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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 oflicer requested the auditor general's oslice 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
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 audit 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 contracts. 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 Motors' refund policy was not known to the Air Force negotiators until it was brought to their attention in our report. In a letter to General Motors dated June 14, 1956, AMC requested a refund. See appendix A. In a reply dated June 27, 1956, General Motors rejected this request and, in part, made the following statements-see appendix C, exhibit E, for the full text of the General Motors reply:
May we also point out that the adjustment of contract prices to effect a revision of earned profit ratios is a matter for internal consideration by General Motors in the overall administration of its affairs and does not constitute a commitment of any nature.
You may be advised that we have considered our profit position in the instant case and it was, and is, the final decision of General Motors that there is no reason to further revise the F-84F contract prices.
On September 26, 1956, and again on January 3, 1957, the Deputy Director for Procurement, AMC, discussed with the comptroller, General Motors Corp., the subject of a refund on this contract. The contractor declined to make a refund and, with reference to the existence or operation of General Motors' policy on adjustment of contract prices, advised the Air Force that this was an internal matter and that the contractor considered the matter closed.
In the letter of June 18, 1957, General Motors Corp. restated its previous position that the contract price was reasonable and that no price adjustment was contemplated. In addition, the contractor stated:
This contract was subject to the Renegotiation Act of 1951 and profits earned on the contract have been included in the overall profits of General Motors Corp. on defense business reported to the Renegotiation Board for each of the years of contract performance.
See appendix C, page 37, of our report.
Also, the contractor stated that renegotiation proceedings have been completed through 1954. In this connection, it should be noted that the bulk of the airplanes covered by this contract were delivered to the Government in 1955.
To summarize, Mr. Chairman, General Motors Corp. realized profits of $17,459,000 on this contract in excess of that contemplated in negotiation. We believe that a portion of this additional profit was attributable to good performance by the contractor but that $8,322,000 of the additional profit was due to overestimates included in the contractor's pricing proposal. Failure of the Air Force to recognize and eliminate these overestimates in the proposal resulted in unreasonably high prices being paid by the Government.
General Motors Corp., whose comments were included in our report, did not disagree with the facts presented by us but did disagree with our conclusions and stated that they considered the contract price to be reasonable.
The Assistant Secretary of the Air Force (Materiel) in a letter dated March 28, 1957—see appendix A-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. We 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.
He informed us that specific measures have been or will be taken by the Air Force to improve the effectiveness of pricing negotiations. We propose to evaluate the effectiveness of these measures during the course of our regular audit work.
Mr. Chairman, with your permission, I would suggest that the following appendixes and exhibits, as included in our report, be included in the record.
Mr. HÉBERT. Without objection.
Mr. POWERS. Appendix A, which is a letter, dated March 28, 1957, from the Assistant Secretary of the Air Force to the Comptroller General of the United States commenting upon the draft of our report.
Appendix B is a letter and attached comments from Mr. T. P. Murphy, resident comptroller, to Mr. Forrest R. Browne, regional audit manager, United States General Accounting Office, Kansas City, Mo. The letter is dated May 3, 1956.
Mr. Murphy is the resident comptroller of Buick-Oldsmobile-Pontiac assembly division, General Motors Corp., Kansas City, Kans.
Appendix C is a letter dated June 18, 1957, from John F. Gordon, vice president, General Motors Corp., Detroit, Mich., to the Honorable Joseph Campbell, Comptroller General of the United States, including General Motors Corp. comments on the draft of our report.
Appendix C, exhibit A, is a letter from H. H. Curtice, executive vice president, General Motors Corp., dated April 21, 1951, to Brig. Gen. Phillips W. Smith, Chief, Procurement Division, Wright-Patterson Air Force Base, Dayton, Ohio.
Appendix C, exhibit B,'is a letter from Brig. Gen. Phillips W. Smith, Chief, Procurement Division, Headquarters, Air Materiel Command, to Mr. H. H. Curtice, executive vice president, General Motors Corp. The letter is dated May 9, 1951.
Appendix C, exhibit C, is a letter, dated August 13, 1951, from H. H. Curtice, executive vice president of General Motors Corp., to Brig. Gen. Phillips W. Smith, Chief, Procurement Division, WrightPatterson Air Force Base, Dayton, Ohio.
Appendix C, exhibit D, is a letter, dated October 25, 1956, from John F. Gordon, vice president, General Motors Corp., to Brig. Gen. William T. Thurman, Deputy Director of Procurement, Directorate of Procurement and Production, Headquarters Air Materiel Command.
Appendix C, exhibit E, is a letter, dated June 27, 1956, from Mr. John F. Gordon, vice president, General Motors—vice president, Buick-Oldsmobile-Pontiac assembly division, General Motors Corp., to the commander, Headquarters, Air Materiel Command, WrightPatterson Air Force Base.
Appendix D is a letter, dated July 8, 1957, from the Honorable Joseph Campbell, Comptroller General of the United States, to the Secretary of the Air Force.
That concludes our testimony, Mr. Chairman. (Appendixes A, B, C, and Dare as follows:)
DEPARTMENT OF THE AIR FORCE,
Washington, March 28, 1957. The honorable the COMPTROLLER GENERAL OF THE UNITED STATES.
DEAR MR. COMPTROLLER GENERAL: I refer to the draft, informally submitted to us for comment by your Defense Accounting and Auditing Division, of a