GAO estimate of unnecessary costs: $5 million.

Time period of GAO report: The GAO draft report was dated June 28, 1963. The review covered the pricing in January 1962 of a Navy letter contract awarded to Bethlehem Steel Co. in 1958. The final report was dated March 18, 1964.

DOD comments on GAO finding: DASD (procurement) by letter of June 1, 1964, enclosing a detailed analysis of the facts by the Navy, questioned the basic finding by GAO that savings of $5 million would have resulted if Navy had permitted the letter contract to stand unpriced until the completion of the job instead of converting it to a fixed-price contract.

GAO's finding assumes that the costs of performance which the contractor actually incurred under the fixed-price contract would have been the same if the letter contract had remained in effect until the completion of the job. This assumption cannot be accepted in view of the strong incentive that a contractor has under a fixed-price contract to keep costs as low as possible and the complete lack of such incentive under a cost-reimbursement type contract (such as the letter contract in this case). In this particular case, the contractor would in fact have had a negative incentive; i.e., an incentive to stretch the contract and continue performance as long as the costs could be passed on to the Government under the cost-type contractual arrangement. Conversion to a fixed-price obviated this possibility.

GAO recommended that efforts be made to obtain a price adjustment from the contractor on the ground that the contractor's cost estimates contained duplications and other overstatements. DOD noted, however, that the Navy relied on its own independent estimates rather than on cost representations made by the contractor. On the basis of these estimates, the Navy strongly questioned the contractor's price proposals. Agreement was eventually reached after protracted negotiations on a fixed-price of $87 million, or about $3.8 million below the price sought by the contractor. Under these circumstances, and since the contract was entered into on a fixed-price basis without provision for price adjustment, DOD concluded that no basis existed for seeking a price adjustment from the contractor.

DOD comments on costs: GAO's estimate of unnecessary costs is based on assumptions, as noted above, with which DOD disagrees.

DOD corrective action: No corrective action is required in this case.

In general, with reference to the problems inherent in letter contracts, the policy of the Department of Defense is that the best way of avoiding these problems is to reduce the use of letter contracts to a minimum. Efforts to achieve this result have been greatly intensified during the past 2 years. As a result, the dollar value of letter contracts has been reduced from over $3 billion in December 1962 to $770 million in May 1964. At the same time, a program has been undertaken to convert existing letter contracts as promptly as possible to definitive contracts in order to avoid problems of the type involved in this report. Navy postscript, May 14, 1965

The pricing decision reached by the Navy in this case was made deliberately and only after thorough consideration of all the pertinent facts. The Navy does not believe that there was any overpricing; therefore, attempts to seek a price adjustment are unwarranted.

GAO Report B-146718, December 11, 1964

37 (a) Title: "Further Comment on Overpricing of the Nuclear Frigate U.S.S. Bainbridge Purchased From the Bethlehem Steel Co., Quincy, Mass." (OSD case No. 1794).

GAO finding: GAO issued report B-146718 on March 18, 1964 which concluded that the Navy paid Bethlehem more for this ship than was warranted on the basis of available cost data and the circumstances existing at the time of negotiations. GAO therefore recommended that DOD take action to obtain a price adjustment. The DOD replied to this report on June 1, 1964 and stated that this was a fixed price contract, there was no misrepresentation of any sort and there is no contractual or other legal or equitable basis to seek a price adjustment. The GAO then issued the subject report which reiterates the GAO position taken in the earlier report; i.e.. that the Navy should not have contracted with Bethlehem on

a fixed-price basis when only 25 percent of the work remained to be completed but should have let the work be completed under the cost-type letter contract. Presumably, this would have resulted in less cost to the Government. The GAO again recommended that action be taken to obtain a price adjustment.

GAO estimate of unnecessary costs: $5 million.

Time period of GAO report: December 1961.

DOD comments on GAO finding: There is no disagreement as to the basic facts. The disagreement arises as to whether the Navy was justified in acting as it did with respect to the facts. The issue is a pure matter of judgment and the Navy concluded that it was in the best interest of the Government to agree to a fixed-price contract for $87 million rather than permit the letter contract to run on to completion. The grounds for this decision were that the costs probably would have exceeded the $87 million had the letter contract been permitted to run out.

DOD comments on costs: No overpricing occurred under the circumstances. DOD correctice action: The Navy decision on the Bainbridge was informed and deliberate and was made only after thorough consideration of the pertinent facts. This decision did not result from misrepresentation of any sort; accordingly, there is no basis in law or equity for the Government to attempt to set aside the resultant contract and seek a price adjustment. DOD believes strongly in using contract procedures that exploit the profit motive to the fullest as a primary means for inducing greater efficiency and lower costs. Current policies therefore encourage the use of fixed-price and other types of contracts that make effective use of this motivation while discouraging contracts in which this motivation is lacking.

GAO Report B-146877, April 8, 1964

38 Title: "Improper Charges to Government Cost- and Incentive-type Contracts Held by Grumman Aircraft Engineering Corp., Bethpage, N.Y., Department of the Navy" (OSD case No. 1840).

GAO finding: Grumman improperly charged Government cost- and incentivetype contracts with $188,000 in costs incurred under other contracts from 1958 through 1961. The other contracts were for research and development projects that were of primary interest to Grumman.

GAO estimate of unnecessary costs: $188,000.

Time period of GAO report: GAO's review was made in 1963 and was directed to the calendar years 1958 through 1961.

DOD comments on GAO finding: The Assistant Secretary of Defense (Comptroller) by letter of November 27, 1963, to GAO stated "The Department of Defense and the Department of the Navy concur with GAO that the costs in question were erroneously charged to Government contracts and that the Armed Services Procurement Regulation prohibits reimbursement of such costs under cost-type contracts."

DOD comments on costs: During the calendar years 1958 through 1961 Grumman improperly charged Government incentive- and cost-type contracts with losses on fixed-price contracts totaling about $188,000. Navy auditors questioned $93,000 of the losses charged to the incentive-type contracts and the contracts were reduced accordingly but at the time of the GAO review they had failed to question the $95,000 improperly charged to cost-type contracts. After the GAO brought the findings to the attention of Grumman, adjustments were made to eliminate the $95,000 of improper charges from the Government cost-type contracts.

DOD corrective action: In accordance with GAO's recommendation the Deputy Assistant Secretary of Defense (accounting and audit) by memorandum dated October 16, 1963, requested the Chiefs of the Military Audit Agencies and the Audit Division, Defense Supply Agency to reemphasize to field auditors that whenever improper charges are detected on one contract or group of contracts, there is a need to review the appropriateness of similar charges to other contracts that might be affected.

Navy postscript, May 14, 1965

The Navy Comptroller on December 10, 1963, provided further guidance to all auditor personnel.

GAO Report B-146751, June 30, 1964

39. Title: "Overcharges to the Government for Change Orders Issued Under Navy Contracts Awarded to the Ingalls Shipbuilding Corp., a Division of Litton Industries, Inc., Pascagoula, Miss. (OSD case No. 1785).

GAO finding: In the pricing of a group of change orders issued under shipbuilding contracts awarded to the Ingalls Shipbuilding Corp. by the Navy, the Government was overcharged because the contractor's estimates were excessive in relation to the most current and accurate cost data available prior to price negotiations, or did not allow sufficient credit to the Government for cancellation of items included in the price of the shipbuilding contracts, or contained mathematical errors.

GAO estimate of unnecessary costs: A net of $160,400.

Time period of GAO report: Fiscal year 1957 through 1963-GAO field work was performed intermittently during July 1962 to June 1963.

DOD comments on GAO finding: It would not be appropriate to institute action to recover the alleged overcharges cited in the report which are based on GAO's disagreement with the method employed by the Navy in pricing change orders. DOD considers the Navy method to be the most sound and desirable from the Government's point of view and guidelines for the uniform application of this method are now being developed for inclusion in a DOD pricing manual.

DOD comments on costs: It is considered that there is no basis for recovery from the contractor under all but 3 of the 16 cases examined in detail by the Navy. The Navy will seek recovery of $5,496 under one change order and equitable adjustments in the case of two others. The potential dollar recovery is not sufficient to warrant the expenditure of time and money that would be required for review of the remaining 1984 change orders included in the GAO report. DOD corrective action: An audit will be made of all future proposals for pricing changes involving a gross value of $50,000 or more per change.

Navy postscript, May 14, 1965

Negotiations are pending with the contractor for recovery of $5,496.

GAO Report B-146900, June 30, 1964

40. Title: "Overcharges for Aircraft Products Liability Insurance Under Various Contracts Awarded to Pratt & Whitney Aircraft Division of United Aircraft Corp., East Hartford, Conn." (OSD case No. 1837).

GAO finding: During the years 1955 through 1961, Pratt & Whitney charged the Government $2,200,000 of the costs of providing aircraft products liability insurance on items sold commercially. Certain adjustments have been made to 1962 contracts and such charges will not be allowed under future contracts. GAO estimate of unnecessary costs: $2,200,000.

Time period of GAO report: The GAO review was made during the period May through September 1963 and covered actions taken by Pratt & Whitney during the years 1955 through 1961.

DOD comments on GAO findings: The Department of the Navy does not agree with the accounting principles or factual conclusions recited in the report.

DOD comments on costs: The Department of the Navy does not disagree with GAO's estimate of this particular cost. However, there is not legal or equitable basis for recovery. The contracts have finally been settled. To reopen negotiations with respect to this particular item of overhead would expose all other items of overhead to reconsideration. This could be prejudicial to the Government's interest because of the substantial overall benefit to the Government believed to have accrued to the Government as a result of Pratt & Whitney's methods of cost distribution.

DOD corrective action: The Department of the Navy took exception to $305,000 in costs for aircraft products liability insurance in the final pricing of contracts for 1962. Action was taken to insure that aircraft products liability insurance not ratably charged to the Government would be questioned in future advisory reports.

Navy postscript, May 14, 1965

Agreements reached by a tri-service negotiation group and the contractor on April 7, 1965, resulted in deletion from overhead expenses applicable to costs reimbursement contracts, of those amounts included for product liability insurance covering the years 1962 and 1963.

GAO Report B-152600, July 31, 1964

41. Title: "Overpricing of Survival Kit Equipment Furnished by Rocket Jet Engineering Corp., Glendale, Calif., to Scott Aviation Corp., Lancaster, N.Y., for the F-4 Aircraft Program" (OSD case No. 1941). GAO finding: Scott Aviation repeatedly accepted subcontract prices proposed by Rocket Jet on sole-source procurements of survial kit components for F4 aircraft without benefit of cost data or other evidence of the reasonableness of the prices. In addition, in awarding a subcontract to Rocket Jet in 1963, Scott Aviation violated Public Law 87-653, as well as the terms of the contract it held by failing not only to obtain pricing certification, but also to include a contract provision giving the Government the right to recover any overpricing. GAO estimate of unnecessary costs: $317,000.

Time period of GAO report: 1961 through 1963.

DOD comments on GAO finding: DOD agrees with GAO finding.

DOD comments on costs: DOD agrees with GAO estimate.

DOD corrective action: Auditor General of the Navy has taken action to disallow part of the excess costs. As a consequence, the prime contractor has not made payment to Scott. The Navy has taken appropriate steps to recover the balance of the excess costs without prejudicing any other rights that the Government may have. DOD has developed policies and procedures which are now in effect to ensure satisfactory subcontract pricing by review and evaluation of contractors' purchasing systems and by the review of individual subcontracts. Navy postscript, May 14, 1965

The Department of Justice is currently considering a proposal for settlement.

GAO Report B-132998, August 4, 1964

42. Title: "Unnecessary Costs Incurred in the Procurement of Ground Speed and Distance Indicators From Douglas Aircraft Co., Inc." (OSD case No. 1892).

GAO finding: The GAO concluded that the Navy incurred unnecessary costs of approximately $200,000 as a result of the premature procurement of a production quantity of an aircraft ground speed and distance indicator for a loft bomb release computer system before an acceptable indicator was developed and before any assurance existed that an acceptable indicator could be developed. GAO estimate of unnecessary costs: $200,000.

Time period of GAO report: GAO review: March through July 1963. Time period of DOD actions reviewed: mid-1957 through mid-1959.

DOD comments on GAO findings: It is considered that the Navy decision to procure the indicators was not unreasonable or unwarranted in the circumstances. When the decision was made, it was recognized that technical problems would likely appear, but the technical principles involved were within the state of the art. Navy personnel concerned judged that the effort to provide the indicators in production quantities for operational use was reasonably likely of success and warranted by the operational advantages to be gained. The timing of placement of purchase orders for the indicators, considering governing contractual aircraft delivery schedules, are not considered imprudent or improper. Navy investigation indicates that decision to terminate the indicator effort and resort to a different device was affected by considerations additional to difficulties in achieving satisfactory quantity production of the indicators.

DOD comments on costs: In view of the circumstances as outlined in paragraph 5 above, the computer effort and its attendant costs were not unwarranted expenditures.

DOD corrective action: Consideration is being given to a proposed change to ASPR 3-903.4 to emphasize the need for the contracting officer to assure that the proposed purchase is in accordance with prudent business practices, after verifying the technical justification of the particular supplies, equipment or services. In addition, directives regarding Government approval of subcontracts now provide detailed guidance to Navy contracting officers to protect the interest of the Government.

Navy postscript, May 14, 1965

An ASPR Subcommittee has studied and endorsed the recommendation that ASPR 3-903.4 be supplemented to require contracting officers to assure the technical justification for selection of particular supplies, equipment, or services.

GAO Report B-146932, October 1, 1964

43. Title: "Unnecessary Costs Incurred in the Procurement of Defective Torpedo Tubes From the Youngstown Welding and Engineering Company, Department of the Navy" (OSD case No. 1952).

GAO findings: The Navy incurred unnecessary costs in the purchase of torpedo tubes from the Youngstown Welding & Engineering Co. because the contractor produced defective tubes; the defects were not detected by Navy inspection and the Navy failed to properly protect this material during removal and shipment back to the manufacturer's plant for rework. Navy made specification changes to overcome the contractor's defective welds.

GAO estimate of unnecessary costs: $214,500.

Time period of GAO report: GAO field work was completed in October 1963 and covered the NSC Oakland firm fixed-price contract dated June 21, 1961, and subsequent actions.

DOD comment on GAO findings: Navy agreed with the findings and recommendations except those alleging that specification changes were issued to overcome the contractor's defective welds.

DOD comments on costs: The Navy agreed with the GAO estimate of unnecessary costs except that portion of $129,000 attributable to Navy-desired changes in specifications. These changes, from monel-clad to solid monel material were made to correct known fleet operational defects.

DOD corrective action: The Navy is pursuing action to effect appropriate recovery from the contractor. The report has been brought to the attention of general inspection offices to illustrate adverse consequences of not following prescribed inspection procedures.

Navy postscript, May 14, 1965

The Navy directed, on April 26, 1965, the accomplishment of an internal reappraisal of the technical, legal and economic issues in this case, with emphasis upon effecting appropriate recovery of any costs incurred for which the contractor should be held liable.

GAO Report B-146946, October 2, 1964

44. Title: "Unnecessary Costs Incurred in the Purchase of Automatic Flight Control Systems for A-4 Series Aircraft, Department of the Navy" (OSD case No. 1964).

GAO finding: The Government incurred unnecessary costs of about $1.1 million in the procurement of the A-4 series aircraft because the Bureau of Naval Weapons purchased Automatic Flight Control Systems (AFCS) through the Douglas Aircraft Co., instead of purchasing them directly from the actual manufacturer. It should have been apparent to the Bureau as early as November 1960 that the continued involvement of Douglas in the procurement of this subsystem was no longer essential because the subsystem had been proven reliable and fully operational through extensive test programs and it was readily obtainable from Eclipse-Pioneer. The Bureau, however, took no action to authorize the purchase of this subsystem from Eclipse-Pioneer until fiscal year 1964 procurement of A-4E-type aircraft.

GAO estimate of unnecessary costs: $1,067,454.

Time period of GAO report: Fiscal years 1962 and 1963. GAO field work was completed November 1963.