being followed. The Air Force believes that AFR 70-9 which deals with this question is being properly applied, and the interests of the Government are being protected.

Status: Case closed.

GAO Report B-146945, October 16, 1964

69. Title: "Overpricing of Valves Purchased from the Garrett Corp, AiResearch Manufacturing Division, Phoenix, Ariz., by General Dynamics Corp., Astronautics Division, San Diego, Calif., for the Atlas Intercontinental Ballistic Missile" (OSD case No. 1966).

GAO finding: The price negotiated by General Dynamics and the Garrett Corp., AiResearch Manufacturing Division and approved by the Air Force for pneumatic relief and shutoff valves for the ATLAS missile disclosed that the firm fixed price was based on cost estimates for material and testing which were overstated in relation to cost data available to AiResearch at the time the proposal was submitted to General Dynamics.

GAO estimate of unnecessary cost: AiResearch cost estimates overstated by at least $80,900 and an undertermined amount for additional fees to General Dynamics.

Time period of GAO report: GAO review concluded in March 1964. Price negotiations conducted January 10 and 11, 1962.

DOD comments on GAO finding: AiResearch has indicated a willingness to make a refund of $80,900 to General Dynamics. In accordance with GAO recommendation, the Department of Justice was requested to review the matter on September 25, 1964, and advise whether there is any objection to directing General Dynamics to accept the offered refund.

DOD comments on costs: The Air Force agrees with the GAO estimate of increased costs.

DOD corrective action: Public Law 87-653, effective December 1, 1962, provides that in negotiated procurements where competition is absent contractors and subcontractors be required to submit cost or pricing data and certify to the currency, completeness, and correctness of such data. The law also provides that contract prices be adjusted in the event such data are found to be inaccurate, incomplete, or noncurrent. Regulations and instructions have been issued to place increased emphasis on the review and evaluation of cost and pricing data furnished by contractors and subcontractors in support of proposed prices under negotiated procurements.

ADDITIONAL COMMENTS BY THE DEPARTMENT OF THE AIR FORCE

Problem

The report alleges that the price negotiated by General Dynamics and AiResearch, and approved by the Air Force on purchase order 6214, for pneumatic relief and shutoff valves for the ATLAS missile, included cost estimates for material and testing which were overstated by about $80,900 in relation to cost data available to AiResearch at the time the proposal was submitted to General Dynamics. It is further alleged that AiResearch certified that all available actual cost or pricing data had been considered in preparing its price estimate and that any significant changes from the time of its preparation to the date the proposal was submitted on December 28, 1961, had been made known to the buyer.

GAO recommendation

That the Air Force, in coordination with the Department of Justice, take steps to obtain a suitable refund under the prime contracts involved, consistent with maximum protection of the Government's interest in terms of penalties that may be appropriate.

Statement

AiResearch has indicated a willingness to make a refund of $80,900 to General Dynamics. In accordance with the GAO recommendation, the Air Force has forwarded this case to the Justice Department for review.

The total overpricing of $80,900 alleged by GAO, consists of $24,200 for materials and $56,700 for testing of valves.

Evidence shows that the AiResearch proposal accepted by General Dynamics was submitted on December 28, 1961. This proposal contained an estimate for material which was about $24,200 higher than it might have been had AiResearch used the latest cost information available. This necessary information for material cost estimates was available from purchase orders which had been issued by AiResearch on December 5, 8, and 20, 1961, and although no willful with. holding is evident, it is believed that the information should have been made available to General Dynamics before completion of negotiations on January 11, 1962.

Respecting that part of the AiResearch proposal to General Dynamics on testing costs, Air Force audit has substantially verified the unit cost findings of the GAO based on the past history of test costs at AiResearch. AiResearch did not use its past history on testing costs as a basis for quoting to General Dynamics, rather it used engineering estimates of testing it believed would be necessary for the subject procurement. This method was used since it was believed at the time that testing requirements on prior orders would not necessarily be indicative of testing requirements on subsequent orders. General Dynamics, based on its own experience, also believed testing requirements on prior orders were not necessarily indicative of testing requirements that would occur under purchase order No. 6214. General Dynamics, therefore, made an independent estimate of the test costs for the valve being procured and concluded that the testing costs as forecasted by AiResearch could be reasonably expected. Although postaudit shows that the judgment of both AiResearch and General Dynamics was faulty, the Air Force believes there is no evidence to show a willful intent of either party to overprice the Government. However, the Justice Department has responsibility to determine whether or not fraud was present.

Status: Case open.

Pending completion of Justice Department review and further advice from that agency.

GAO Report B-146705, November 24, 1964

70. Title: "Overstated Cost Estimates Included in Target Prices Negotiated for B-52G Airplanes Produced by the Boeing Co., Wichita Branch, Wichita, Kans." (OSD case No. 1943).

GAO finding: Target prices negotiated for 140 B-52G airplanes, contracts AF 33(600)-34670 and -37481, included target costs based on cost estimates for sustaining tooling labor, production labor and subcontracting which were overstated by about $7,575,500. Unless adjusted the Government will incur increased costs of about $1,261.000 in the form of additional profit to Boeing. After advice of GAO findings the Air Force and Boeing agreed to reduce target costs by only $597,340, representing reduction in the increased costs to the Government of about $60,400.

GAO estimate of unnecessary costs: About $1,261,000.

Time period of GAO report: Date of GAO review unknown. Contract -34670, firm target price and profit established April 1959; final price negotiated August 1962; -37481, firm target price negotiated March 1960.

DOD comments on GAO findings: The Air Force agrees that subcontract costs were overstated. The remaining estimated costs alleged to have been overstated appear to have been reasonably priced and considered during negotiations. An actual cost incurred for an element that has varied to some degree from the initially evaluated amount does not constitute a sound basis for reopening a negotiated contract for the purpose of increasing or decreasing a target price. On the contrary, this situation is one of the risks shared by both parties to a contract.

DOD comments on costs: Boeing concurred in September 1962 to a target reduction of $39,400 because of overstated subcontract costs of $492,506 under contract -37481. Supplemental agreement was issued in April 1963 reducing the firm target cost by $104,834 for overstated contract termination costs resulting in a Government saving of about $21,000. Total saving $60,400. Adequate tests of reasonableness of other estimated costs were made by the Air Force negotiating team at the time of negotiations and there is no basis for seeking further contract price adjustments.

DOD corrective action: The Air Force agrees that the contract files should contain sufficient data and documentation fully supporting prices, including the computations made and the evaluations performed by the contracting parties, and allowances for such anticipated increases in future production costs. Increased field support through emphasis on field surveys of contractors' procedures, current Armed Services Procurement Regulations, Air Force Procurement Instructions and pricing guide instructions furnish adequate guidance for providing contract files with sufficient data and documenation. Since the time these two contracts were negotiated (April 1959) there has been considerable improvement in the documentation in support of the rationale employed in the pricing of contracts.

ADDITIONAL COMMENTS BY THE DEPARTMENT OF THE AIR FORCE

Problem

The report states that target prices negotiated by the Air Force and Boeing for 140 B-52G airplanes under contracts AF 33(600)-34670 and AF 33(600) – 37481 included target costs which were based on cost estimates for sustaining tooling labor, production labor, and subcontracting that were overstated by about $7,575,500. The report further states that unless the contract prices are adjusted to eliminate the overstated cost estimates indicated, the Government will incur increased costs of about $1,261,000 in the form of unearned profit to Boeing.

GAO recommendations

(a) That the Secretary of Defense take vigorous action to obtain for the Government appropriate reductions in the contract prices for the overstated cost estimates included in the target prices negotiated by the Air Force and Boeing for the B-52G airplanes purchased under contracts -34670 and -37481. (b) That this report be brought to the attention of responsible Government officials to stress the importance of (1) requiring contractors to document fully in writing, and to furnish to the Government's contracting officials, the bases and methods used in preparing cost estimates included in proposed prices and (2) carefully evaluating contractors' proposals and documenting clearly in writing the nature and extent of the evaluations made of the various elements of costs in relation to costs previously experienced and costs which reasonably should be expected for future production.

Statement

The Air Force agrees with GAO's findings pertaining to overstated subcontract costs of $492,506 under contract -37481, as in fact has Boeing. An appropriate adjustment will be made to cover this matter at the time of final contract price negotiations during February 1965. In addition, supplemental agreement No. 34 to contract -37481 was issued on April 29, 1963, accomplishing a reduction of $104,834 for overstated subcontract termination costs as recommended in the report.

The Air Force does not agree, however, that the estimated costs in sustaining tooling labor and production labor, alleged to have been overstated, should be adjusted. It is our opinion that adequate tests of reasonableness of these estimated costs were made by the Air Force negotiating team at the time of negotiation.

Respecting GAO's second recommendation, we are constantly striving for improvements in the documentation in support of the rationale employed in the pricing of Air Force contracts. Our contracting officials presently require Boeing, and other contractors dealing with the Air Force under negotiated procurements, to furnish all appropriate data and rationale employed in the preparation and support of proposed prices. A management review of all Air Force negotia tion objectives is made prior to negotiations with a contractor. One of the objec tives of this review is to assure that the contractor will provide all appropriate data. In addition to increased field support through emphasis on field surveys of contractors' procedures, it is our opinion that current armed services procurement regulations, Air Force procurement instuctions and pricing guide instruc tions provide adequate guidance in the areas of the second recommendation.

For this reason, further action on the recommendation is not considered necessary.

Details of Air Force position in disagreeing with GAO on sustaining tooling labor and production labor follow:

(1) Sustaining tooling labor

GAO comment

It is stated that in the preparation of target cost estimates for sustaining tooling labor for the airplanes purchased under contracts -34670 and -37481, Boeing failed to give proper consideration to its prior experience in producing B-52G airplanes. Sustaining tooling labor is used to support and maintain the tools and equipment utilized in production. In view of this reflected relationship to production, the GAO stated that sustaining tooling labor had been estimated by Boeing as a percentage of production labor. According to the GAO, Air Force records of negotiations for B-52G airplanes indicated that the G was essentially a new airplane compared to prior models, as a result of numerous engineering changes incorporated to reduce the airframe weight and to increase the defensive capabilities of the airplane. It is stated that in the preparation of the proposal for the firm targeting of contract -34670 for 101 G's in April 1959, Boeing estimated that 1,425,000 sustaining tooling hours would be expended, based on a computation of 11.7 percent of the estimated production labor hours. This rate is said to have been developed by Boeing on the basis that airplanes under contract -34670 were comparable to the 225 airplanes previously procured although the Air Force and Boeing had agreed that the G was a completely new airplane. According to the GAO, only 53 airplanes (the previous B-52G buy) should have been considered comparable to those to be produced under contract -34670. Thus, it is said, had Boeing estimated sustained tooling labor as it estimated other cost elements in its proposal, it would have developed a sustaining tooling rate of about 7.8 percent of the estimated production hours. The GAO stated that the use of the 7.8 percent factor would have provided a sound basis for reducing its estimate by about 426,000 hours, reflecting a target cost reduction of $3,216,000 on contract -34670.

Similarly, the GAO stated, that in the proposal in April 1950 for the initial target price for 39 B-52G airplanes on contract -37481, 417,234 sustaining tooling hours were included, representing 10.9 percent of the estimated production hours. Here, again, the GAO stated that the 10.9 percent factor was based on 326 B-52 airplanes as comparable experience, although only the last 154 airplanes (53 and 101 G's) should have been considered. According to the GAO, had Boing based its estimate on G experience only, a factor of 6.5 percent would have been developed. The reflected reduction indicated by the GAO in its 6.5 percent application amounts to 165,000 hours, or $1,283,000.

Air Force Reply

A review was accomplished of Air Force pricing data used in the April 1959 negotiation for firm targeting the 101 B-52G airplanes on contract -34670. This review revealed that Boeing estimated that 1,425,000 hours would be needed to support production requirements in the form of sustaining tooling labor. This estimate was developed by projecting 75,000 hours per month, starting with the first unit entering the assembly area (December 1958) and ending with the delivery of the last unit (June 1960), for a total of 19 months. The 75,000 hours per month was based upon an analysis of prior B-47 and B-52 programs which indicated that from 70,000 to 80,000 hours per month of sustaining tooling labor had been expended, and would probably be expended on this program. Application of 75,000 hours to 19 months effort generated the 1,425,000 hours proposed by Boeing or, as the GAO stated, a factor of 11.7 percent of the estimated production hours. This estimate was also supported by the learning curve approach, utilizing an 80 percent curve, experienced on prior B-52 programs to project the estimated percentage of production labor to represent tool sustaining labor on this contract.

The sustaining tooling hours reflect a rate of 11.7 percent of the production hours considered in the Air Force breakdown of the negotiated target cost. This rate was considerably less than had been previously experienced, and represented considerable improvement over a period of time. It is also noted that sustaining engineering labor, another element that supports production, was estimated in the same manner, i.e., average hours per month, based on prior B-52, A, B, C, D, and G experiences. Sustaining developmental labor represented a percentage of sustaining engineering labor.

Elements comprising the estimated total target price in the negotiations which established the initial target pricing of contract -37481 were evaluated in the same manner as were the elements included in the firm target negotiation on contract -34670. As the GAO has indicated, the initial targets were negotiated on contract -37481 immediately following negotiations which estab lished the firm targets for contract -34670. Sustaining tooling labor considered in the target of AF-37481 represented 10.9 percent of production labor. This gave recognition to additional learning to be acquired on this purchase of 39 airplanes. It was noted that in the evaluation of production costs on both contracts negotiated in April 1959, some elements of production labor were evaluated by utilizing only the experience obtained from the earlier B-52G program. However, tests of the reasonableness of estimated production costs were made by the Air Force in six different ways to assure fairness to both parties involved. Because of the interrelationship of costs of various elements of contract performance, it is the policy of the Air Force to negotiate a fair and reasonable total price. Sustaining tooling hours actually indicated 10.6 and 7.8 percent of production hours expended per respective contract. On the basis of this comparison, it appears that the target costs on both contracts were adequately priced.

(2) Production labor

GAO comments

The GAO has stated that the initial target cost of contract -37481 included an Air Force allowance of $2,479,000 to compensate Boeing for anticipated losses in labor efficiency during the production of the last 39 B-52G airplanes without any support or assurance that such costs would be incurred. It is said that the Air Force record of negotiation of this initial target shows that the production labor hours estimate was based on estimated hours per unit accepted in the negotiations that had been just completed on the firm targeting of the 101 buy on contract -34670. This production labor hour estimate was reportedly increased by the Air Force to compensate Boeing for (a) reduced monthly delivery schedule, (b) phaseout of the B-52G model, (c) reduced lot sizes for fabrication, and (d) integration of the B-52H model into the assembly line during the last 5 months of production of the G model. A total estimated cost for 3,764,124 production labor hours was accepted by the Air Force and included in the initial target, according to the GAO report. Using the same basis as that stated in the Air Force record of negotiation, the GAO computed 3,453,000 production labor hours that should have been required for the 39 airplanes. This reflected difference of 311,000 hours, according to the GAO, represented an amount which the Air Force allowed to Boeing for anticipated losses in production labor efficiency. The GAO stated that a review of the Air Force negotiation record disclosed no information concerning the basis for the 311,000 hours, in which to substantiate the reasonableness of the allowance. It is said that the Air Force negotiator informed the GAO that the record of negotiations contained the reasons for the increase in production labor hours, but he was unable to locate any data to show how the 311,000 hours allowance was computed. According to the GAO, Boeing officials informed them that information supporting this allowance had been furnished to the Air Force during negotiations. A GAO review of Boeing's experience relative to the transition of production from one B-52 model indicated very little, if any, decrease in production labor efficiency during the transition period. Therefore, the GAO stated, there appears to have been no sound basis for the increase of 311,000 hours in the production labor estimate which resulted in about $2,479,000 increase to the initial target price.

The GAO stated that in Boeing's proposal for the firm target negotiations conducted in March 1960 for contract -37481, Boeing included 77,287 labor hours for anticipated losses in labor efficiency caused by phasing out of the G model