September 1990 CONTRACT PRICING Implementation of Cost Estimating Regulations . ----- _L-_ GAO,‘NSLAD-90-290 : United States GAO General Accounting Office Washington, D.C. ‘20648 National Security and International Affairs Division B-241017.1 September 28, 1990 The Honorable John Conyers, Jr. Chairman, Legislation and National Security Subcommittee Committee on Government Operations House of Representatives Dear Mr. Chairman: As you requested, we reviewed contract auditors’ and administrative contracting officers’ compliance with Department of Defense (DOD) regu- lations for reviewing contractor estimating systems. Our objectives were to determine whether (1) DOD estimating system reviews were conducted as joint contract audit and contract administration team efforts as required, (2) estimating system reports prepared by Defense Contract Audit Agency (DCAA)personnel contained appropriate recommendations for disapproving all or parts of contractor systems as called for by the DOD regulations, and (3) DOD administrative contracting officers followed the procedures prescribed for correcting identified deficiencies. revised its procurement regulations in March 1988 to establish more Results in Brief DOD stringent requirements governing contractor estimating systems, and KAA has devoted significantly more resources to reviewing contractor cost estimating systems. Although DOD has revised its regulations, con- tract auditors and administrative contracting officers have not fully complied with them. For example: . Contract administration personnel did not participate as a team member in 10 of the 16 reviews we examined even though their participation is essential in evaluating certain costs generated by contractor estimating systems and included in contract proposals. . Only 1 of the 16 KXXAreports that we examined recommended disap- proval of all or part of a contractor’s system, although all 16 reports identified potentially significant deficiencies. . Administrative contracting officers generally did not follow the regula- tory process for correcting identified estimating deficiencies. When DOD awards contracts noncompetitively, it lacks the economic Background safeguards normally found in the competitive marketplace and must Page 1 GAO/NSIAD90.290 Contract Pricing E-341017.1 contract prices because the contractors had not evaluated the subcon- tracts as required by procurement regulations. . In January 1988, we reported that the prices of 17 noncompetitive DOD contracts were overstated by $21 million because contractor labor esti- mates had not considered actual labor experience on prior contracts.” Rather, contractors’ proposed labor estimates were based on judgment and lacked verifiable support. The actual labor cost incurred on the 17 contracts was about 22 percent below the estimates proposed by the contractors. l In January 1988, we also reported that contractors had proposed about $135 million (on eight noncompetitive contracts) for scrap, raw mater- ials, engineering changes, and other items. The estimates were based on rates, percentage factors, and cost estimating relationships without veri- fiable data because contractors had not accounted for such costs. How. ever, DOD contracting officers negotiated $95 million in the contract prices. Our prior work and hearings by the House Government Operations’ Leg- islation and National Security Subcommittee had revealed a number of problems with DOD’S oversight of contractor estimating systems: (1) esti- mating deficiencies remained uncorrected for long periods; (2) the ele- ments of an acceptable estimating system were not well defined; (3) responsibility for resolving deficiencies was not clear; and (4) contract audit and administration team reviews of contractor estimating systems generally had not been conducted since the early 1970s. The March 1988 revision to DOD’s regulations was designed to overcome these shortcomings. According to DOD’S revised regulations, contractor estimating systems Revised Regulations should consistently produce well-supported proposals that are accept- Provide for able to the government as a basis for negotiating fair and reasonable Identifying and contract prices. To ensure that a contractor meets this criterion, the reg- ulations require that the DCAAcontract auditor lead a team effort, along Resolving Estimating with the contract administration office, to regularly review (generally System Deficiencies every 3 years) the adequacy of each contractor’s estimating system. DCAAshould then document the review results in a report to the adminis- trative contracting officer. If the review finds “significant” estimating 3Cmtract Pricing: Defense Contractor Cost Estimatii Systems (GAO/NSIAD-88-7, Jan. 5. 1988) Page 3 GAO,‘NSL4DOO-290 Contract Pricing 5241017.1 For 6 of the 16 DCA~Z estimating system reports we reviewed, KG and contract administration personnel had made team reviews. However, in the other 10 cases, contract administration personnel did not participate as team members in reviewing contractor estimating policies, proce- dures, and practices. We found essentially the same situation in our 1985 review. Although EAA has significantly increased the time it devotes to System Review reviewing contractor estimating systems (from 37,566 hours in 1986 to Reports Did Not 114,lZ 1 hours in 1989) its system review reports to administrative con- Identify the tracting officers have not fully met the requirements of the revised reg- ulations. While all 16 estimating system reports that we reviewed Significance of identified potentially significant deficiencies, only 1 report recom- Deficiencies or mended disapproval of all or a part of the contractor’s estimating system as required. Recommend Disapproval When we brought this matter to the attention of the DCAAauditors responsible for conducting the estimating system reviews, they told us that, at the time they had prepared the reports, they were not aware of the regulatory requirement to recommend system disapprovals. Rather, they had followed the DCAAaudit manual, which did not contain gui- dance on disapproval recommendations. DCU notified its auditors of the estimating system regulations in May 1988 but did not provide guidance in its audit manual until July 1989. At that time, the manual was revised to state that deficiencies should be identified as minor or significant and that, if significant, the auditors should recommend system disapproval in whole or in part. Administrative contracting officers frequently did not follow the proce- Administrative dures established to ensure the timely correction of identified deficien- Contracting Officers cies in contractor estimating systems. For example, administrative Generally Did Not contracting officers had not provided 10 of the 16 reports we reviewed to the contractors for their comments. This omission short-circuited the Follow Procedures for regulatory process that is aimed at placing administrative contracting Correcting officers in positions to determine the adequacy of contractor systems. Of Deficiencies the 10 reports, 3 were provided to the contractors after we visited the contract administration offices. Also, for 12 of the 16 reports, administrative contracting officers had not determined. as required by the regulations, whether (1) the esti- mating systems contained deficiencies that needed correction, (2) any Page 6 GAO/‘NSuD9o-29O Contract F’hine B-241017.1 Please contact me at (202) 275-8400 if you or your staff have any ques- tions concerning this report. Other major contributors to this report are listed in appendix II. Sincerely yours, Director, Research, Development, Acquisition, and Procurement Issues Page 7 GAO/NSlADOO.2SO Contract Pride@ Page 9 GAO/NSIABBMBO Contract Pricing Ppe kzir Contributors to This Report David E. Cooper, Assistant Director National Security and International Affairs Division, Washington, D.C. George C. Burdette, Regional Assignment Manager Atlanta Regional Gene M. Barnes, Evaluator Office Magdalene Harris, Evaluator Paul M. Greeley, Evaluator-in-Charge Boston Regional Office Susie A. Pickens, Evaluator Stephen J. Licari, Evaluator (39665.9) Page 11 GAO/NSlAJM@2BO Contract Prlchg I ,,, -,- ,_ ,,,,I., .- ..- ..- ,_-- ,,- _. .- .-- .,.- ,_- - ,.,,_ ,_ ,,_ ,,_ ,,_,,_ _ Ordering Information The first five copies of each GAO report are free. ;VRm copies are $2 each. Orders should be sent to the IVl~ address, accompanied by a check or money order made the Superintendent of Documents, when I~~u~%ILL~~~~~~~~.- 100 or more copies to be mailed to a single :liFmd=---. discounted 25 percent. U.S. General Accounting Office P. 0. Box 601.5 Gaithersburg, MD 20877 Orders may also be placed by calling (202) ‘AL.. -----.- -., .I. ,. -_,.- .-,, -,..-,-.---.-. - -. -.. _ -1 United States I First-Class \m General Accounting Office Postage & Fees : Washington, D.C. 20548 GAO Permit No. HIII Official Business Penalty for Private Use $300 Appendix I Scow and Methodology Using Defense Federal Acquisition Regulation Supplement 215.811 and related DOD guidance on cost estimating system reviews as criteria. we reviewed 16 estimating system reports, all of which were issued after March 18, 1988, the effective date of DOD’S regulations. We also analyzed related documents prepared by XAA and contract administrators and interviewed DCXAand contract administration officials about their system review activities and actions regarding the selected reports. The 16 reports we reviewed were judgmentally selected and addressed the estimating systems of the following 16 defense contractors: 9 E-Systems, Incorporated, St. Petersburg, Florida; . General Dynamics Corporation, Groton, Connecticut; . GTE Communication Systems Division, Needham, Massachusetts; . GTE Strategic Systems Division, Westborough, Massachusetts; . Harris Corporation, Melbourne, Florida; . Hazeltine Corporation, Greenlawn, New York; l Hercules, Incorporated, Clearwater, Florida; . Honeywell, Incorporated, Clearwater, Florida; . Raytheon Company, Equipment Division, Marlborough, Massachusetts; . Raytheon Company, Submarine Signal Division, Portsmouth, Rhode Island; 0 Rockwell International Corporation, Duluth, Georgia; . Lockheed Corporation, Nashua, New Hampshire; + SC1Technology, Incorporated, Huntsville, Alabama; l United Technologies Corporation, Hamilton Standard Aircraft Systems and System Controls and Accessories, Windsor Locks, Connecticut; l United Technologies Corporation, Hamilton Standard Space and Sea Sys- tems, Windsor Locks, Connecticut; and l United Technologies Corporation, Pratt & Whitney, West Palm Beach, Florida. We made our review between January 1989 and July 1990 in accor- dance with generally accepted government auditing standards. Page 10 GAO/NSIAD90-290 Contract Pricing Letter Appendix I 10 Scopeand Methodology Appendix II 11 Major Contributors to This Report Abbreviations XAA Defense Contract Audit Agency DOD Department of Defense GAO General Accounting Office Page 8 GAO/NSUDgO-290 Contract Pricing B241017.1 deficiencies were significant enough to warrant disapproving all or a portion of the systems, or (3) any contractor-proposed corrective actions were adequate to correct the deficiencies. At the completion of our review, 11 of the 12 reports contained one or more significant deficien- cies that had been uncorrected for at least 2 years. Administrative contracting officers had followed procedures for cor- recting identified estimating deficiencies in 4 of the 16 reports we reviewed. As a result, two contractors had corrected the deficiencies, and two contractors had their estimating systems disapproved. Our prior work has shown that millions of dollars could be saved if DOD Conclusions identified and promptly corrected inadequate contractor estimating sys- tems. We support DOD’S emphasis on contractor estimating systems and believe the revised regulations are an important step toward negotiating fair and reasonable prices. However, our sample of 16 DCAAreports has indicated that DOD’s efforts to identify and eliminate estimating system deficiencies have not been as successful as possible. Our scope and methodology are discussed in appendix I. As requested, we did not obtain written agency comments on this report. However, we discussed its contents with DOD officials and have included 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 Direc- tors of the Defense Logistics Agency and m. We will also send copies to interested parties and make copies available to others upon request. Page 6 GAO/NSlAWXM90 Contract Pricing B-241017.1 deficiencies,’ the report should recommend the disapproval of all or a portion of the estimating system. The regulations clearly assign responsibility for determining the ade- quacy of contractor systems to the administrative contracting officer. The regulations also provide the following detailed sequence of actions that the administrative contracting officer should follow to ensure the timely correction of estimating system deficiencies: . After receiving LXXA’Sreport, the administrative contracting officer should submit a copy to the contractor and request written agreement or disagreement with the report’s findings and recommendations. l After considering the contractor’s response and consulting with the DCAA auditor, the administrative contracting officer should determine whether (1) the estimating system contains deficiencies needing correc- tion, (2) any deficiencies are significant and would result in the disap- proval of all or a portion of the estimating system, or (3) any proposed corrective actions are adequate. The administrative contracting officer should then notify the contractor l of the determination and, if appropriate, the government’s intent to dis- approve all or part of the system. The auditor and administrative contracting officer are required to mon- itor the contractor’s progress in correcting any deficiencies. If the con- tractor fails to make adequate progress, the administrative contracting officer must take whatever actions are necessary to ensure that the defi- ciencies are corrected. Such actions include reducing or suspending pro- gress payments and recommending that potential contracts not be awarded to the contractor. Many Estimating expertise needed to analyze such things as the accuracy and reliability System Reviews Were of contractor estimates for manufacturing and engineering labor hours, Not Conducted as material quantities, scrap and rework costs, and various overhead costs. The costs for such items represent a substantial portion of contractors’ Team Efforts proposals and can total millions of dollars. ‘The regulations define a “s@ificant” estimating deficiency as a shortcoming that is likely to consist- ently result in estimates that in total, or for a major cost element, do not constitute an acceptable basis for negotiating faw and reasonable prices. Page 4 GAO/NS~90.290 Contract Prlci~~~ B241017.1 rely largely on information produced by contractor cost estimating sys- tems to establish contract prices. Therefore, sound estimating systems that produce reliable contract proposals are fundamental to negotiating fair and reasonable noncompetitive contract prices. To ensure that such contract prices are fair and reasonable, DOD issued revised regulations on contractor cost estimating systems in March 1988. The regulations, issued in response to the House Committee on Government Operations’ and our recommendations, require certain major contractors to establish and maintain adequate cost estimating systems and to disclose their systems to DOD. DOD’s revised regulations are contained in section 215.811 of the Defense Supplement to the Federal Acquisition Regulation. According to the reg- ulations, an “estimating system” encompasses all of a contractor’s poli- cies, procedures, and practices for generating cost estimates based on available information. It includes the organizational structure; estab- lished lines of authority, duties, and responsibilities; internal controls and managerial reviews; flow of work, coordination, and communica- tion; and estimating methods and analyses, accumulation of historical costs, and other data included in contract proposals. Estimating system deficiencies can cause inflated contract prices. In sev- Our Past Reviews eral reviews conducted between 1986 and 1988, we found a number of Found Problems With weaknesses in the way contractors had estimated material, labor, and Estimating Systems other costs for noncompetitive contracts, such as the following: and DOD Oversight . In October 1985, we reported on a review of 87 subcontracts negotiated under DOD prime contracts valued at $785 million1 We found that prime contractors had been able to negotiate subcontract prices that were $42 million (about 5 percent) below those included in prime contract prices. The reductions resulted because contractors had not evaluated subcontracts before prime contracts were awarded, as required by DOD procurement regulations. . In June 1987, we reported on an additional 28 subcontracts which had been negotiated into DOD prime contracts for about $92 million.* Again, we found that prime contractors had negotiated subcontract prices that were about $10 million (about 11 percent) below those included in prime ‘GAO Work at Defense Contractor Plants, statement of Frank C. Conahan before the Legislation and Kational Security Subcommittee, House Committee on Government Operation (Ott 3, 1986). *Contract pricing: Contractor Cost Estimating System (GAO/NSIAD-87-140, June 3,1987) Page 2 GA0/NSIAD80.280 Contract Priw
Contract Pricing: Implementation of Cost Estimating Regulations
Published by the Government Accountability Office on 1990-09-28.
Below is a raw (and likely hideous) rendition of the original report. (PDF)