GAO Report B-146717, May 25, 1964 60. Title: "Overstated Cost Estimates Included in the Initial Target Prices of Incentive Contracts AF 33 (600) --36319 and AF 33 (600)-38098 With the Boeing Co., Seattle, Wash., for the Bomarc 'A' Weapon System" (OSD case No. 1805). GAO finding: The initial target prices negotiated by the Air Force and Boeing for the production of Bomarc A missiles under two Air Force contracts included certain proposed costs which were overstated by about $23,034,500. The overstated initial target costs made available to Boeing additional profits of at least $2.303,450. GAO estimate of unnecessary costs: $2,303,450. Time period of GAO report: April 1958 through May 1960. DOD comments on GAO finding: Air Force partially concurs with GAO finding. DOD comments on costs: Air Force is of the opinion that downward adjustments of $11,284,828 in target prices should be sought rather than $23,034,500. DOD corrective action: Air Force has already obtained downward adjustments of $3,927,204 in initial target prices with resultant savings of $392,720 in profits. Further negotiations have been discontinued because the report has been referred to the Department of Justice in accordance with the current policy of bringing all cases of this type to the attention of Justice before completing administrative action. Problem ADDITIONAL COMMENTS BY THE DEPARTMENT OF THE AIR FORCE GAO alleges that the initial target costs for the subject contracts were overstated by about $23,034,500 because costs proposed by Boeing and negotiated with the Air Force (1) were not based on available current cost or pricing data even though Boeing certified that such data were used for contract-38098, (2) were not properly related to the requirements of the contract, (3) were not based on reasonably firm designs and specifications, and (4) were not adequately evaluated. GAO recommendations (a) That the Secretary of the Air Force take aggressive action to obtain appropriate adjustment of the overstated initial target costs discussed in this report and, in coordination with the Department of Justice before an administrative settlement of contract -38098 is reached, take steps to enforce rights which the Government may have because of the false certificate given by the contractor with respect to making known to the Air Force negotiator all available cost and pricing data for his use in evaluating Boeing's cost proposal. (b) That the Secretary of Defense establish policies, and have appropriate officials establish criteria and procedures to properly implement such policies, which will provide (1) that, whenever adequate data for the development of realistic estimates of the probable cost of future production for areas of contract cost or performance are lacking, negotiation of prices be deferred for those areas until such time as sufficient and adequate data for developing realistic prices become available, (2) that, wherever an audit of a contractor's initial price proposal is appropriate, the audit be performed, whenever practicable, prior to negotiating contract prices and that where it is impracticable to perform the audit before prices are negotiated, the audit be performed as soon as possible after the prices are negotiated, and (3) that, where it is found that prices included in the contract are not based upon the most accurate, complete, and current pricing information or experience available when the contract prices were negotiated, the contracting officer negotiate prompt adjustment of all such prices and initiate action to enforce all rights that vest in the Government because the contractor used cost or pricing data that were inaccurate, incomplete, or not current. Statement The Air Force agrees that overpricing occurred under the two contracts, but we believe the initial target prices were overstated by about $11,284,828, rather than $23,034,500 as indicated by GAO. It is the Air Force opinion that Boeing could not have reasonably been expected to quote prices low enough to account for the difference of $11,749,672, and we, therefore, disagree with GAO to that extent. There are 14 different areas of overpricing involved. As of the present time, the Air Force has negotiated total downward adjustments of $3,927,204 in initial target prices under the two contracts. The case is now under review by the Department of Justice, Civil Division, to determine whether or not there was fraud on the part of Boeing. The Air Force is precluded from any further effort to obtain additional downward price adjustments until the Department of Justice advises us of the results of its examination. The Air Force agrees with the objectives of the three policy recommendations. The first such recommendation is concerned with the basic need for obtaining adequate pricing data from contractors before prices are established. Procedures have been adopted and vigorously implemented to insure that adequate cost or pricing information is obtained and thoroughly considered by contracting personnel before prices are agreed upon. In cases where adequate data cannot be obtained, the regulations make it clear that firm fixed-price and fixed-price-incentive contracts will not be used. ASPR 3-404.4 states explicitly that fixed-price-incentive contracts are not to be used "where cost or pricing information adequate for firm targets is not available at the time of initial contract negotiation or at a very early point in performance." Further, in connection with firm fixed-price contracts, ASPR 3-404.2 states that such contracts are suitable where "cost or pricing information is available permitting the development of realistic estimates of the probable cost of performance." Existing policy is, therefore, consistent with the GAO recommendation requiring contracting officials to evaluate the adequacy of available data, not only for purposes of establishing prices, but also for the purpose of selecting the appropriate form of contract. On the other hand, existing policy emphasizes the value of firm fixed-price and incentive contracting. After-the-fact pricing may be the soundest approach in a very limited number of situations, however, such pricing gives the contractor little or no incentive to attempt to reduce costs. Accordingly, advance pricing and fixed-price contracting is favored, whenever this can reasonably be done, and it is believed that such pricing is practicable even though uncertainties exist which cannot be fully resolved at the time of negotiation. This view is expressed in ASPR 3-404.2, which provides with respect to firm fixed-price contracts that such contracts are suitable where "the uncertainties involved in contract performance can be identified and reasonable estimates of their possible impact on costs made, and the contractor is willing to accept a firm fixed price at a level which represents assumption of a reasonable proportion of the risks involved." Because the prudent use of fixed-price contracting can mean very substantial savings to the Government, DOD policy seeks to emphasize both factors—first, the need of assuring that sufficient information is available to permit reasonable predictions of future costs and, second, the importance of recognizing that this does not preclude a reasonable degree of uncertainty as long as the risks are identifiable and both parties are willing to assume the risks and share them on a fair and equitable basis. Subject to the above comments, the first recommendation in the report dealing with procurement policy is concurred in. Respecting the second policy recommendation, DOD policy on "audit as a pricing aid" is stated in ASPR 3-809. Audit reviews are obtained not only to verify contractors' data on cost previously incurred but also to assist in evaluating contractors' projections of future costs by obtaining information on cost trends, labor efficiency curves, and other pertinent data. By Headquarters USAF letter of May 7, 1964, appropriate Air Force procurement and audit personnel were instructed that Air Force audit review is mandatory in the case of any contractor proposal of $250,000 or more, except if the potential contract or amendment thereto is to be cost plus fixed fee, in which event audit is mandatory if the proposal is $350,000 or more. In addition, audit may be requested by the contracting officer when considered appropriate, even when the proposal is for less than $250.000. Respecting the third policy recommendation, ASPR 7-104.41 makes post-pricing reviews possible by providing a contractual right for contracting officers and their authorized representatives to examine contractors' records for the purpose of verifying cost and pricing data in fixed-price noncompetitive procurements. By this means, practical effect can be given to ASPR 7-104.29 which provides for price adjustment in cases where the contracting officer determines that the contract price was significantly increased because of defective cost or pricing data. Status: Case open. Pending advice from Justice Department. Air Force may or may not find it necessary to resume negotiations with Boeing to obtain further downward price adjustments, depending upon whether or not Justice makes a settlement with Boeing. GAO Report B-118663, June 9, 1964 61. Title: "Overstatement of Contract Target Price Negotiated with American Bosch Arma Corp., Arma Division, Garden City, N.Y." (OSD Case No. 1865). GAO finding: The target cost negotiated was overstated by $216,153 because the contractor estimated costs of purchased parts that were higher than were reasonable in view of suppliers' known prices at the time of negotiations. Unless adjusted increased costs to the Government in the form of unwarranted profits to the contractor of $52,958 will result. GAO estimate of unnecessary costs: $52,958. Time period of GAO report: Negotiations commenced in September 1960, contract completion September 1962. DOD comments on GAO findings: The resident auditor's additional tests disclosed overpricing of material of $170,178 on approximately 72 percent of the proposed material costs versus $127,104 for 60.6 percent stated in the report. Prorated over 100 percent of the material costs results in an overpayment of $236,288. Adding G. & A. of 9 percent, the total overstatement is $258,097. DOD comments on costs: Overstatement of the target cost resulted in unwarranted profit of $63,233 computed as follows: Target profit (9.5 percent of $258,097) – Total___ $24, 519 38, 714 63, 233 Problem ADDITIONAL COMMENTS BY THE DEPARTMENT OF THE AIR FORCE GAO review of the contract target price negotiated in September 1960 for Department of the Air Force fixed-price incentive contract AF 04 (647)-684 with American Bosch Arma Corp., Arma Division, Garden City, N.Y., disclosed that the negotiated target cost was overstated by $216,153. This overstatement occurred because the contractor proposed, and the Air Force accepted, estimated costs of purchased parts that were higher than were reasonable in view of suppliers' known prices at the time of negotiations. Unless adjusted, this overstatement will result in increased costs to the Government in the firm of unwarranted profits to the contractor of $52,958. GAO recommendation Because the total price negotiated is only as sound and equitable as the individual cost elements that make up the total price, GAO believes that this case illustrates the need for adequate records evidencing the agreements which were reached by the parties with respect to the elements of the negotiations. GAO recommends, therefore, that the Secretary of the Air Force take appropriate action to emphasize to all contracting officers the need for such supporting records. GAO requests that the Secretary of the Air Force advise GAO of action taken in this matter. Statement The Assistant Deputy for Procurement stated the DOD position as follows: (a) With respect to the overstatement in the bill of material by the contractor, additional tests made by the Air Force resident auditor disclosed a total overpricing in the bill of material of $170,128 on approximately 72 percent of the proposed material costs compared with the $127,104 stated in your report for the 60.6 percent reviewed by the auditors. The net overstatement of $170,128 for the 72 percent examined, when prorated over 100 percent of the material cost, results in an overstatement of $236,288. When G. & A. of 9 percent is added to this amount, the total overstatement is $258,097. (b) The contracting officer determined that the initial target costs of contract AF 04 (647)-684 was overstated by $258,097 as a result of the contractor's failure to disclose to the Government negotiators recent price changes in material that were reasonably available to the contractor's representatives. (c) The contracting officer's determination has been reviewed and approved by the Staff Judge Advocate and was dispatched to the contractor by certified mail on August 26, 1964. The contractor appealed the contracting officer's deci sion on September 15, 1964. The appeal was forwarded to ASBCA on September 24, 1964, and the case has been assigned docket No. 10305. Status: Awaiting disposition of the matter by the ASBCA. Policy: A price adjustment was sought in this case pursuant to our policy that price adjustments will be sought when it is determined that the contractor failed to consider and/or disclose to the Government negotiators all reasonably available appropriate cost or pricing data in preparation of its proposal and/or during subsequent negotiations. GAO Report B-125071, July 31, 1964 62. Title: "Overpricing of Modification Kits and Spare Parts Purchased From Hughes Aircraft Co., Culver City, Calif., Under Negotiated Firm Fixed-Price Contracts Department of the Air Force" (OSD case No. 1957). GAO finding: Prices negotiated for certain modification kits and spare parts were overstated in relation to cost and pricing information that was available to the contractor prior to or during price negotiations, but was not made known to Air Force contracting officials. GAO estimate of unnecessary costs: $722,200. Time period of GAO report: July 1956 through April 1960. DOD comments on GAO finding: The Air Force agreed with the GAO finding. DOD comments on costs: The GAO estimate of unnecessary costs is not questioned. DOD corrective action: A refund of $722,191 has been received from Hughes Aircraft Co. Since the time of the pricing action covered, the Air Force has worked closely with Hughes to accomplish improvements in Hughes estimating and pricing procedures. Several areas were involved, including accounting and estimating procedures and the certification of current cost on pricing data. Steps were also taken to improve the pricing capability of the Air Force representatives at the Hughes plant and Air Force procurement personnel were apprised of the circumstances of the case. ADDITIONAL COMMENTS BY THE DEPARTMENT OF THE AIR FORCE Problem During the period of July 23, 1956, through April 30, 1960, the Air Force ordered items with a value of $10,448.000 under contract -2173, $6,489,000 under contract -2676, and $18,412,000 under contract -33098. Based upon its costs to deliver the items, Hughes realized profits of $2.232,000, $1,774,000, and $2.153,000, respectively, or 27, 37, and 13 percent of incurred costs. The Air Force plant representative of the Air Materiel Command located at the Hughes facility, was responsible for the administration of these contracts. The approval of the fairness and reasonableness of the prices discussed in this report was the responsibility of administrative contracting officers of the staff of the Air Force plant representative. GAO recommendations The Air Force has stated that numerous improvements have been made in the pricing capability of its plant representative's office since the time of the pricing actions covered by our review. GAO has not evaluated these improvements, but plans to consider them in their reviews of more current pricing actions. However, since their review of contracts -2173, -2676, and -33098 was limited to selected items under certain calls totaling less than 20 percent of the total contract prices, GAO recommended that the Air Force review the pricing of other sig. nificant items and calls under these contracts to determine whether action to obtain additional price adjustments would be appropriate. GAO requested they be informed of the results of this review and the action taken or contemplated by the Air Force on the matter. Statement Contrary to the GAO statement that only 20 percent of the total contract dollars were reviewed, in actuality the GAO reviewed 79.1 percent of the dollars on contract -2173, 70 percent on contract -2676, and 5.6 percent on -33098. Regarding contract -33098, the Air Force plant representative advises that discussion with GAO personnel confirms that the GAO auditors did not consider the total profit on the calls to contain sufficient abnormal profit to warrant the time and expense of further analysis and audit. GAO auditors found, on their second visit to Hughes, that a substantial number of calls did not, or were not likely to, produce reportable findings either because the profits were not unreasonable, or in some cases because essential data was not available for analysis and evaluation. It is understood, also, that the GAO auditors determined it was not feasible to examine in detail numerous line items of small amounts. Accordingly, the GAO excluded these items from their review statistics and pursued them no further. We advised the GAO that we concur fully with their determinations and it is doubtful that our resident audit staff would be any more successful than the GAO effort. We informed the Comptroller General that we were advised that an agreement had been made between the General Accounting Office and a Hughes representative resulting in GAO auditors employing the moving average costing method (actual costs), whereas for the period reported Hughes employed a pool concept of costing (standard costs plus or minus a variance). Hughes Co. representatives have advised that the agreement to use moving average actual costs for the purpose of costing the calls was not proper and this method was not used and is not being used currently. Hughes further advised that the attorney who agreed to the GAO auditors employing the moving average system is no longer with the company. Status: Case closed. Policy: In accordance with the objectives of our subcontract review and approval policy, many of the deficiencies in the estimating system employed by Hughes have been corrected. The contractor now employs a system providing for recheck of the prices of significant items prior to execution of a price certificate. Overreliance was placed on the use of a price deck using a negotiated pricing formula. This system is no longer employed by the contractor and spare parts are estimated on an individual basis. Material is now priced using specific purchase order quotes, purchase record history cards, tab runs for the moving average actual cost for each item, etc. Numerous other changes have been made by the contractor as a result of Air Force surveillance in this area. GAO Report B-133143, July 31, 1964 63. Title: "Excessive Prices Negotiated for Installation and Test of Radar Systems. Under a Negotiated Fixed-Price Contract with Avco Corp., Electronics Division, Cincinnati, Ohio" (OSD Case No. 1935). Problem The GAO found that the price negotiated by the Air Force in May 1963 with Avco Corp., Electronics Division, Cincinnati, Ohio, for installing and testing radar systems under a fixed-price order was excessive by about $119,200 because Aveo proposed and the Air Force accepted an allowance for labor that was greater than Avco could reasonably expect to incur on the basis of prior experience. Labor costs previously incurred by Aveo for work of a similar nature were not adequately considered in the negotiaton of this price, although recent cost experience was available in Avco's records. After the GAO findings were brought to the attention of Air Force and Avco officials, Avco refunded $119,200 to the Air Force on April 7, 1964. GAO recommendation That the Secretary of Defense, in line with his recent emphasis on this point, have this report brought to the attention of Air Force contracting officials to illustrate the importance of adequately considering contractors' most recent cost experience when negotiating prices. Time period of GAO report: Proposal submitted in January 1963, negotiation concluded in May 1963. 48-132-65- -51 |