The department had spent millions of dollars subsidising the lifestyle of military personnel, The Sydney Morning Herald reported on Tuesday.
Purchases included oil paintings and custom-made furniture, membership of exclusive clubs, first-class flights and five-star hotel accommodation.
Foreign Minister Stephen Smith said the department was going through an "enormous" cost-saving exercise of $20 billion over the next 10 years.
"You can always make anything in government expenditure seem extravagant if you want to by focusing on one particular matter," he told Sky News of the report.
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"Of course, we want to make sure there is no lavish expenditure, there's no waste."
