Adequacy of Contractors' Cost Records

Published by the Government Accountability Office on 1971-01-01.

Below is a raw (and likely hideous) rendition of the original report. (PDF)


             Adequacy of                                 69//9cf
             Contractors' C(ost Records

             GAO's study o/ the /easibiliey oJ cstablbshing and applying
             cost accounting Standards in the negotiahion and administration
             ol dejense contracts, as required by Public Law 90-370, was
             described in the GAO Review, Spring 1970. In connection s;ith
             this study, 15 0AO regional of/ices made a special inquiry into
             the nature and extent oJ cost accounting systems and related
             records maintcined by selected contractors.

   A provision of ilte Armed Services small contractors engaged In both Gov.
 Procurement Act, as revised in 1956, ernment and'commercial work on a
 (10 U.S.C. 2313(b) ), sets toith that:         wide variety of products, Of these con.
   * * * each contract negotlated under this tractors, 18 bahz total annual sales of
chapter *hall provido that the Comptroller more than $50 million; 14 had annual
Central and his representatives artc entitled, sales ranging between $!5 million and
until the expiratlon of three years after final $50 million; and 13 h'td annual sales of
payment, to examine any books, documents less than $15 mIllion.
papers, or records of the cordractor, or any      E
of ha wubcontuactors, that directly pertain to,     fforts were directed toward ascer
aud Involve transactlons gelating to, the con taining whether contractor cost ac.
tract or subcontract.                           counting records and the records used
   liao approach taken in making this to support price proposals for negoti.
review was to gather information on tlia ated tonttracts were generally ade.
characteristics of cost records main. quate; in particular, liae purpose of the
tainej by defensm contractors and study was to find out:
evaluute their usefulnem for specific             -Whether tho accounting system
purpose. 1 1io cost accounting records               provided sufficient data to deter.
of 45 contractors were examined. The                 mine tho cost of performing given
selectiou included large, medium, and               contracts.

   lir. Harney Is an aulstant regional mcnager In the Philadelphia Reginnal Office.
  le has been witIA GAL mince 1957. lie Is a CPA (Pennsylvania and Nrw Jersey) and
  a member of the American Tntiltutd of CPA., the Pennsylvania Institute of CPA.,
  the N7tiapal Auociltlor. of Accountant; and bho Federal Government Accountants

 18                                                         CONTRACTORS COST RECORDS

   -Whether the accounting records           As shown below. Wwecral types of cost
     permitted p r I c I n g evaluation systems were found among the 45
     reviews.                            contractors;
               . iero usoful for other ~~~~~~~~~~~~rnf
   -Whether they                                St a~o a1yten,^,,t,         - :1
      eyaluution reviews such as those       Job order         ..                   ,   .   .       .    .                ,   .       35
      for terminations, delay claims, or     Process .    ..            .       .       .   .       .   .         .               .    2
      ehange-order prictng.                  Prtoduet       .       .       .
                                             Departmental                                                                             I...............
  A byptoduct of this inquiry was the        job order/process ....                                 .   . .                       .   I
Information it provided on the extent        Job order/product . .                              . .          .        .   .       .   I
of similarity and/or uniformity of cost      None                       .                       .       .        .                ,   2
rcords presently prepared by dofense                                      45
contractors. This information should be
useful to the Cost Accounting Stand. There was litth relationship
ardu Board,                                  type of cost accounting system and the
                                             typo of summary or report-typo records
Rdsults of Survey                            available,
                                       During the survey emphasis was di-
   nTe survey showed that supposing rececd to the following;
documentation was maintained by all            -Adequacy of contractor cost ac-
contractors for basic accounting trans-          counting records for the calcula-
actions, Material costs, both direct and         tion of cost of performance.
indirect, and regardless of the typo of        -Identification of costs by contract,
 accounting system, were supported by            line Item, and change order.
 records such as purchase orders, in.           -Inclusion in contactor records of
 voices, receiving reports, voucheri, 'cnd        the infornation required for pric.
paid checks. Similarly, labor costs, both         Ing reviews.
direct and indirect, were supported by         -Comparability of proposal costs
some form of labor timecard or Job                with incurred costs.
ticket and other payroll and payment         Each of these points is commented upon
records.' To this extent the survey          below.
showed a general imiformity in types of
cost records in use by contractors.          CRlcdatfon of Cost of Performance
   'The area in which contractors cost
records were found to differ was in the         From the results of our inquiries, we
summary records prepared from the            classified the adequacy of contractor
above source 'locumelis. Reports, for        cost accounting records for the calcula.
management summariret material, la.          tiot of cost performance. (See the table
bor, and overhead costs in mniay forms.      on the following page.)
ror example, labor costs were summa-           Noteworthy is tie fact that the con.
rized by contract, work package, labor       tractois whose records were inadequat'
classification, or whatever other form       were in the lower sales volume groups
was required by managen.tnt or the           andl that more than half In the third
customer.                                    group were inadequate.
CONTRACTORS' COST RECORDS                                                                                19

                                                          Nwhn ol                  Head eocdne
                Assuas eahn yolum*                        eccIracla"   -    dqasIsrUI
                                                                           Ahdquaia         inaetqusi.

Over $50   inill., ..........      . .....   .   .. . ,      18              18                ..........
*1l   to $5 muilon ...............                 ,.        14              11               3or 21%
Under $15 mWiou ........... ,                                13               6               7or54%

       Total ........................I .                     45              35              10

      The 10 contractors whose jecords                    the individual contracts may generally
were inadequate employed a variety of                     exempt their records from any critical
cost accounting systems ana practices,                    scutiny to determine the              hl       for
but there was lile correlution of the                     pricing.
type of system with the type of product                        hae larger defense conlrautors segre-
or the volume of Government sales,                         gate costs in such a manner that sum.
   Of the 10 inadequate accounting sys.                    mary data related to overall costs of
tems, two did provide for the recording                   performance iro readily available. They
of c03ts by contractor or job order, but                  maintain not only source documents but
neither of the two contractor3 effec.                     also summaries that identify, in one for.
tively administeredits system. For those                   mat or another, costs associated with
contractors who employed other than                       total contractual effort. However, in
a job ordir system, our conclusions                        only a relatively few cases are contract
that sufficient data were not available                   costs segregated as b'tween basic con.
were baaed on overall 'aspects of the                     tract costs and weparately negotiated
systems or practices. For exampje, one                    modificatlions to the contract. ntese
contractor's cobb were recorded by de-                     contractors, who receive a large per.
partment; as a result, coats applicable                   *-:ntago of the defense procurement
to Government work were not identifi.                     dollars, already have, in effect, stand-
able to specific contracts or products.                   ards of their own for summarizing
Two smnall contractors who had no cost                    costs.
systems mnintained only records re                            Tho reason or reasons for this differ.
qtit.ed for basic financial requirements                  ence In recordkeerIng between large
and operating statements.                                 and small contrarsors were not devel-
   Overall, the survey results suggest                    oped in depth during this survey. In the
that the nonsvallability of sufficient                    case of the smaller contractor, however,
summary data to provide cost of per.                      it appears that management is more
formance by contract may be limited to                    cloy.ty associated with production and
relatively small companis having a low                    other aspects of operations; thus there
volume or percentage of Govormment                        is less need for records to provide a cost
sales. Ilowiver, the aggregate of their                   control or a reporting system. Con.
prime and t.:┬▒bcontract sales to the Govy                 versely, the larger contractor whose
ernment is likely to be quite substantial                 managernent is possibly three or four
even though the relatively small size of                  echelons removed from operations finds
 400                                                     CONTRACTORS' COST RECORDS

   hL4 a com" r'eienslve reporting system    provcdures, Hlowever, from the survev
 i, essential 'IV the assembly of data for   it appears that the problem is not orsy
   i'niormed decisions,                      whether records are available by w lfeh
      A contractor whose involverP'.t is     a contractors interpretation of cfet of
*aubountial In etbher Government or          performance can be evaluated, bit also
 crcnmercial work, or both, develops end     whether the various treatments ein.
 rpeords shrnificarnt cost Ecouiting data    ployed by contractors yielo uniform
 Irvuwe they arc needed for efflctivo        and meaningful cost determinations.
 t~erations. With respect to Inadequate
 record., the most critically affected         Idmntflauton of cots by Contract,
 gt:lj1p of Government contractors may Une eRm, *nd Chane Order
 be Ostpeo to ble Lhosc Who have out.            We found that contractors whoa"
     l ' he snona&isodbuntrol possible accounting records permit a calculation
 Jl' the am.'il enterprise but have not yetofcsofpfranogealyr.
 aidopted [iesophlsticatedi reporting of cost of performance generallyr pro.
   dop~ted (,tho aopitd          reporting vide for identification of cost by con.
  rcspenu!wlity must be delegaled Then tract, The survey, however, Indicated
 adeorn. ffect on thx contractor will, to instances where adequate determina.
   Wilaextentalmostalways be passedOn tions of cost of performance could be
 tobio Goternment,                            made even though costs were not re.
     Although summary data related t corded by conract. Typical of such a
 cost of performanco of the smaller                                 which a contractor
                                                          Is one in wthution
 cotlractors may not be available or with a process or product line cost
 readily asembled, ind the volumi6 of system has records that require only the
 trmnsecions involved might seem to establishmrent of individual contract
 lsnxlt tbo significance of thsi problem production cutoff points to Identify the
 &ar, the facts, if available, might well shop costs related to a contract. Appli.
ulow that this is not the casn. ni            cable general and administra'ive and
                                    G,iple    otiler costs could then be allocated.
nodeo by the GAO Philad\9rphia                   Both large and small contrac'ors
Regional Office have disclosed indica. tende                d tmztn             for cos
11ons of significant overpricing which tended ts nisilmise the need for cost
were not reported because of the Inad- reporting systems refined to the point
e cguc of documcntation available          to of associating incurred CostS to lIne
GA        ofroexisting accounving records, items or change orders. Although the
G(AQon be          sl ng
                            h rttecords. reasons for minimizing such refine.
Din the other hand, we have seen in. ments In their costs systems were not
stanices where failure to summarize cost developed as a part of thin survne, we
dJat in tIh normal course of operations believe they represent the difference
bus caused contractors to be unaware between satisfying the recognized needs
of or to oyrrlook costs that would be of company management and the
acceptableInpricenegotiations.                Government in the Identification of
    'With xnpect to contractor records cosb.
providing cost of performance, we               The identificationof cost by line ilem
wade detenninations as to adequacy on or change order is, nevertheless, neces.
the basis of contractor definitions and sary In certain instances. For example,
cONTRACrTo.1S COST RECORDS                                                          21
 contractors' claims against lhe Govean.      contractors could not bo made because
  nent occur with amOrn frequency and a        daW related to cost of performance
 reasonably precise identification of coat     were not recorded by co6itract, line
 Is necmssary If an equitable settlement      item, or change order to p"mit com-
 Is to be achieved. In addition, congres.     parison with pricing proposals. As in.
 sional inquiries regarding contract          dicated previously, individual instancee
 ovejjjuis may request an Identification      o( such a condition may not be signifi.
 of cost not only by contract but also by     cant in respect to poaihbe adverse con*
 itemanprocured under the contract, Al.      'tract pricing lHowver, the author be.
 so, the megrcgation of coat by line item     lieves that in the aggregate a significant
 and/or change order generally pro.           number of Government procurements
 video A better busis fox Identifying pro.   and contracting entities -re seldom subs
 curement and/or production weak.             jected to the restraints provided by in.
neses, AlR in all, It would seem that such    dependent reviewa of pricing and pric.
 a desirable refinement of coats has de.      ing praclices,
pended primarily on a company's view             For the larger contractors, historical
 as to whether the value to management        cost data were conuidered generally ad.
exceeded the added coat.                      equate for pricing reviews. It was noted
    Tho Defense Cintract Audit Ajency         that contractor records generally were
 and contrec!.-4 officers are continually    relained for a sufficient period to satisfy
required to make pricing decisions that      any postaward audit requirements.
rest on the reasonableness and validity
 of contract costs. In addition the Armed    Comparlson ot Proposed and
Services Board of Contract Appeals,          Incurred Cost
tho GAG, and the Federal courts are
 * from time to time involved in efforls        Not all desirable comparisonxs of pro.
which require determination of the           posed and incurred costs could be made
reasonablenesa or equitability of con-       readily for 20 of the 45 contractors
tract costs, The fact that such reviews      surveyed, For some of these contrac-
may be necessary makes difficult any         tors, uummarlea of cost of performance
persuasive argument for denying the          wore not available; for others, certain
need for records to be kept in such a        comparisons could not be made for
manner as to permit Identification,          reasons such as the commingling of
when necessary, of cost by significant       basic contract costs and change order
line Item and/or change order, espe.         costs. The deficiencies here concerned
clally for the larger procurements.          the  smnallerx,-ontractora
                                             thm'e"        otatr and       contrarts.
                                             We ftel thati close line of reference
Information Required for                     should exist between the classifications
Prking R     evur                            of proposed costs and actual costs.
                                               The inability to make a reasonable
   Reviews of pricing proposals could        comparison appears to bo the result of
not ho effectively performed at the          a lack of similarity betweon estimating
plants of several relatively small con-      and accounting systems. Although such
tractors. Comparisons of proposal coats      comparisons may not provide a total
with costs of performance for these          measure of a contractor's erliciency,
  22                                                         CONtRACtORS' COST RECORDS

  reliability, or overall technical capa.       Concluding Comments
  bilily, they do provide a common basis          As mentioned previously, the direc.
  for evaluating the performance of a cols.
   tract, procurement decisions and/or           hIuo taken in this inquiry was to gatiler
   Ilth efTectiveness of operations by coni      Information on thie kinds of records
  tractor officials as well as by those Gov.     kept by defense contractors and the ade,
   ernment representatives witi related re.      quacy of the records for examinations
  sponsibilltles.                                made by tile Comptroller General. All
       Teia degree to which contract costs      of the 45 contractors surveyed main.
  should be segregated depends upon tlhe        tamned basic transaction records. From
  specific circumstances involved. A clear      that point their accounting sulnmalions
  relationship between line item costs oil      ranged from simple operating state.
  a proposal and the costs subsequently         mrenis prepared on an enterprise basis
  recorded for the contract should be           to luigly sophisticated statements pre-
  evident, Where this relationship Is not
  evident, tle identification of costs by       liaret in great detail on a diisIon,
  contract and cost element should be           plant contracttaIsk, product proc
 the minimum requirement for cost pres           or o ther a         asiss
 eltalion. Wit) respect to the recording            The existence o( a wide variely of aye
 of such data, regulations or standards          temized cost controls rortainly is no
 could provide for specific contractual         surprise to the accountant with broad
 agreement on the identification of costs       commercial or Government experience,
 by change order whenever practicable           Correspondingly, it should he no great
 and necessary. In many Instances, the          surprise to find Inconsistencies among
 segregation of change order costs may          contraclors as to what should be tile
 be neither feasible nor economical. In         nature of any selected cost accounting
 such instances, contractors might be           principles tu be applied In the Identifi.
 required to satisfy Government pro-            cation9 classification, and coitrol of
 curement officials, generally In advance       costs. Cost control systems, whatever
 of performance, as to why costs of             their form, can be guided by broadly
change orders cannot or should not be          defined cost accounting standards, when
 identified.                                   established generally wittout radically
     Improvement in the auditability of        esablishedegenerally         ou adically
 proposals and performance data for             chIangingpresent systemsorattempting
any desired review, including those for          ot introduce uniform systems. Exisilng
posiaward audit or contract pricing            cost controls provide a valuable fund
purposes, depends largely on improve.          of information on procedures and sys-
ment in estimating and cost accounting         tems which could serve as a framework
systems and a corresponding improve-           for the development and application of
ment in the relationship between these         sound cost accounting standards that
systems.                                       will gain general acceptance.