.._” ...__” . ..-- _. ..- -- _ _....._ _.,..“. _ .I- __.-..._. __- ._..-._ -_ .._ -.” _. Arlppst 19!FO CONTRACT PRICING Rev iew s of Defense Contrac tor Compensation Cos ts ---....?--- -I (;hO/NSIAI)-!)O-241!)PS - United States GAO General Accounting Office Washington, D.C. 20648 National Security and International Affairs Division B-219741 August 29,199O The Honorable William V. Roth, Jr. United States Senate Dear Senator Roth: In response to your request, we have developed information on Defense Contract Audit Agency (DCXA) reviews of contractor compensation costs. Specifically, this fact sheet provides information on the number of com- pensation reviews conducted by DCAA,the amount of unreasonable com- pensation identified by DCAA, and the status of the government’s efforts to reduce unreasonable compensation, We found that: Results in Brief . Between October 1, 1987, and December 31, 1989, DCAA completed 361 reviews of defense contractors’ compensation costs. q In 123 of these reviews, DCAAidentified about $340 million in what it viewed as unreasonable compensation, . As of December 31,1989, action had been completed on 39 of these reviews which had identified about $63 million in unreasonable compen- sation, In negotiations with the government, contractors agreed to con- tract and rate agreement reductions based on approximately $17 million of the $63 million. Compensation is one of the largest components of costs incurred under Background government contracts. The Federal Acquisition Regulation (FAR) 31.206-6 (a) defines compensation as $4 .all remuneration paid currently or accrued, in whatever form and whether paid . . immediately or deferred, for services rendered by employees to the contractor during the period of contract performance. . . . It includes, but is not limited to, salaries; wages; directors’ and executive committee members’ fees; bonuses (including stock bonuses); incentive awards; employee stock options, stock apprecia- tion rights, and stock ownership plans; employee insurance; fringe benefits; contri- butions to pension, annuity, and management employee incentive compensation plans; and allowances for off-site pay, incentive pay, location allowances, hardship pay, severance pay, and cost of living differential.” Responsibility for determining the reasonableness of contractors’ com- pensation costs rests with the government administrative contracting Page 1 GAO/NSIAIMO-249FS DCAA B-219741 officers. Until October 1, 1987, both the Defense Contract Administra- tion Services, an organization within the Defense Logistics Agency, and DCAA jointly reviewed defense contractors’ compensation costs and made recommendations to administrative contracting officers regarding unreasonable compensation. Effective October 1, 1987, the Department of Defense (DOD) gave DCAA sole responsibility for reviewing contractor compensation costs. FAR requires that negotiated contracts include employee compensation costs-such as salaries, bonuses, and fringe benefits-only to the extent that they are “reasonable.” According to FAR, “A cost is reasonable if, in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business.” DCAA reviews defense contractors’ compensation costs under its Con- DCAA’s Contractor tractor Employee Compensation System Review program. DCAA selects Employee contractors for review based on selection criteria that take into account CompensationSystem the government’s risk of accepting excessive compensation in govern- ment contracts. Review Program In determining which contractors to review, DCM considers conducting reviews every 2 years on contractors who have annual government sales of $10 million or greater and receive at least 10 percent of their business from government sales. DCAA also considers the amount of compensation included in the contractor’s government sales, previous compensation review findings regarding that contractor, and the expiration date of the contractor’s collective bargaining agreements. Scheduling reviews to coincide with the expiration date of bargaining agreements allows DCAA’Sfindings to be considered in renewing those agreements. DCAA also conducts special purpose reviews that focus on specific groups of employees and follow-up reviews to determine what action the contractor has taken regarding the findings. The availability of DCM staff is another consideration in planning the number of com- pensation reviews each year. How DCAA Determines Before April 1986, FAR required that compensation be considered rea- Reasonableness sonable if total compensation generally conformed to compensation paid by other firms of the same size, in the same industry, or in the same geographic area for similar services or work performed. Under the total compensation approach, the government had little success in challenging Page 2 GAO/NSIAD-99-249FS DCAA , 6219741 the reasonableness of compensation costs because there were no widely acceptable measurements of total compensation. In April 1986, FAR was revised to permit the government to challenge any single element of compensation, such as fringe benefits. When an element is challenged, the burden is placed on the contractor to either defend the reasonableness of the element or show that lower costs for other elements of the compensation package offset the “unreasonable” costs. According to the FAR, a government contractor’s compensation costs will be considered reasonable, if each of the allowable elements of the employee’s compensation package is reasonable. Consideration should be given to all potentially relevant facts, such as, whether the elements of the compensation package are in general conformity with the compensation practices of other firms of the same size, the compen- sation practices of other firms in the same industry, the compensation practices of other firms in the same geographic area, and the compensa- tion practices of other firms engaged in predominately nongovernment work. The cost of comparable services obtainable from outside sources is another reasonableness criterion identified in FAR. To determine whether a contractor’s compensation is reasonable, DCU compares it to comparable data from compensation surveys. Compensa- tion surveys are prepared by private companies (as well as defense con- tractors) using compensation data collected from various firms. D&U considers a contractor’s compensation reasonable if it is within 14 per- cent of appropriate survey compensation (within 26 percent for execu- tives). DCAAallows the 14 and 26 percent variances because of an Armed Services Board of Contract Appeals decision that reasonableness of com- pensation is better represented by a range than by a precise figure. A range also allows for variations in surveys based on the way employees doing comparable work are paid in different firms. Results of DCAA compensation reviews, some of which are for different divisions of the Compensation same parent companies. The DCAACompensation Program Manager said Reviews that most major contractors (those with over $40 million in government sales) have had at least one compensation review. DCU initially identified about $460 million in unreasonable compensa- Y tion in 140 of the 361 reviews. As of December 31,1989, DCAAhad made about $110 million in reductions to the unreasonable compensation find- ings in these reports, based on such things as additional contractor data Page 2 GAO/NSIAD-90-249Fs DC4A F&219741 or changes in DCAAaudit guidance. These revisions reduced the number of reviews with findings of unreasonable compensation to 123 and the total amount of those findings to approximately $340 million. If DCAAdetermines that a contractor’s employee compensation is more Government’s Success than 14 percent above the appropriate wage survey average (25 percent in Reducing above for executives), it requests the contractor to either justify the Unreasonable compensation or submit an action plan to reduce the compensation to a reasonable level. DCAAthen submits a report of its findings and the con- Compensation tractor’s response to the cognizant administrative contracting officer. According to the Office of the DOD Inspector General, the administrative contracting officer may . negotiate a settlement or other agreement to reduce the contractor’s unreasonable compensation, . issue a formal notice of intention to disallow unreasonable compensation included in future contract costs, or l take no action if it is determined that the contractor’s compensation is not unreasonable. Of the approximately $340 million in unreasonable compensation identi- fied in the 123 reviews, the DCU Compensation Program Manager said that action has been completed on 39 DCU reviews with identified unreasonable compensation of about $63 million. The program manager said that in negotiations with the government, contractors agreed to contract and rate agreement reductions based on approximately $17 mil- lion of the $63 million in unreasonable compensation identified in the 39 reviews. Scopeand DCAAstatus reports of compensation reviews, and made a limited anal- Methodology ysis of 10 IXXA reviews that reported large dollar amounts of unreason- able contractor employee compensation. We validated selected data by examining the relevant individual compensation review reports. We also interviewed DUA officials at their Washington headquarters office and several regional offices and met with DOD Inspector General officials who were conducting a related review. Our work on this assign- ment did not include discussions with government contracting officers or contractor representatives, As agreed with your staff, we will, in a Page 4 GAO/NSIAD-90-249FS DCAA B-219741 separate review, evaluate whether certain DC~Acompensation findings and recommendations were supportable and convincing and why DOD contracting officers have not acted on them. Our review was performed from August 1989 to May 1990. We did not obtain official agency comments on a draft of this report, but we dis- cussed our findings with DCAA officials and have incorporated their com- ments where appropriate. Unless you publicly announce its contents earlier, we plan no further distribution of this report until 30 days from the date of this letter. At that time, we will send copies to the Secretary of Defense and the Director, DCAA,and make copies available to other interested parties on request. The major contributors to this fact sheet are David E. Cooper, Assistant Director, and John L. Carter, Assignment Manager, from headquarters; and Joe D. Quicksall, Evaluator-in-Charge, Ronald M . Haun, Site Senior, and Jerilyn Green, Staff Evaluator, Dallas Regional Office. Please contact me at (202) 2758400 if you or your staff have any ques- tions concerning this fact sheet. Sincerely yours, ._ ..I.._ ll.“,l .-_. -_l-..-.ll--..“.--- -
Contract Pricing: Reviews of Defense Contractor Compensation Costs
Published by the Government Accountability Office on 1990-08-29.
Below is a raw (and likely hideous) rendition of the original report. (PDF)