on work brought into the plant which previously had been performed by another division of General Motors.

Our review of statistical data prepared by the contractor from experienced costs of the first 71 airplanes produced under the contract, and projected forward, disclosed a clerical error in the original estimate of 1,600 hours per airplane. The difference amounted to an overstatement of direct labor costs of $736,000. The contractor's direct labor estimate was overstated also by an additional $106,000, the difference between the amount of direct-labor inventory in process included in the proposal and the amount of such labor as shown by the contractor's records. Consequently, the cost information used in the negotiations did not conform to the contractor's actual experience.

Although the Air Force reduced the contractor's direct labor projections by 1,500 hours, this reduction was apparently made to reflect anticipated efficiencies and not to correct errors in the contractor's proposals. We believe that, if the contracting officials had been aware of the errors in the contractor's proposal, they would have applied to the corrected estimate an adjustment for anticipated efficiency, thereby obtaining further price reductions. That such an adjustment would have been appropriate appears to be demonstrated by the fact that actual direct labor for this phase of the contract was about 19,700 hours per airplane compared with the 23,000 hours accepted by the Air Force in negotiations.

The contractor has stated that the projected hours were the results of the best thinking of management based on facts available at the time the forecast was made. However, he agreed that the directlabor hours' projection was overstated, through a clerical error, to the extent of 1,006 hours per airplane. This amounts to an overstatement of about $461,000 compared with the $736,000 which we estimated. The contractor agreed, also, that the direct labor in process appears to have been overvalued and stated that the cause is undetermined. I refer you to appendixes B and C of our report. The Air Force informed us that

while the negotiators did review the contractor's presentation in some detail, the hours used in developing the revised price resulted from independent analyses and studies by the negotiators utilizing industry man-hour averages and the experience of other contractors on like airplanes. Therefore, while the contractor's presentation was in error, the error was not reflected in the hours computed by the negotiators.

We believe that use of data unrelated to experience of the contractor on the contract being repriced is not a sufficient guide to the reasonableness of the price being negotiated and should not be substituted for review and analysis of the contractor's own experience. Further, it seems clear that, when a contract provides for price revision on the basis of cost experience, the contract-pricing technique should be tied primarily to the experience of the contractor involved rather than to the costs of other producers.

In our opinion, contractors' labor projections included in pricing proposals should be adequately analyzed and evaluated by contracting officials in order to correct errors such as those indicated above and to determine the reliability of labor trend projections used in establishing contract prices.

With respect to the third element, which constitutes the manufacturing overhead estimate: A thorough analysis and evaluation of

experienced cost data could have resulted in a reduction of the contractor's estimated manufacturing overhead by approximately $15,000 per airplane or a total of $4,500,000.

The contractor's revised proposal for the final 300 airplanes to be produced under the contract included $69,000 per unit for manufacturing overhead, which was reduced in negotiations to $66,500 per unit. However, overhead cost data available at the time the contractor submitted his proposal indicated that, immediately prior to the redetermination point, 76 airplanes had been produced at an average manufacturing overhead cost of $59,000 per airplane and that the average unit cost of the last 26 airplanes of that group had decreased to $53,400. The average cost per airplane could have been expected to continue decreasing over the runout portion of the contract until phase-out conditions arose on the last few airplanes. Such a decrease actually did occur, and the average manufacturing overhead costs for the runout portion of the contract totaled $48,000 per airplane. This was about $6,300,000 less than the manufacturing overhead included in the contractor's proposal and about $5,550,000 less than the amount included in the price negotiated.

In commenting on the manufacturing overhead used in his proposal, the contractor, in a letter dated May 3, 1956- see appendix B in our report-stated:

It is not agreed that our experience on the last 76 airplanes of the second segment would have been a basis for forecasting the burden expenditures for the 300 airplanes, for the reason that it did not give effect to phasing out the program.

This reply by the contractor does not evidence consideration of the substantial efficiencies which should have been anticipated in production of the last 300 airplanes and that phase-out conditions would arise only on the last few airplanes. Further, in estimating the overstatement of manufacturing overhead, we took into consideration anticipated phase-out costs estimated by the contractor.

In comments furnished to us on June 18, 1957-see appendix C, page 35, of our report-the contractor included data on the amounts of manufacturing overhead incurred monthly and the number of planes delivered monthly during the period July 1953 through February 1955 to show that overhead was constant in the face of fluctuating deliveries. Since manufacturing overhead was applied by the contractor on the basis of production, not on deliveries, there is no direct relationship between overhead incurred and the number of planes delivered. Therefore, this data does not furnish a sound basis for evaluation of the reasonableness of the contractor's proposed overhead.

We believe that (1) the overhead cost included in the price negotiated was unreasonably high in view of the lower overhead cost experienced on prior production and in view of the prevailing cost trends available at the time of negotiations and (2) analysis of the contractor's experienced and projected manufacturing overhead would have made evident the contractor's failure to fully recognize in his proposal the declining cost trends.

With respect to the fourth or general and administrative expense estimate: Analysis of the contractor's experienced general and administrative expense showed that the amount negotiated exceeded by $355,000 the amount which could have been reasonably anticipated.

We found that the contractor's experienced general and administrative expense for the 6-month period preceding submission of the contractor's price proposal averaged $149,300 a month. We projected this average over the remaining 512 months of the contract, in accordance with the delivery schedule agreed upon by the contractor and the Air Materiel Command, and included, in addition, $150,000 for phase-out costs. On this basis our estimate of general and administrative expense for the runout portion of the contract totaled $970,000 compared to the negotiated amount of $1,325,000. The general and administrative expense actually incurred for the runout portion of the contract was $557,000, or $768,000 less than the amount included in the negotiated price.

In commenting on our opinion that general and administrative expense could have been projected on a more reasonable basis, the contractor stated:

At the time of price reset on this last segment, there were many phase-out items of cost that we could foresee as factors influencing our third segment manufacturing and general and administrative costs, and we included them as we saw them as of that date. This method of pricing may appear to give little consideration to burden rates and past trends; however, we believe that each of these items was given due consideration in estimating the expenditure necessary to complete the contract, as conditions then appeared.

These comments are included in appendix B of our report.

We believe that contractors' cost projections should be based on recent cost experience as projected over the anticipated period of performance of the contract and that any other factors influencing the projections should be clearly set forth in the proposals and thoroughly evaluated for use in negotiations.

Spare parts for mutual defense assistance program

The price for spare parts to be delivered under the contract for the mutual defense assistance program (MDAP) was revised on the basis of cost experience through the delivery of the 210th airplane rather than through delivery of the 299th airplane as provided by the contract. Costs experienced through the date of delivery of the 299th airplane would have provided a basis for establishing a contract price about $333,000 less than the amount negotiated.

For purposes of establishing a price for spare parts to be delivered after the acceptance of the 299th airplane, the contractor submitted a price-revision proposal which included experienced cost for spare parts delivered through the acceptance of the 210th airplane, when only 10 percent of the spare parts had been delivered. The prices for undelivered spare parts were adjusted in negotiations on the basis of this proposal even though cost experience through delivery of the 299th airplane was available at the time of the negotiations. The contractor proposed a price reduction in spare-parts prices of $825,000, and an additional reduction of $25,000 was agreed upon in negotiations. If costs experienced through the delivery of the 299th airplane had been used as provided by the contract, at which time 25 percent of the spare parts had been delivered, there would have been a reasonable basis for a further reduction at negotiations of about $333,000.

The contractor stated, as contained in appendixes B and C of our report, that the cost of each spare part remaining unshipped at delivery of the 210th airplane was reestimated and that the cost statement played a very small part in the negotiation of the agreed-upon

price for MDAP spares. The contractor further stated that the cost statement relative to MDAP spares was submitted after delivery of the 210th airplane in accordance with a mutual arrangement between representatives of AMC and General Motors, and the contractor did not agree in principle that, if the price had been reset on the basis of the 299th plane, they would have had more sound support than they actually used.

We believe that the contractor's proposal did not include sufficient cost experience to provide a satisfactory basis for establishing revised prices for undelivered spare parts and that the Air Force should not, therefore, have entered into an arrangement with the contractor to use earlier cost data than was provided for by the terms of the

contract.

With reference to the statement by the contractor that the cost statement played a very small part in the negotiation of a price for spare parts, we believe that costs experienced are an important factor in estimating costs of future production of similar items and should be given full consideration in establishing contract prices.

Administrative audit

The contracting officer requested the auditor general's office to submit an advisory audit report for use in price-redetermination negotiations under the contract. The Air Force auditors reviewed incurred costs and the contractor's basis for allocation of costs between commercial and defense work. The Air Force auditors also compared incurred costs with the contractor's proposals, but a review and evaluation was not made of the projected portions of the contractor's pricing proposals.

Our findings in this case show that a review by audit personnel of the accounting techniques used by the contractor in preparing forward-pricing estimates would have developed important information for use in negotiation of prices. Examples of areas where audit personnel could have been of particular assistance to Air Force contracting officials are the review of priced bills of materials, labor statistics, and overhead cost trends and forecasts which were used as a basis for estimates contained in the contractor's proposal.

We believe that agency auditors, by virtue of their professional training and the intimate knowledge developed in their examination of experienced cost and other operating data, should be in a position to give contracting officials valuable information concerning contractors' projected costs. Since existing procurement instructions did not provide for review by administrative auditors of contractors' cost projections, we recommended to the Air Force that these instructions be revised to provide for the Air Force auditors to review contractors' projected costs and that advisory audit reports include the auditors' opinions as to the reasonableness of such projections. We recommended, also, that steps be taken to assure that both contracting and auditing personnel recognize the importance and value of agency auditors' evaluations of contractors' cost projections.

In response, we were informed by the Assistant Secretary of the Air Force (Materiel) that the Air Force feels that agency auditors should make recommendations concerning the accuracy and reliability of contractors' cost representations. The Assistant Secretary

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further stated that the Air Force had a major share in developing part 8, section III, armed services procurement regulation (ASPR), issued February 1, 1957, subject, Price Negotiation Policies and Techniques, which provides in paragraph 3-809 that audit reports for either retroactive or prospective pricing should not only establish costs accrued to a specific cutoff point for price-proposal purposes but should also include cost trends and other available information which would be of assistance to contracting officials in price negotiations. We believe that full utilization by contracting officials of the services of their agency auditors in reviewing and reporting on contractors' forward cost and price proposals would be of material assistance to those officials in negotiating reasonable contract prices.

Action taken by the Air Force--more effective pricing negotiations

The Assistant Secretary of the Air Force (Materiel) in a letter dated March 28, 1957-see appendix A of our report-agreed with us that the high rate of profit actually earned by the contractor in this instance was attributable in part to the failure of contracting officials to analyze and evaluate effectively the contractor's forward-pricing proposals. He concurred in our recommendation that the importance of adequate review of contractors' cost projections be emphasized to contracting officials and informed us that this would be done.

The Assistant Secretary informed us that the following specific measures have been or will be taken by the Air Force to improve the effectiveness of pricing negotiations.

1. An advanced course in pricing has been developed and is being given to key procurement personnel.

2. Selected examples of deficient procurement practices will be brought to the attention of contracting officials through the medium of "pricing bulletins."

3. A section on the role of agency audit in prospective pricing has been added to the armed services procurement regulation, with Air Force participation in its development.

4. AMC and the auditor general are working together to establish the best possible working team relationships between procurement and audít personnel.

We believe that the attention which the Air Force is giving to the need for improving contract negotiations should have a salutary effect on pricing actions. The specific measures described by the Assistant Secretary of the Air Force should result in more complete utilization of the talents of agency auditors, more adequate analysis of contractors' cost projections, and more effective price negotiations, particularly of the forward portion of price-redeterminable con

tracts.

Refund requested from the contractor

Our review indicated that General Motors Corp. has a voluntary refund policy which provides for refunding to the Government the amount by which profit realized is more than 25 percent greater than the rate of profit negotiated. In April 1956 we reported the existence of this policy to the Air Force, and, at a conference at AMC in May 1956, we discussed this policy with Air Force officials who stated that the applicability of the refund policy to this contract would be followed up. AMC also advised us that the existence of a General