 2009 through 2017, we also compared DOD’s projected O&M and  MILPERS funding needs, based on its initial and revised foreign currency  budget rates, against projected funding needs based on the use of foreign  currency rates published by Treasury during the fiscal year. Our  analysis shows that DOD’s projected O&M and MILPERS foreign  currency funding needs using Treasury rates would have been about  $58.4 billion, or about $885 million more than the $57.5 billion that DOD  had projected using its initial and revised budget rates.

DOD also uses foreign currency budget rates to calculate gains or losses  attributable to foreign currency fluctuations. Specifically, DOD determines  gains and losses due to foreign currency fluctuations by comparing the  budget rate (that is, initial or revised budget rate) used to incur obligations  against a more current market rate at the time it liquidates its obligations  through disbursements. Therefore, revisions to the budget rates not only  change DOD’s projected O&M and MILPERS funding requirements for  the fiscal year in which the revisions occur, but also change the baseline  from which the potential gains or losses would result when DOD  liquidates its overseas O&M and MILPERS obligations through  disbursements. For example, in fiscal year 2016, Congress reduced  DOD’s total appropriations by $1.5 billion. As a result of this reduction and  favorable foreign currency rates, DOD revised its fiscal year 2016 budget  rates in February 2016 and applied the revised foreign currency budget  rates in its calculations of gains and losses due to foreign currency  fluctuations since the beginning of the fiscal year to absorb the reduced  funding level. In applying the revised budget rates, a $30 million gain  DOD had previously projected became a projected loss of about $186.2  million. The use of revised budget rates also affects the movement of  funds from the FCFD account. For example, if the use of the revised  budget rate creates a loss and DOD is unable to cover the increased  costs to its O&M or MILPERS appropriations, funds from the FCFD  account may be used to cover its planned overseas expenditures.

DOD Has Taken Some Steps to Reduce Costs, but Has Not Fully Explored Additional Opportunities to Achieve Savings When Selecting Foreign Currency Rates

DOD has taken some steps to reduce costs in selecting foreign currency  rates to liquidate its obligations through disbursements. However, DOD  organizations are not always selecting the most cost-effective rates to  convert U.S. Dollars, and DOD has not determined whether opportunities  exist to achieve additional efficiencies when making disbursements. DOD  liquidates its obligations through disbursements for overseas  expenditures using Treasury’s ITS.gov system, which provides DOD  organizations with a choice of foreign currency rates to apply when  making disbursements in a foreign currency. The foreign currency rate  chosen determines how many U.S. Dollars must be paid for the  transaction. Treasury officials explained that customers may choose  either the spot rate or an advanced rate. The spot rate is the price for  foreign currencies for delivery in 2 business days. Treasury officials  explained that advanced rates are exchange rates that are “locked in” and  guaranteed by the bank processing the disbursement 5, 4, or 3 days in  advance of payment processing, which is known as the “value date” of a  disbursement. Normally, the cost of the rate increases the further from the  date of disbursement that it is locked in.

While DOD often uses a 5-day advanced rate to make its disbursements,  the other rate options available, such as a 3-day advanced and a spot  rate, can be more cost-effective. We analyzed data provided by Treasury  from its ITS.gov system and found that for disbursements made during  the period of June and July 2017, the 5-day advanced rate was more  costly than the 3-day advanced rate. In instances where the spot rate was  available, we found that it was also more cost-effective than either the 3- day or 5-day advanced rates. For example, for those transactions  processed through ITS.gov on June 13, 2017, DOD would have paid 1  U.S. Dollar for .881 European Euros if using the 5-day advanced rate;  .883 European Euros if using the 3-day advanced rate; and .889  European Euros if using the spot rate.

In the case of the Army, an Army Financial Management Command  official provided us information indicating that the service has estimated  potential cost savings that would result from more consistently selecting  3-day advanced rates through the ITS.gov system to make overseas  disbursements of amounts, rather than the 5-day advanced rate. More  specifically, the Army estimated between $8 million and $10 million in  annual savings by transitioning from a 5-day to a 3-day advanced rate  when selecting foreign currency rates. According to officials, the Army  has transitioned all paying locations to the 3-day advanced rate. The  Army estimates that these locations have produced $6.04 million in  savings through February 2018. Although the Army indicated that it also  planned to analyze whether use of the spot rate was feasible, it had not  conducted this review at the time of our review.

Data provided to us by Treasury from its ITS.gov system indicate that in  June and July of 2017, the Air Force used the 5-day advanced rate  exclusively for its disbursements, while the Navy and Marine Corps relied  on both the 5-day and the 3-day advanced rates. Our analysis of these  data show the Air Force would have achieved total savings for those 2  months of about $258,000 if it had made its disbursements using the 3- day versus the 5-day advanced rate. The savings resulting from each  transaction varied based on the amount of the transaction. For example,  on June 13, 2017, the Air Force disbursed a payment exceeding $3.7  million and would have saved more than $9,000 for that transaction if the  3-day advanced rate had been used. For the same single transaction, if  the spot rate had been used instead of the 5-day advanced rate, the Air  Force would have saved more than $31,000. The savings associated with  the Navy’s and Marine Corps’ disbursements for the same 2-month  period showed the potential for less dramatic savings of less than $100  because the Navy and Marine Corps used the 3-day advanced rate as  opposed to the 5-day advanced rate for most of its disbursements. Where  information on the spot rate was available, its use, as opposed to either  the 5-day or 3-day advanced rate, would have resulted in additional  savings opportunities for those 2 months. While these examples are  illustrative of cost savings opportunities in June and July 2017, Treasury  data show that in fiscal year 2016, DOD disbursed more than $11.8 billion  through ITS.gov and, as of July 2017, had disbursed more than $9.6  billion through ITS.gov.

Our analysis suggests that DOD could achieve further cost savings by  more consistently selecting cost-effective foreign currency rates, such as  the 3-day advanced or spot rates, with which to make disbursements. In  selecting foreign currency rates, DOD’s Financial Management  Regulation states that disbursements should be computed to avoid gains  or deficiencies (losses) due to fluctuations in rates of exchange to the  greatest extent possible. If there is no rate of exchange established by  agreement between the U.S. government and the foreign country, then  foreign currency transactions are to be conducted at the prevailing rate.

The prevailing rate of exchange is the most favorable rate legally  available for acquisition of foreign currency for official disbursement and  other exchange transactions. Additionally, GAO’s Standards for Internal  Control in the Federal Government calls for management to periodically  review policies, procedures, and related control activities for continued  relevance and effectiveness in achieving the entity’s objectives or  addressing related risks.

DOD disbursement organizations have flexibility in selecting foreign  currency rates to use when making disbursements using ITS.gov. There  is no DOD-wide requirement for the services to review the rates used to  make disbursements and, except for the Army, the services have not  conducted such a review. This step is necessary to determine whether  there are opportunities for savings by more consistently selecting cost- effective foreign currency rates. We discussed disbursement processes  with DOD and Air Force, Navy, and Marine Corps financial management  officials, including the factors considered when selecting foreign currency  rates. In addition, a Defense Finance and Accounting Service official  noted that currencies can have criteria specifying when a payment is  made and provided us the ITS.gov user’s guide, which addresses “special  currency requirements,” such as those that would drive advanced  payment for a currency. For example, the user’s guide indicates that  payment for transactions involving the Afghanistan Afghani must be made  2 days in advance of the value date, and cannot be made on a Friday.  However, information that is contained in the ITS.gov user’s guide and  that we received from a Treasury official indicate that none of the nine  foreign currencies for which DOD budgets place restrictions on when  payment must be made; and therefore, this consideration should not drive  the use of a specific rate at disbursement.

Marine Corps financial management officials told us that the foreign  currency rate selected at disbursement is at the discretion of the  disbursing officer based on operational requirements, with the  understanding that the most favorable rate for the government is the  preference, while balancing mission requirements and the time necessary  to process the transaction. These officials acknowledged that the 3-day advanced rate can be more cost-effective to the government but indicated  that there are occasions when the 5-day advanced rate should be used  because it provides more time to process the payments from deployed  locations operating in different time zones or with limited communication  capabilities.

However, we found that OUSD (C) officials and financial management  officials with the headquarters of the Air Force, Navy, and Marine Corps  were not involved in disbursement, were unaware of what rates were  being used at disbursement, and had not reviewed the rationale for  selecting one rate over another. For example, Air Force and Navy  headquarters officials we spoke with were unable to provide insight as to  what drives the decision to use one rate over another. One Navy financial  management official told us that he was unaware of any Navy policy that  directs a specific rate to be used when disbursing funds, and suggested  that the absence of such a policy provides the flexibility for officials to  determine which approach is best. Headquarters, Marine Corps officials  also stated that they did not monitor foreign currency rates used for  disbursements or the reasons why one rate was selected over another.  Based on our inquiry, officials indicated that they would analyze the  foreign currency rates used for disbursements in 2017 and whether  opportunities existed to achieve savings by using other rates available  through ITS.gov. A Marine Corps official subsequently provided us with  information that showed that two of three disbursing offices that currently  utilize ITS.gov for disbursements use the 3-day advanced rate exclusively  and one uses the 5-day advanced rate. The official noted that a technical  issue within ITS.gov has restricted the disbursing office currently using  the 5-day advanced rate from choosing any other rate, but that the  service was further assessing options to correct the issue.

In our conversations with an official in OUSD(C) about why the other  services had not reviewed the foreign currency rates used for  disbursements to determine what was being paid through ITS.gov and  whether there was an opportunity for savings, the official commented that  OUSD(C) had not directed the services to conduct any reviews in this  area. This official was unaware that different foreign currency rates were  used to make disbursements, and assumed that the military services all  make disbursements in the same way. However, as discussed above, the  services are using different rates resulting in inconsistency across the  department. The official further indicated that DOD could perform a  review to determine the cost differences of using one disbursement rate  over another. Absent a review of the rates the services are using in  making disbursements and whether cost savings could be achieved by  more consistently selecting the most cost-effective foreign currency rates  available for use at disbursement, DOD is at risk for paying more to  convert U.S. Dollars for overseas expenditures than would otherwise be  required.

DOD Has Used the FCFD Account to Cover Losses Due to Foreign Currency Fluctuations, but Does Not Manage the Account Balance Based on Projected Losses or Quality Data

In fiscal years 2009 through 2016, DOD used the FCFD account to cover  losses that the services experienced due to foreign currency fluctuations  in 6 of the 8 years we reviewed. However, DOD does not effectively  manage the FCFD account balance based on projected gains or losses.  Transfers of expired unobligated balances from MILPERS and O&M  accounts into the FCFD account have been made to replenish the  account balance to the statutory limit of $970 million, without  consideration of projected losses due to foreign currency fluctuations.  Furthermore, DOD’s financial reporting on foreign currency fluctuations  for fiscal years 2009 through 2016 contains incomplete and inaccurate  information.

DOD Has Used the FCFD Account to Cover Losses and Has Maintained the Account at the Maximum Level since Fiscal Year 2012

In fiscal years 2009 through 2016, DOD transferred approximately $1.92  billion out of the FCFD account to cover losses that the services  experienced due to foreign currency fluctuations in 6 of the 8 years we  reviewed. For these years, DOD transferred funds from the FCFD  account to the services’ MILPERS and O&M accounts during the fiscal  year in which the funds were obligated for overseas expenses. The  transfer amounts were based on both losses realized from actual  disbursements and projected losses for any remaining obligations to be  liquidated. The projected losses were calculated based on the current  foreign currency market rates as of the time of the calculation. Based on  the service-level data we reviewed, all of the services reported that they  experienced losses in at least 5 of the fiscal years we reviewed. For  example, the Army reported that it experienced losses in its MILPERS  account for 5 of 8 years, while the Marine Corps reported that it  experienced losses in its O&M and MILPERS accounts in each of the 8  years. In addition to the transfers to cover losses within the services’  MILPERS and O&M accounts, in fiscal year 2013 DOD transferred an  additional $969 million to the Defense Working Capital Fund to offset fuel  cost losses.

Since fiscal year 2012, DOD has maintained the FCFD end-of-year  account balance at $970 million—the maximum allowed by statute. To  replenish the funds that were transferred out of the FCFD account, DOD  transferred unobligated balances to the FCFD account from the services’  O&M and MILPERS accounts. While DOD can also replenish the FCFD  account or absorb foreign currency losses in certain currencies by  transferring to the FCFD account any gains experienced by the services,  our analysis found that DOD did not transfer any gains into the FCFD  account for fiscal years 2009 through 2016. Figure 3 shows the transfers  into and out of the FCFD account and the end-of-year FCFD account  balance for fiscal years 2009 through 2016.

Our analysis also shows that DOD transferred funds to maintain the  FCFD account at its maximum balance since 2012, despite experiencing  fewer losses due to foreign currency fluctuations than it had experienced  in fiscal years 2009 to 2011. Of the $1.92 billion transferred from the  FCFD account to the services’ MILPERS and O&M accounts to cover  losses, $464.5 million was transferred since fiscal year 2012, when DOD  began maintaining its FCFD account at the maximum level. During that  time, some of the services experienced foreign currency gains, while  others experienced losses. For example, at the end of fiscal year 2013  the Navy reported a total realized and projected cumulative gain for its  O&M and MILPERS accounts of about $98.6 million. In that same year,  the Marine Corps reported a cumulative realized and projected loss for its  O&M and MILPERS accounts of approximately $12.7 million. Had DOD  not transferred unobligated funds back into the FCFD account, it would  have retained a positive balance of approximately $505.5 million.  However, DOD maintained the account balance at $970 million by  transferring approximately $495.3 million in unobligated balances into the  account.

DOD Analyzes Projected Losses to Inform Transfers out of the FCFD Account, but Does Not Consider Similar Information When Making Transfers into the FCFD Account

As part of its management of the FCFD account balance, DOD analyzes  data on realized and projected losses as the basis for transferring funds  from the FCFD account to the services’ MILPERS and O&M accounts to  cover losses. However, DOD does not consider projected losses when  making transfers of unobligated O&M and MILPERS balances into the  FCFD account. Figure 4 below shows the FCFD account balance that  DOD has maintained in relation to the transfers out of the account to  cover losses.

Specifically, according to the OUSD(C) official responsible for managing  the FCFD account, DOD maintains the FCFD account balance at $970  million to maximize unobligated balances within the military services’  O&M and MILPERS accounts before they are canceled and are no longer  available to DOD. In addition, this official stated that DOD prefers to  maintain the maximum balance in case it is needed due to sudden,  unfavorable swings in foreign currency exchange rates.

Our review of the documentation used to make transfers into and out of  the FCFD account corroborates that DOD maintains the FCFD account  balance to maximize the retention of unobligated balances. Specifically,  we found instances in which the documentation states that the transfers  of unobligated balances into the FCFD account were made for the  purpose of replenishing the account balance to the statutory limit. For  example, DOD transferred $89 million from the FCFD account to the  Army for losses it had realized and projected in fiscal year 2014, and later  transferred unobligated balances of the same amount back into the  account. DOD’s documentation states that this transfer of unobligated  balances was made for the purpose of replenishing the account to $970  million in order to finance estimated foreign currency losses resulting from  the decline in value of the U.S. Dollar. However, the transfer to the Army  already covered the realized losses and projected losses for any  remaining disbursements. In other words, estimated foreign currency  losses had already been accounted for at the time of the transfer to the  Army.

In addition, based on data reported by the Air Force, Marine Corps, and  Navy, DOD had an estimated cumulative gain of about $30 million for  fiscal year 2014 based on the other services’ gains and losses, which  could have been transferred to the FCFD account to absorb any  additional foreign currency losses elsewhere. However, DOD did not  transfer those gains to the FCFD account. Similarly, based on data  reported by these services, DOD experienced cumulative realized and  projected gains of more than $200 million in fiscal year 2013 and about  $92.6 million in fiscal year 2015, but it did not transfer any gains to the  FCFD account because the account balance had already reached its  maximum using transferred unobligated balances.

Despite replenishing the account balance to the maximum amount for the  purpose of covering additional losses, the FCFD transfers have not been  made to fully offset losses in some years, further raising questions about  the need to maintain the balance at the statutory cap of $970 million  annually. Specifically, in 3 of the 6 years in which DOD transferred funds  from the FCFD account to the services’ MILPERS and O&M accounts,  DOD did not use the FCFD account to fully cover the losses that the Air  Force, Marine Corps, and Navy experienced. In fiscal year 2011, for  example, DOD’s transfers out of the FCFD account to these services  covered about 88 percent of the reported MILPERS and O&M losses that  these services had realized and projected to lose by the end of the fiscal  year. In fiscal year 2012, FCFD transfers covered almost 72 percent of  the MILPERS and O&M realized and projected losses reported by the Air  Force, Marine Corps, and Navy, as of the end of the fiscal year. In fiscal  year 2016, DOD FCFD transfers to these services covered approximately  55 percent of their reported MILPERS and O&M realized and projected  losses by the end of the fiscal year.

The OUSD(C) official we spoke with stated that FCFD transfers to cover  losses begin with a request from the services, and the OUSD(C) office  and the services then coordinate on the final transfer amount. In addition,  some service officials told us that they try to cover their losses using each  service’s available funding before reaching out for assistance from the  FCFD account. Therefore, based on a service’s ability to cover the loss, it  may not always request an FCFD transfer to cover the full amount of  realized and projected losses. Further, according to an OUSD(C) official,  the timing of a service’s request for an FCFD transfer may also affect any  differences between the amount transferred and the actual losses  experienced. Specifically, if a service requests a transfer early in the fiscal  year based on realized and projected losses, actual losses experienced  as of the end of the fiscal year may be greater than or less than the  transfer amount due to foreign currency fluctuations.

Using transfers of unobligated balances, DOD has maintained its FCFD  account balance at the maximum level allowed by statute because it has  not analyzed realized and projected losses to determine what size  account balance is necessary to meet the intended purpose of the  account. In our prior work, we have developed key questions for  evaluating federal account balances that agencies may use to identify the  amount of the balance necessary to maintain agency or program  operations. Through examination of carryover balances, oversight of  agencies’ management of federal funds may be enhanced. Specifically,  we reported that understanding an agency’s processes for estimating and  managing carryover balances provides information to assess how  effectively agencies anticipate program needs, and ensure the most  efficient use of resources. To estimate and manage carryover balances,  agencies may consider such factors as future needs of the account,  economic indicators, and historical data. If an agency does not have a  robust strategy in place to manage carryover balances or is unable to  adequately explain or support the reported carryover balance, then a  more in-depth review is warranted. In those cases, balances may either  fall too low to efficiently manage operations or rise to unnecessarily high  levels, producing potential opportunities for those funds to be used more  efficiently elsewhere.

When asked about maintaining the balance at a level necessary to cover  losses, rather than at the maximum level allowed by statute, the  OUSD(C) official indicated that the OUSD(C) takes a cautious approach  and prefers to have the additional flexibility allowed by the higher balance.  Further, the official stated that it would be difficult for DOD to attempt to  base its unobligated balance transfers and the FCFD account balance on  analysis and evaluation, given the unpredictable nature and constant  volatility of foreign currency rates. Our guidelines on evaluating carryover  balances acknowledge that external events beyond an agency’s control  can dramatically affect carryover balances. However, the challenges that  are inherent in predicting foreign currency rates do not preclude DOD  from conducting analysis to glean insight as to the appropriate size for the  balance of the account and what potential opportunities for savings might  exist. Specifically, our guidelines suggest that agencies would benefit  from considering the sources and fiscal characteristics of an account with  carryover balances. In this case, the FCFD account can receive funds  from transfers of unobligated balances and realized foreign currency  gains. In addition, DOD can make multiple transfers throughout a fiscal  year and can transfer funds from the FCFD to and from the services’  O&M and MILPERS accounts simultaneously, if necessary.

These characteristics of the FCFD account already provide the  department with flexibility, indicating that DOD may be positioned to  manage the FCFD balance in a more analytical manner based on any  projected losses. Without analyzing any realized or projected losses to  determine what balance may be needed to meet the FCFD account’s  intended purpose, the account balance may be kept at a higher level than  is necessary. As a result, although an exact amount is unknown, DOD  may be maintaining balances in the FCFD account that are hundreds of  millions of dollars higher than needed to cover any losses it has  experienced, and these funds may have been more efficiently used in  supporting other defense activities or returned to Treasury after the  account is canceled by law.

DOD Lacks Quality Data to Support Management of the FCFD Account

DOD prepares financial reports to monitor the status of its foreign  currency funds, but some of DOD’s financial reporting on foreign currency  fluctuations for fiscal years 2009 through 2016 is incomplete and  inaccurate. DOD’s Financial Management Regulation establishes  reporting requirements specifically for tracking all transactions that  increase or decrease the FCFD. In accordance with that guidance, the  services provide data from their accounting systems to the Defense  Finance and Accounting Service to generate reports that are used as a  tool with which the services and OUSD(C) can monitor how they are  expending funds appropriated for overseas expenditures. For O&M  appropriations, the Foreign Currency Fluctuations, Defense (O&M) report  provides data on foreign currency gains and losses for each service, by  currency, including data on projected gains or losses for any remaining  obligations that have not yet been disbursed at the time of the report. The  Foreign Currency Fluctuations, Defense Report (MILPERS) provides  similar information for the MILPERS appropriation.

We reviewed end-of-year Foreign Currency Fluctuations, Defense (O&M)  and (MILPERS) reports for fiscal years 2009 through 2016 and found that  some of the reporting for O&M was incomplete and inaccurate, which  hampers the quality of information available to manage the FCFD  account. For instance, we found the following:  Incomplete data in the Foreign Currency Fluctuations Defense  (O&M) reports: In our review of the end-of-year Foreign Currency  Fluctuations Defense (O&M) and (MILPERS) reports we observed  several instances of incomplete data in the O&M reports, and these  affect managers’ ability to make sound decisions to manage foreign  currency gains and losses. First, for the Navy, we found that the  report data showed, for multiple currencies across fiscal years 2011  through 2016, values in the realized variance column, indicating that  the service had experienced a gain or loss in a particular currency;  however, the reports showed values of zero in other columns that are  necessary for calculating the gain or loss. Second, the Air Force data  for the Turkey Lira, in fiscal year 2012, showed a gain or loss without  any data indicating what would have driven the gain or loss. Third, in  one instance, Marine Corps data on obligations for fiscal year 2011  were missing from the end-of-year reports until 2014. Missing  obligation data for these end-of-year reports indicate a limitation in  using these reports for tracking actual gains and losses.

Inaccurate data in the Army’s Foreign Currency Fluctuations  Defense (O&M) reports: The Army’s Foreign Currency Fluctuation  Defense (O&M) reports are inaccurate and cannot be used to reliably  track gains or losses, and this hinders managers from making sound  decisions regarding the Army’s foreign currency gains and losses.  The reports are inaccurate in that the Army’s accounting system  charges disbursements to the current fiscal year appropriation rather  than to the fiscal year appropriation that incurred the obligation, as  required by the Financial Management Regulation. According to  officials from the Army Budget Office, the Army designed its General  Fund Enterprise Business System (GFEBS) to record disbursements  to the current fiscal year based on differing interpretations of a  previous version of the Regulation. Because the Army is not recording  its disbursements to the fiscal year appropriation as the other services  are, Army data are inaccurate and cannot be used by the OUSD(C)  official responsible for overseeing DOD’s foreign currency program to  track the Army’s foreign currency transactions and maintain full  visibility of DOD’s overall gains and losses in a given fiscal year. Army  Budget Office officials acknowledged that the Army will need to modify  its system to record disbursements consistent with Financial  Management Regulation guidance, but it has not developed a plan or  timeline for doing so. Without accurate reporting of the Army’s foreign  currency transactions, DOD lacks information for tracking and helping  to manage the Army’s foreign currency gain and losses.

DOD’s Financial Management Regulation specifies the data that must be  included in the Foreign Currency Fluctuations Defense (O&M) and  (MILPERS) reports and the roles and responsibilities of the services as  well as the Defense Finance and Accounting Service for ensuring the  quality of those data. However, we identified data issues in our analysis  that indicate that quality is inconsistent. For example, officials from the  Navy stated that they had observed the incomplete data for some  currencies and speculated that the incompleteness was attributable to  data entry errors. Similarly, according to an OUSD(C) official, the Defense  Finance and Accounting Service is notified when discrepancies are found  in the reports and the Defense Finance and Accounting Service officials  coordinate with the services to correct the data. However, neither Navy  nor the Defense Finance and Accounting Service officials have corrected  the data. Although DOD’s Financial Management Regulation specifies the  data that are to be included, as well as roles and responsibilities of the  services and the Defense Finance and Accounting Service, it does not  identify who is responsible for correcting erroneous or missing data.  According to an OUSD(C) official, correcting reporting issues is an area  that OUSD(C), the Defense Finance and Accounting Service, and the  services can improve on, and they would benefit from guidance in the  Financial Management Regulation that establishes the steps that should  be taken for making such corrections.

Further, GAO’s Standards for Internal Control in the Federal Government  and the Federal Accounting Standards Advisory Board’s Handbook of  Federal Accounting Standards and Other Pronouncements, as Amended,  both establish the importance of using reliable and complete information  for making decisions. In addition, DOD’s Financial Management  Regulation establishes responsibilities for both the DOD components and  the Defense Finance and Accounting Service to establish appropriate  internal controls to ensure that financial reporting data are complete,  accurate, and supportable, in order for managers to make sound  decisions and exercise proper stewardship over these resources.

Effectively managing foreign currency gains and losses as well as any  projected gains or losses for any remaining obligations that have not yet  been liquidated through disbursement requires complete and accurate  data. OUSD(C) and service officials recognize the importance of reliable  data, as well as the need to take steps to improve the quality of the  foreign currency gains and losses data. Without OUSD(C) establishing  guidance to ensure that the Foreign Currency Fluctuation Defense (O&M)  report data that tracks foreign currency gains and losses are complete,  DOD and Congress do not have information to make sound decisions and  exercise proper stewardship over resources due to foreign currency  fluctuations. Furthermore, until the Army establishes a plan and timeline  for modifying its system to record foreign currency disbursements in an  accurate manner, the Army and DOD will lack quality information for  tracking and helping to manage the Army’s and DOD’s foreign currency  gain and losses.

Congress provides DOD with a significant amount of funding each year to  purchase goods and services overseas and to pay service-members  stationed abroad. DOD develops and can revise foreign currency budget  rates to determine its funding needs and calculate any gains or losses  that result from DOD’s overseas expenditures. The Army has estimated  potential cost savings that would result from more consistently selecting a  more cost-effective foreign currency rate for making disbursements to  liquidate its overseas O&M obligations. However, DOD has not fully  determined whether additional cost-saving opportunities exist because  the services have not reviewed the rates used for foreign currency  disbursements. Absent a review of the foreign currency rates the services  are using at disbursement, including whether cost-saving opportunities  exist, by more consistently selecting cost-effective foreign currency rates,  DOD risks paying more than would be required otherwise. Further, while  DOD has used the FCFD account to cover losses that resulted from  foreign currency fluctuations, it has not managed the FCFD account  balance by basing the transfers of unobligated balances into the FCFD  account on an analysis of realized and projected losses. Without basing  its FCFD account balance on such analyses, DOD may be maintaining  balances in the FCFD account that are hundreds of millions of dollars  higher than needed to cover any losses it has experienced, and these  amounts may have been more efficiently used supporting other defense  activities or ultimately returned to Treasury, once expired. Moreover, DOD  has not established guidance and other procedures to ensure that  complete and accurate data are included in financial reporting on foreign  currency funds, and this limits the quality of information available to  effectively manage the FCFD account.

We are making the following four recommendations to DOD. The  Secretary of Defense ensures that:  The Under Secretary of Defense (Comptroller), in coordination with the  U.S. Army, Air Force, Navy, and Marine Corps, should conduct a review  of the foreign currency rates used at disbursement to determine whether  cost-saving opportunities exist by more consistently selecting cost- effective rates at disbursement. (Recommendation 1)

The Under Secretary of Defense (Comptroller) should analyze realized  and projected losses to determine the necessary size of the FCFD  account balance and use the results of this analysis as the basis for  transfers of unobligated balances to the account. (Recommendation 2)

The Under Secretary of Defense (Comptroller) should revise the Financial  Management Regulation to include guidance on ensuring that data are  complete and accurate, including assignment of responsibility for  correcting erroneous data in its Foreign Currency Fluctuations Defense  (O&M) reports. (Recommendation 3)

The Secretary of the Army should develop a plan with timelines for  implementing changes to its General Fund Enterprise Business System to  accurately record its disbursements, consistent with DOD Financial  Management Regulation guidance. (Recommendation 4)

We provided a draft of this report to DOD for review and comment. In its  written comments, reproduced in appendix II, DOD concurred with our  first, third, and fourth recommendations and outlined its plan to address  them. DOD partially concurred with our second recommendation that the  Under Secretary of Defense (Comptroller) analyze realized and projected  losses to determine the necessary size of the FCFD account balance and  use the results of the analysis as the basis for transfers of unobligated  balances to the account. DOD also provided technical comments, which  we incorporated in the report, where appropriate.

In partially concurring with our second recommendation, DOD stated that  projecting foreign currency gains or losses can be difficult given that  foreign currency rates can be volatile due to various factors, such as  trade balances, money supply, and national income, as well as arbitrary  disturbances that affect foreign currency rates that cannot be predicted or  forecasted, such as the departure of the United Kingdom from the  European Union. DOD noted that because of the risk and volatility  associated with foreign currency rates, the Congress established the  FCFD account.

We agree that forecasting foreign currency rates is challenging due to  market volatility and include examples in our report of the effect of foreign  currency rate fluctuations on DOD’s planned foreign currency obligations.  Our report also describes the relationship between gains and losses and  foreign currency fluctuations, and the movement of funds from the FCFD  account to offset any losses. As our report also discusses, DOD  calculates actual and projected losses due to foreign currency fluctuations  and uses those projections as the basis, at least in part, for any transfers  out of the FCFD account to cover losses experienced in the military  services’ O&M and MILPERS appropriations. However, our report also  notes that DOD does not consider its calculations of actual and future  projected losses when making transfers of unobligated O&M and  MILPERS balances to replenish the FCFD account. Instead, since fiscal  year 2012, DOD has kept the FCFD account balance at the maximum  level allowed by statute by using unobligated balances before they are  canceled and are no longer available to DOD, regardless of whether the  funds were needed in the account to offset any projected losses.

DOD’s comments also stated that projecting gains or losses for foreign  currency to determine the size of the FCFD account opens the door to  greater uncertainty and risk at a time when the department is working to  rebuild readiness and implement the National Defense Strategy. Our  report describes the characteristics of the FCFD account that provide  DOD with flexibility to manage market volatility, thereby helping to  address uncertainty and reduce risk. For example, DOD can make  multiple transfers of funds to the FCFD account throughout a fiscal year in  response to unforeseen foreign currency fluctuations. The FCFD account  can also receive funds from transfers of actual foreign currency gains  and/or unobligated balances. As we also noted, DOD made use of its  authority to transfer expired unobligated MILPERS and O&M amounts  into the FCFD account in the event that actual losses exceeded the  projected amounts and additional transfers were deemed necessary.

We continue to believe that by analyzing actual and projected losses and  basing the transfer of any unobligated balances on these losses, DOD  would be better positioned to determine the size of the FCFD account  balance that is necessary to meet its intended purpose. Further, such  analyses would provide opportunities to more efficiently use unobligated  balances for other defense activities or return the balances to Treasury.

We are sending copies of this report to the Secretary of Defense, the  Under Secretary of Defense (Comptroller), the Secretary of the Army, the  Secretary of the Navy, the Secretary of the Air Force, the Commandant of  the Marine Corps, and appropriate congressional committees. In addition,  the report is available at no charge on the GAO website at  http://www.gao.gov.

If you or your staff have any questions about this report, please contact  me at (202) 512-5431 or russellc@gao.gov. Contact points for our Offices  of Congressional Relations and Public Affairs may be found on the last  page of this report. Key contributors to this report are listed in appendix  III.

To describe the Department of Defense’s (DOD) revised foreign currency  budget rates since 2009 and the relationship between the revised budget  rates and DOD’s projected Operation and Maintenance (O&M) and  Military Personnel (MILPERS) funding needs, we reviewed DOD’s foreign  currency budget rates for the period of fiscal years 2009 through 2017,  and we identified any years during which DOD revised the initial budget  rates. We compared DOD’s initial foreign currency budget rates and  revised foreign currency budget rates with rates published by the U.S.  Treasury Department (Treasury) for fiscal years 2009 through 2017. This  period corresponded with data available to us on DOD’s initial and  revised rates and allowed for use of the most current data available, since  DOD had not yet decided whether or not to revise the fiscal year 2018  budget rates, while we were conducting our audit work. We chose rates  published by Treasury for this comparison because Treasury has the sole  authority to establish for all foreign currencies or credits the exchange  rates at which such currencies are to be reported by all agencies of the  government.

Because Treasury rates are issued quarterly, we averaged Treasury’s  first and second quarter rates for each currency and compared the  Treasury average with DOD’s initial budget rates. Similarly, we computed  an average of the third and fourth quarter Treasury rates for each  currency and compared them with the DOD initial or revised budget rates,  where applicable. These comparisons are meant to show the difference  between DOD’s budget rates and Treasury rates for the first 6 months of  the fiscal year, and the difference between DOD’s revised exchange rates  and Treasury rates for the last 6 months of the fiscal year. Further, we  analyzed the extent to which DOD’s budget rates were within 10 percent  of Treasury rates during these same years. We chose 10 percent as the  basis for our analysis because Treasury’s guidance states that  amendments to the quarterly rates will be published during the quarter to  reflect significant changes in the quarterly data, such as rate changes of  10 percent or more.

Additionally, to understand the effect that revising the budget rates had on  DOD’s O&M and MILPERS funding estimates and on potential gains or  losses due to foreign currency fluctuations, we used a three-step  approach. First, we identified the amount of O&M and MILPERS funds DOD requested for each currency. We converted the U.S. Dollars  requested to the total amount of foreign currency needed by multiplying  the U.S. Dollars requested by DOD’s initial budget rate. Second, we  determined the total amount of U.S. Dollars required using the revised  rates by dividing the total amount of foreign currency needed using  DOD’s initial budget rate by DOD’s revised budget rate. We used this  same approach to determine the total amount of U.S. Dollars required  using the average Treasury rates. Third, we computed the differences in  DOD’s O&M and MILPERS foreign currency funding needs by subtracting  the U.S. Dollars required to meet its foreign currency needs based on the  average Treasury rates from the amounts required based on DOD’s initial  budget rates and DOD’s revised budget rates, respectively. We discussed  further with officials from the Office of the Under Secretary of Defense,  Comptroller (OUSD(C)) the factors considered in revising the rates and  whether those factors are communicated within and outside of the  department.

To evaluate the extent to which DOD has taken steps to reduce costs in  selecting foreign currency rates at which to make disbursements and  determine whether opportunities exist to gain additional savings, we  reviewed accounting standards and any guidelines that exist regarding  disbursements and calculations of foreign currency gains and losses,  such as DOD’s Financial Management Regulation 7000.14-R, which calls  for the use of prevailing foreign currency rates to make disbursements.  We also discussed with agency officials how those guidelines are being  carried out, and whether DOD or the services have developed guidance  that instructs the services in selecting rates used for disbursements in  foreign currencies. Additionally, we examined a non-generalizable  selection of data for DOD disbursements made during the months June  and July 2017 from Treasury’s International Treasury Service (ITS.gov)  system to determine which rates DOD used during this period and what  savings might be achievable from using alternate rates. We chose data  from those 2 months because it was the most recent data available on  disbursements at the time Treasury provided the data for our review.  Additionally, we discussed with officials from OUSD(C) and the services  any analysis and ongoing efforts to transition to more cost-effective rates,  including savings that may result.

To assess the extent to which DOD has effectively managed the Foreign  Currency Fluctuations, Defense (FCFD) account to cover losses, and  maintained quality information to manage these funds, we analyzed DOD  data for fiscal years 2009 through 2016 on foreign currency gains and  losses reported by each of the services as reported in their Foreign  Currency Fluctuation, Defense (O&M) and (MILPERS) reports;  movements of funds between the FCFD account and the services’ O&M  and MILPERS accounts; and the end-of-year FCFD account balances.  We chose this time period in order to capture years in which both gains  and losses were experienced, and for which DOD had complete data on  gains and losses, fund transfers, and end-of-year balances for the FCFD  account. Because the Army charges disbursements to the current fiscal  year appropriation instead of the fiscal year appropriation that incurred  the obligation, we requested that the Army adjust its reported data on  foreign currency gains and losses and provide information consistent with  how the other services report them, and with DOD’s Financial  Management Regulation. However, the Army was unable to provide us  with data that were consistent with what was provided by the other  services at the time of our review. We, therefore, were unable to use  Army data for purposes of comparison with data provided by the other  services. We compared the end-of-year FCFD account balances and the  use of the account with guidelines established in our prior work on the  importance of examining unobligated balances. Additionally, we  reviewed and analyzed DOD financial reports on foreign currency gains  or losses and compared the reports, including any identified  discrepancies, against best practices and standards on accurate reporting  and maintaining quality information, such as those in GAO’s Standards  for Internal Control in the Federal Government, and the Federal  Accounting Standards Advisory Board’s Handbook of Federal Accounting  Standards and Other Pronouncements, as Amended.

To determine the reliability of the data used in addressing these  objectives, we analyzed DOD and Treasury foreign currency rates, data  on DOD foreign currency disbursements, and DOD financial reporting  data on foreign currency gains and losses to identify any missing or  inaccurate information, and we discussed with agency officials any  identified abnormalities and how the information was extracted from  systems, when appropriate. We found the data to be sufficiently reliable  for the purposes of our reporting objectives, with the exception of the  financial reporting on financial gains and losses. Specifically, based on  problems with the completeness and accuracy of DOD’s financial  reporting on foreign currency gains and losses, we found that these data  were not sufficiently reliable for the purpose of computing exact totals for  the gains and losses DOD experienced. However, because DOD uses  these data as the basis for decisions related to management of the FCFD  account, we included the data in our analysis to provide insight into the  scope of gains and losses experienced. We also spoke with OUSD(C),  military service, and Treasury officials regarding the process and systems  used to input the reviewed data and generate the foreign currency reports  we reviewed.

We conducted this performance audit from February 2017 to April 2018 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.

Appendix II: Comments from the Department of Defense

In addition to the contact named above, Matt Ullengren, Assistant  Director; and Tulsi Bhojwani, Justin Bolivar, Carol Bray, Amie Lesser,  Kelly Liptan, Felicia Lopez, Leah Nash, Randy Neice, Jacqueline McColl,  Mike Silver, Roger Stoltz, Susan Tindall, John Trubey, Elaine Vaurio, and  Cheryl Weissman made key contributions to this report.