oversight

High-Risk Series: Defense Contract Management

Published by the Government Accountability Office on 1997-02-01.

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

                United States General Accounting Office

GAO             High-Risk Series




February 1997
                Defense Contract
                Management




GAO/HR-97-4
GAO   United States
      General Accounting Office
      Washington, D.C. 20548

      Comptroller General
      of the United States



      February 1997
      The President of the Senate
      The Speaker of the House of Representatives

      In 1990, the General Accounting Office began a special
      effort to review and report on the federal program areas
      its work identified as high risk because of vulnerabilities
      to waste, fraud, abuse, and mismanagement. This effort,
      which was supported by the Senate Committee on
      Governmental Affairs and the House Committee on
      Government Reform and Oversight, brought a
      much-needed focus on problems that were costing the
      government billions of dollars.

      In December 1992, GAO issued a series of reports on the
      fundamental causes of problems in high-risk areas, and in
      a second series in February 1995, it reported on the status
      of efforts to improve those areas. This, GAO’s third series
      of reports, provides the current status of designated
      high-risk areas.

      This report discusses the high risks in contract
      management that the Department of Defense continues to
      face, despite improvements in selected areas.
Copies of this report series are being sent to the
President, the congressional leadership, all other
Members of the Congress, the Director of the Office of
Management and Budget, and the heads of major
departments and agencies.




James F. Hinchman
Acting Comptroller General
of the United States




            Page 2      GAO/HR-97-4 Defense Contract Management
Page 3   GAO/HR-97-4 Defense Contract Management
Contents



Overview                                                          6

Background                                                        9

DOD’s Contract                                                   11
Payment Process
Is Error Prone
and Costly
Effective                                                        14
Cost-Estimating
Systems Are Key
to Sound
Contract Prices
Improving the                                                    17
Administration of
DOD’s Voluntary
Disclosure
Program
Managing Future                                                  20
Contract Risk
Further Action                                                   23
Needed
Related GAO                                                      26
Products



                    Page 4   GAO/HR-97-4 Defense Contract Management
                 Contents




1997 High-Risk                                                  27
Series




                 Page 5     GAO/HR-97-4 Defense Contract Management
Overview



           Improvement and simplification of the
           Department of Defense’s (DOD) contract
           payment system is imperative. If DOD does
           not achieve effective control over its
           payment process, DOD’s Defense Finance and
           Accounting Service (DFAS) will continue to
           risk overpaying contractors millions of
           dollars. Further, failure to reform the
           payment system perpetuates other financial
           management and accounting control
           problems and increases the administrative
           burden of identifying and correcting
           erroneous payments and their associated
           costs. DOD is aware of the seriousness of its
           payment problems and is taking steps to
           address them.

           With improved contractor cost-estimating
           systems, DOD could reduce the risk of
           overpricing and manage contracts more
           efficiently. Contractors’ cost-estimating
           systems are a critical control for ensuring
           sound price proposals. Sound price
           proposals reduce the risk that the
           government will pay excessive prices, and
           they permit less government oversight and
           management attention. DOD has improved its
           oversight of contractors’ cost-estimating
           systems, and some improvement in
           contractor systems is indicated.
           Nevertheless, poor cost-estimating systems


           Page 6      GAO/HR-97-4 Defense Contract Management
Overview




remain an area of concern at some
contractors’ locations and require continued
attention by contractors and government
contracting officials.

Maintaining public support for defense
programs requires that potential fraud
involving defense contractors be identified
and dealt with swiftly. DOD has established a
voluntary disclosure program to encourage
defense contractors to report potential civil
or criminal procurement fraud to the
government. However, contractors’
participation in the program has been
relatively small and the dollar recoveries
modest. Efforts to improve the
administration of the program, including
coordination between DOD and the
Department of Justice, may encourage
program participation and improve dollar
recoveries.

As is the case with many other elements of
defense, contract administration and audit
resources have been reduced, and further
reductions are planned. At the same time,
DOD continues to look to additional
outsourcing opportunities, and it plans to
increase its procurement budgets
significantly in the coming years. Both these
actions may increase contracting actions and


Page 7      GAO/HR-97-4 Defense Contract Management
Overview




the need for effective contract
administration and audits. As DOD seeks to
reengineer and streamline its contracting
and acquisition processes, including contract
administration and audit, new business
process techniques will be key to
accomplishing effective and efficient
oversight in the future.

We will continue to monitor DOD’s progress
in addressing the contract management
issues discussed in this report.




Page 8      GAO/HR-97-4 Defense Contract Management
Background



             Over the last few years, many changes have
             been witnessed in the defense contracting
             environment—both within DOD and in the
             private contractor community. Between
             fiscal year 1991 and 1995, the defense
             procurement budget was reduced by almost
             40 percent. Many defense contractors, in
             response to budgetary changes, substantially
             restructured their businesses. DOD,
             recognizing that it could no longer afford to
             buy weapon systems as it had in the past,
             began broad-based changes to its acquisition
             and contracting processes. With these
             changes, DOD is attempting to significantly
             improve the way it relates to its contractors
             and the rules governing their relationships.
             And the changes are by no means complete.
             Acquisition reform, with its emphasis on
             widespread reengineering of fundamental
             processes, continues to receive attention at
             the highest levels in DOD.

             In spite of budget reductions and other
             changes, DOD’s contracting activity remains
             substantial, amounting to about $110 billion
             in fiscal year 1995. The risks associated with
             this level of contracting activity alone are
             high. The risk increases substantially when
             this activity is coupled with (1) continuing
             fundamental changes in the acquisition and
             contracting processes that have yet to be


             Page 9      GAO/HR-97-4 Defense Contract Management
Background




fully implemented or evaluated and (2) a
contract administration and auditing
resource base that has already been
substantially reduced. Therefore, contract
management must remain an area of
potential high risk that receives marked DOD
management attention.




Page 10      GAO/HR-97-4 Defense Contract Management
DOD’s Contract Payment Process Is
Error Prone and Costly


            The need for DOD to achieve effective control
            over its payment process is imperative. If it
            does not, it continues to risk erroneously
            paying contractors millions of dollars and
            perpetuating other financial management
            and accounting control problems. In recent
            years, we have reported on DOD’s numerous
            problems in making accurate payments to
            defense contractors. These reports identify
            millions of dollars in government
            overpayments, underpayments, and interest
            on late payments, in addition to other
            financial management problems. For
            example, as we reported in our 1995
            high-risk report, during a 6-month period in
            fiscal year 1993, DFAS in Columbus, Ohio—a
            principal DOD contract-paying
            activity—processed $751 million in checks
            returned by defense contractors. Our
            examination of $392 million of the
            $751 million disclosed that about
            $305 million, or about 78 percent,
            represented overpayments by the
            government. Later, we found that some
            contractors had retained overpayments. For
            example, in one case, a contractor was
            overpaid $7.5 million due to numerous
            errors. The overpayment remained
            outstanding for 8 years. We estimate that the
            government lost interest on the overpayment
            amounting to nearly $5 million. We
            concluded that neither DOD nor the
            Page 11     GAO/HR-97-4 Defense Contract Management
DOD’s Contract Payment Process Is
Error Prone and Costly




responsible contractors appeared to be
aggressively pursuing resolution of payment
discrepancies.

As of May 1996, DOD reported that its
problem disbursements totaled about
$18 billion. However, our preliminary work
on DOD’s reporting of problem disbursement
data indicates that reported amounts are
substantially understated. This
understatement raises concerns over
whether DOD has sufficient, reliable
information to determine the extent to which
disbursement problems have been reduced.1

In our most recent review, we concluded
that the following factors have contributed
significantly to errors in DOD’s payment
process: (1) nonintegrated computer
systems often require data to be entered
manually, and the data are often erroneous
or incomplete; (2) multiple documents must
be matched before contractors are paid; and
(3) payments are allocated among numerous
accounting classifications. In addition to
contributing to numerous errors, these
factors increase the cost of paying contract
invoices.


1
 For a discussion of DOD’s inability to resolve problem
disbursements, see our Defense Financial Management high-risk
report (GAO/HR-97-3).

Page 12          GAO/HR-97-4 Defense Contract Management
DOD’s Contract Payment Process Is
Error Prone and Costly




DOD  is taking steps to address its payment
problems. Its initiatives include testing and
adopting some best practices. In the long
term, it is developing procurement and
payment systems that are linked by sharing
common data. This linkage is expected to
allow one-time entry of contract data critical
to making correct payments. DOD plans to
implement the payment system in fiscal year
1999 and to make both systems fully
operational in 2004. In the meantime, DOD is
enhancing its current technologies to further
automate the payment process. DOD is also
testing streamlined payment practices.

While DOD’s planned procurement and
payment systems could improve the
accuracy and reliability of new contract
payment data and reduce processing costs,
they will not fully address the factors
identified as contributing to payment
problems. Ongoing contracts may be
transferred to the new system with existing
errors, multiple document matching will still
be done, and payments will continue to
require allocation among sometimes
numerous accounting classifications.




Page 13        GAO/HR-97-4 Defense Contract Management
Effective Cost-Estimating Systems Are
Key to Sound Contract Prices


             Cost-estimating systems that produce
             accurate price proposals are a key safeguard
             for obtaining fair and reasonable contract
             prices and minimizing overpricing. In the
             past, we found significant problems with
             contractors’ cost-estimating systems. In
             July 1994, we reported that 11 of 30 DOD
             contractors had cost-estimating systems
             containing significant uncorrected
             deficiencies that had been outstanding an
             average of 3.8 years. Although DOD
             administrative contracting officers are
             responsible for determining the adequacy of
             the contractors’ cost-estimating systems and
             requiring correction if the systems are
             deficient, we found that contracting officers
             were reluctant to use all available sanctions
             to encourage contractors to correct
             deficiencies. The failure to correct these
             deficiencies in a timely manner, we reported,
             creates a variety of problems for DOD,
             including increased costs and delays in
             contract award.

             Based on our audit recommendations, DOD
             took steps to strengthen oversight of its
             contractors’ estimating systems. Specifically,
             it issued new internal guidance for
             monitoring contractors’ cost-estimating
             systems and established positions within
             Defense Contract Management Command


             Page 14     GAO/HR-97-4 Defense Contract Management
Effective Cost-Estimating Systems Are
Key to Sound Contract Prices




(DCMC) district offices to serve as focal
points for overseeing the status of
contractors’ cost-estimating systems. DOD
now requires a biannual status report from
administrative contracting officers on the
status of outstanding deficiencies in
contractors’ estimating systems. According
to these reports, the number of estimating
system deficiencies has declined. However,
DCAA’s audits continue to identify proposals
that lack complete, accurate, and current
data. According to DCAA information, its
audits of proposals have saved $5.3 billion
over the last 3 fiscal years.

Despite DOD’s changes, some contractors
continue to have long-outstanding
deficiencies in their estimating systems. For
example, one contractor had significant
deficiencies dating to at least June 1992.
According to a June 1992 DCAA audit report,
this contractor had outdated support for its
material estimates as well as other material
and subcontractor cost deficiencies.
Additional audits by DCAA in September 1993,
May 1994, and April 1996 continued to find
material estimating weaknesses, such as the
use of undocumented judgmental cost
estimates instead of vendor quotes and the
use of outdated vendor quotes. In July 1996,
the administrative contracting officer


Page 15        GAO/HR-97-4 Defense Contract Management
Effective Cost-Estimating Systems Are
Key to Sound Contract Prices




reported that the company’s corrective
action plan was being monitored by a
contractor-government team. The
contracting officer also said that the risk to
the government is being minimized by more
extensive government review during
pre-award activities and increased scrutiny
of contractor billings.

Because of the importance of accurate
cost-estimating systems for producing sound
contractor price proposals and the
additional government resources and costs
associated with the more extensive review
required when contractors have deficient
systems, DOD needs to continue to encourage
contractors to resolve deficiencies in their
estimating systems quickly. Where necessary
to achieve compliance, government
administrative contracting officers need to
use the full range of tools available to them
to motivate contractors to address
estimating system deficiencies.




Page 16        GAO/HR-97-4 Defense Contract Management
Improving the Administration of DOD’s
Voluntary Disclosure Program


             In 1986, a report to the President on defense
             management concluded that the defense
             industry needed to promote principles of
             ethical business conduct, detect acts of
             procurement fraud through self-governance,
             and voluntarily report potential fraud to the
             government. In response to the report, a
             number of defense contractors established
             self-governance programs that included
             monitoring compliance with federal
             procurement laws and voluntarily disclosing
             violations to government authorities. These
             efforts became known as the Defense
             Industry Initiative on Business Ethics and
             Conduct.

             To facilitate contractors’ self-governance
             and encourage contractors to adopt a
             voluntary disclosure policy, DOD established
             the Voluntary Disclosure Program in
             July 1986. This program provides general
             guidelines, policy, and processes to enable
             DOD and its contractors to address matters of
             wrongdoing that contractors discover. At the
             time, DOD recognized that a process was
             needed for consistently handling matters
             disclosed by contractors. In return for
             voluntarily disclosing potential wrongdoing
             and cooperating in any government audit
             and investigation, the government generally
             allows contractors to conduct their own


             Page 17     GAO/HR-97-4 Defense Contract Management
Improving the Administration of DOD’s
Voluntary Disclosure Program




investigations, which the government then
attempts to verify expeditiously.

We reviewed DOD’s administration of its
Voluntary Disclosure Program and found
that contractors’ participation in the
program has been relatively small and the
dollar recoveries modest. From its inception
in 1986 through September 1994, DOD
reported that of the thousands of defense
contractors, 138 had made 325 voluntary
disclosures of potential procurement fraud.
DOD reported recoveries from these
disclosures to be $290 million, about 17
percent of the total reported DOD
procurement fraud recoveries between fiscal
year 1987 and 1994. However, our review
indicated that DOD’s reported recoveries of
$290 million were overstated because they
included $75 million in premature progress
payments and amounts from disclosures
made prior to the program.

We also found that DOD had accepted some
disclosures in the program that the Justice
Department believed were triggered by
imminent government discovery and thus
did not meet the criteria for admission.
Further, contractors’ less-than-full
cooperation with the government and DOD’s
and other investigative agencies’ low priority


Page 18        GAO/HR-97-4 Defense Contract Management
Improving the Administration of DOD’s
Voluntary Disclosure Program




on managing cases expeditiously may have
been problems in some cases.

Most disclosures did not result in significant
dollar recoveries for the government. Of 129
closed cases, 81 cases, or about 63 percent,
had reported recoveries of less than
$100,000, of which 52 cases, or 40 percent,
had no dollar recoveries. Forty-eight cases
had reported recoveries of $100,000 or more,
of which 15 cases had reported recoveries of
$2 million or more.

To ensure continued public support for
defense programs, it is critical that potential
fraud involving defense contractors be
identified quickly and pursued aggressively.
DOD’s Voluntary Disclosure Program has the
potential to contribute to that end, but
improvements are needed. Efforts to
improve the administration of the program,
including improving coordination between
DOD and the Department of Justice, could
increase both program participation and
dollar recoveries. Such improvements could
also help reduce the risk to the government
from procurement fraud.




Page 19        GAO/HR-97-4 Defense Contract Management
Managing Future Contract Risk



             DOD’s  budget declined from about
             $311 billion in fiscal year 1991 to about
             $254 billion in fiscal year 1996. However,
             beginning in fiscal year 1998, DOD projects a
             steady budget increase to about $270 billion
             by fiscal year 2001. While DOD’s contracting
             activity is related to the size of the defense
             budget, it is particularly related to trends in
             the procurement part of the budget. In this
             regard, DOD plans to increase its
             procurement budget from $43 billion in fiscal
             year 1996 to $60 billion by fiscal year 2001.
             As procurement activity increases, the
             amount of contracting and the demands for
             contract administration and audits are also
             likely to increase.

             DCMC  administers defense contracts, and
             DCAA audits them. Consistent with recent
             declines in the defense budget, resources for
             administering and auditing contracts have
             been cut significantly. However, unlike
             future defense budgets, contract
             administration and audit resources are
             expected to be cut back further. By fiscal
             year 2001, the staff at DCMC and DCAA are
             expected to be reduced to around 12,650 and
             4,200, respectively—a reduction of about 41
             and 32 percent from fiscal year 1991 levels.




             Page 20     GAO/HR-97-4 Defense Contract Management
Managing Future Contract Risk




DOD  is also moving toward outsourcing more
government functions. This is, perhaps,
nowhere more apparent than in recent
debates over privatizing depot maintenance
workloads. DOD’s depot maintenance is a
vast undertaking, supporting millions of
equipment items. DOD annually spends about
$15 billion on depot maintenance activities,
and its depot maintenance facilities and
equipment are valued at over $50 billion. DOD
and the Congress are redefining the role of
DOD depots in the post-Cold War era, much in
the same way the roles of U.S. war-fighting
forces are being reshaped. While the new
model for managing depot maintenance is
evolving, there appears to be a clear shift
toward greater reliance on the private
sector. This shift affects force structure and
the public and private activities’ supporting
force structure. It is also likely to affect the
degree of DOD contracting activity.

If DOD increases procurement budgets,
increases outsourcing, and reduces contract
administration and audit resources, DOD will
need to be creative in finding ways to meet
an expected increase in demand for contract
oversight and be more efficient in using its
existing resources. In this regard, recent
acquisition reform initiatives may create



Page 21        GAO/HR-97-4 Defense Contract Management
Managing Future Contract Risk




opportunities for DOD to redeploy oversight
resources.




Page 22        GAO/HR-97-4 Defense Contract Management
Further Action Needed



            The need for DOD to achieve effective control
            over its payment process is imperative. If it
            does not, it continues to risk erroneously
            paying contractors millions of dollars and
            perpetuating other financial management
            and accounting control problems. While DOD
            is taking steps to improve its payment
            process and controls, other actions are
            needed to better ensure that payments are
            effectively monitored. Because of the effect
            of acquisition decisions on the payment
            system, it is most critical that the DOD
            Comptroller and the Under Secretary of
            Defense for Acquisition and Technology
            work together to ensure that changes in the
            acquisition process and systems do not place
            undue burdens on the payment system. The
            focus of changes should be to optimize the
            use of technology and simplify the payment
            process.

            While the level of overpricing of defense
            contracts varies from year to year,
            overpricing remains an area that must
            continually be watched. Contractors may be
            deterred from overpricing if they know that
            the government will identify and deal with it
            aggressively. DOD must ensure that adequate
            systems and resources are available to
            protect government interests. Particularly
            important is the need to ensure that


            Page 23     GAO/HR-97-4 Defense Contract Management
Further Action Needed




contractors’ cost-estimating systems are
sound and that estimating deficiencies are
quickly corrected. While DOD records
indicate improvement, some contractors’
systems still contain long-standing
deficiencies. They must continue to be the
focus of DOD’s attention. Where appropriate,
DOD contracting officials need to use the full
range of tools to achieve contractors’
compliance with requirements.

DOD’s Voluntary Disclosure Program is
intended to encourage defense contractors
to report potential civil or criminal fraud to
the government. To realize the maximum
benefits from the program, increase program
participation, and improve dollar recoveries,
DOD needs to strengthen the administration
of the program, including improving
coordination between DOD and the
Department of Justice.

DOD is facing uncertainty and potential risk
in defense contracting in the future, given
projected increases in procurement spending
beginning in fiscal year 1998, increases in
outsourcing, and further reductions in
resources for administering and auditing
contracts. Over the last few years, DOD has
placed a high priority on streamlining and
reengineering its contracting and acquisition


Page 24        GAO/HR-97-4 Defense Contract Management
Further Action Needed




processes, including contract administration
and audit. These efforts are designed to
reduce oversight requirements where little
value can be gained and increase the
efficiency of the acquisition process. DOD
deserves much credit for these efforts.
However, continued high-level management
attention will be required to ensure success
of the efforts underway. Furthermore, DOD
will be challenged to find more efficient
ways to meet contract administration and
audit requirements with fewer resources. We
will continue to monitor DOD’s progress in
addressing the contract management issues
discussed in this report.




Page 25        GAO/HR-97-4 Defense Contract Management
Related GAO Products



            Defense Depot Maintenance: Privatization
            and the Debate Over the Public-Private Mix
            (GAO/T-NSIAD-96-146, Apr. 16, 1996).

            DOD Procurement: Use and Administration of
            DOD’s Voluntary Disclosure Program
            (GAO/NSIAD-96-21, Feb. 6, 1996).

            DODProcurement: Millions in Contract
            Payment Errors Not Detected and Resolved
            Promptly (GAO/NSIAD-96-8, Oct. 6, 1995).

            High-Risk Series: Defense Contract
            Management (GAO/HR-95-3, Feb. 1995).

            DOD Procurement: Overpayments and
            Underpayments at Selected Contractors
            Show Major Problem (GAO/NSIAD-94-245, Aug. 5,
            1994).

            DOD Procurement: Millions in Overpayments
            Returned by DOD Contractors
            (GAO/NSIAD-94-106, Mar. 14, 1994).




            Page 26     GAO/HR-97-4 Defense Contract Management
1997 High-Risk Series



             An Overview (GAO/HR-97-1)

             Quick Reference Guide (GAO/HR-97-2)

             Defense Financial Management (GAO/HR-97-3)

             Defense Contract Management (GAO/HR-97-4)

             Defense Inventory Management (GAO/HR-97-5)

             Defense Weapon Systems Acquisition
             (GAO/HR-97-6)

             Defense Infrastructure (GAO/HR-97-7)

             IRS Management (GAO/HR-97-8)

             Information Management and Technology
             (GAO/HR-97-9)

             Medicare (GAO/HR-97-10)

             Student Financial Aid (GAO/HR-97-11)

             Department of Housing and Urban
             Development (GAO/HR-97-12)

             Department of Energy Contract Management
             (GAO/HR-97-13)




             Page 27     GAO/HR-97-4 Defense Contract Management
1997 High-Risk Series




Superfund Program Management
(GAO/HR-97-14)




The entire series of 14 high-risk reports
can be ordered using the order number
GAO/HR-97-20SET.




Page 28         GAO/HR-97-4 Defense Contract Management
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