oversight

DOD Contract Management: Greater Attention Needed to Identify and Recover Overpayments

Published by the Government Accountability Office on 1999-07-19.

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

                   United States General Accounting Office

GAO                Report to the Honorable
                   Tom Harkin U.S. Senate



July 1999
                   DOD CONTRACT
                   MANAGEMENT

                   Greater Attention
                   Needed to Identify and
                   Recover
                   Overpayments




GAO/NSIAD-99-131
United States General Accounting Office                                                                National Security and
Washington, D.C. 20548                                                                          International Affairs Division



                                    B-280329                                                                                        Letter

                                    July 19, 1999

                                    The Honorable Tom Harkin
                                    United States Senate

                                    Dear Senator Harkin:

                                    In October 1997, we reported to you that from October 1992 through April
                                    1997, defense contractors refunded $5.1 billion to the Defense Finance and
                                    Accounting Service’s (DFAS), Columbus Center, the largest Department of
                                    Defense (DOD) payment center, and we discussed the reasons for the
                                    refunds. As requested, we (1) updated this information through fiscal year
                                    1998 and (2) visited 13 contractor locations to ascertain if the contractors
                                    were retaining overpayments and how quickly overpayments were
                                    refunded. We also obtained information on the backlog of contracts
                                    waiting to be examined for possible overpayment.



Results in Brief                    In the 5 years between fiscal year 1994 and 1998, defense contractors
                                    returned about $4.6 billion to the Columbus Center--in fiscal year 1998,
                                    $746 million. The Center attributes most of the returned money to
                                    overpayments caused by factors outside its control. However, payment
                                    errors by the Center were also a factor.

                                    It took about a year, on average, before the 13 contractors refunded
                                    overpayments of $56.2 million to the Center. In addition, four of the
                                    contractors were still retaining overpayments totaling $1.1 million. After
                                    we brought these overpayments to the contractors’ and the government’s
                                    attention, the contractors refunded the overpayments. A Defense Contract
                                    Management Command area office also instructed its personnel to ask
                                    contractors reporting overpayments to immediately return the money. In
                                    some cases, government personnel were aware of overpayments, but they
                                    did not take timely action to obtain recovery. Under current law, there is no
                                    requirement for contractors who have been overpaid to notify the
                                    government of overpayments or to return overpayments prior to the
                                    government issuing a demand letter. 1



                                    1
                                     A demand letter is a formal notification to the contractor to pay money owed the government.




                                    Page 1                                           GAO/NSIAD-99-131 DOD Contract Management
             B-280329




             The Center has a sizable and growing backlog of contracts waiting to be
             examined to ensure that contractors were properly paid—a process called
             reconciliation. Reconciliation has often resulted in claims against
             contractors for overpayments. The longer a contract remains
             unreconciled, the longer any overpayment identified through reconciliation
             will remain undetected, and the greater will be the government’s loss of the
             timely use of these monies. Further, delays in seeking return of
             overpayments may result in increased difficulty in collection or actual
             monetary loss to the government.

             We are making recommendations to the Secretary of Defense to improve
             the process for identifying and collecting overpayments.



Background   In August 1988, the Defense Logistics Agency established a finance center
             in Columbus, Ohio, to consolidate contract payments and other functions
             previously performed at 20 agency sites. In January 1991, the Agency’s
             finance operations at Columbus became part of DFAS, a consolidated DOD
             finance and accounting function under the DOD Comptroller. According to
             the Columbus Center, in fiscal year 1998, it paid about $70.5 billion on over
             1 million invoices.

             DOD’s payment process involves several organizations, including DFAS.
             Some of the organizations are the Defense Contract Management
             Command (DCMC), which administers contracts, and the Defense Contract
             Audit Agency (DCAA), which reviews contractors’ records, internal
             controls, and billing systems. The contractors that perform the contracted
             work and bill the government are also involved in the process.

             Contractors retaining overpayments is not a new issue. In 1994, based on
             our work at nine contractor locations, we reported that while each
             contractor had returned some overpayments, all were retaining additional
             overpayments.2




             2
              DOD Procurement: Overpayments and Underpayments at Selected Contractors Show Major Problem
             (GAO/NSIAD-94-245, Aug. 5, 1994).




             Page 2                                       GAO/NSIAD-99-131 DOD Contract Management
                          B-280329




Refunds Amount to         Between fiscal year 1994 and 1998, the Columbus Center received refunds
                          from defense contractors totaling $4.6 billion. The amounts have declined
Hundreds of Millions of   since fiscal year 1996. (See fig. 1.)
Dollars a Year

                          Figure 1: Refunds from Defense Contractors
                          Dollars in millions

                          1,200



                          1,000



                            800



                            600



                            400



                            200



                              0
                                         94         95              96                97       98
                                                               Fisca l ye a r


                                                           Total am ounts rec eived


                          Source: DFAS, Columbus.


                          According to the Columbus Center, $3.6 billion of the $4.6 billion it received
                          was due to factors outside its control, such as downward contract price
                          adjustments that resulted in overpayments. The remaining $984 million
                          was attributable to Center payment errors, such as paying the same invoice
                          twice, making erroneous progress payment liquidations, and misreading
                          invoice amounts.

                          As indicated in figure 2, Center payment errors decreased from fiscal year
                          1994 to 1997 but increased in fiscal year 1998. According to Center
                          personnel, the increase was due to a computer problem resulting in two
                          overpayments to one contractor, one for $20 million and another for




                          Page 3                                  GAO/NSIAD-99-131 DOD Contract Management
                        B-280329




                        $10 million. The overpayments were promptly returned, and DFAS said the
                        computer problem was immediately corrected.



                        Figure 2: Contractor Refunds by Reason

                        Dollars in millions
                        900

                        800

                        700

                        600

                        500

                        400

                        300

                        200

                        100

                          0
                                    94            95             96          97            98

                                                          Fisca l Ye a r

                                     DFAS payment error
                                     Contract administration and other non-DFAS actions
                        Source: DFAS, Columbus.




Review of Selected      From overpayments returned to the Center in fiscal year 1998, we selected
                        and visited 13 contractor locations to ascertain (1) if contractors were
Contractors Discloses   retaining overpayments and (2) how quickly overpayments were refunded.
Additional Payment
Problems


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                            B-280329




Some Contractor Locations   Four of the 13 contractors were retaining overpayments totaling about
Retain Overpayments         $1.1 million. Contractor personnel at each location told us they had not
                            returned the money because each contractor had a practice of retaining
                            overpayments until the government issued a demand letter. Under current
                            law, there is no requirement for contractors who have been overpaid to
                            notify the government of overpayments or to return overpayments before
                            the government issues a demand letter.

                            Contractor officials at one location we visited in May 1998 told us that they
                            were retaining an overpayment of about $36,800 received in 1995 because
                            their practice is to retain overpayments until the end of a contract unless a
                            demand letter is received. They said without a demand letter, they could
                            not be sure that their account would be properly credited. For that reason,
                            they said they did not notify DOD about the overpayment. At our request,
                            the contractor reported the overpayment to the government’s
                            administrative contracting officer (ACO) who issued a demand letter. The
                            contractor refunded the overpayment in June 1998. After our visit, DCAA
                            issued an audit report on an audit that was ongoing at the time of our visit,
                            requiring the contractor to establish written policies and procedures to
                            ensure overpayments are identified and reported to the government.
                            According to DCAA, the contractor has established such controls.

                            At another location, a contractor was retaining overpayments of about
                            $41,700 that it had known about since January 1997. A contractor official
                            said that it is company policy to first resolve payment discrepancies with
                            DFAS. The official also said that unless this is done and a demand letter
                            issued, DFAS does not properly credit their account. At our request, the
                            contractor notified the ACO of the overpayment in June 1998. The ACO
                            requested the Center to verify the accuracy of the reported overpayment.
                            Initially, the Center concluded that no overpayment had occurred.
                            However, upon closer examination, the Center concluded that the
                            government had overpaid the contractor. In October 1998, the Center
                            issued a demand letter, and the contractor refunded the money promptly.
                            The DCMC area office also issued a memorandum to its field operations
                            personnel instructing them to ask a contractor reporting an overpayment to
                            immediately return the money.

                            We also found cases where the government was aware of overpayments but
                            did not take timely action to obtain recovery. For example, the ACO at one
                            contractor location told us that he had identified overpayments of more
                            than $400,000 in March 1997. According to the ACO, he notified the Center
                            of the overpayments because it had access to the payment records and



                            Page 5                               GAO/NSIAD-99-131 DOD Contract Management
                          B-280329




                          was, therefore, in a position to determine the amount of overpayments and
                          issue a demand letter. According to the ACO, the Center informed him that
                          the overpayments would be recovered from the contractor’s future
                          shipment, even though he had informed the Center that the contract had
                          been completed and no future shipment would be made. Notwithstanding
                          this information, the Center did not issue a demand letter. After our visit,
                          the ACO issued two demand letters for about $425,000, which the
                          contractor refunded.

                          At another location, according to a contractor official, contractor
                          personnel notified the Center of overpayments beginning in 1991 but did
                          not refund the money because they were waiting for a demand letter.
                          According to this official, their experience has been that their account was
                          not properly credited when they refunded money without a demand letter.
                          As a result, the contractor kept track of the overpayments and waited for
                          the government to issue a demand letter. At our request, the contractor
                          provided us a list showing accumulated overpayments of about $627,000. In
                          August 1998, we provided the Center the list and requested it to recover the
                          overpayments, and in December 1998, the Center requested that the
                          overpayments be returned. In April 1999, a company official advised us
                          that the money had been refunded and that the company would revise its
                          procedures to refund overpayments without a demand letter.


Timeliness in Obtaining   Obtaining timely return of overpayments is important. If overpayments are
Refunds of Overpayments   not recovered promptly, DOD forgoes the use of these monies and may
                          suffer actual monetary loss if the debt becomes uncollectible. It took about
                          a year, on average, before overpayments of $56.2 million were refunded to
                          the Center by the 13 contractors. This varied from about 2 weeks to nearly
                          6 years in one case.

                          At one location, the contractor was overpaid $6.1 million between 1992 and
                          1996. In December 1997, the contractor voluntarily refunded the money.
                          According to a contractor official, the company’s practice was to retain
                          overpayments in an advance payment account until a demand letter was
                          received or the end of the contract to ensure the Center would properly
                          credit the company’s account. Due to a change in company practice, the
                          overpayments were remitted before the end of the contract.

                          At a second location, the government’s contracting officer did not request a
                          refund when, in August 1995, the government agreed to replace contractor
                          purchased material with government-furnished material, resulting in the



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                        B-280329




                        contractor being overpaid. According to contractor officials and the DOD
                        contracting office, the amount of overpayment was difficult to determine
                        because the extent of use of the government material was uncertain. Yet,
                        even after production was completed and contract items had been
                        delivered in November 1996, the contracting officer did not request a
                        refund. The government ultimately negotiated price reductions of over
                        $1.6 million in July 1997 and requested repayment in September 1997.

                        At a third location, the ACO did not take timely steps to recover
                        overpayments of over $4 million that had been identified as early as June
                        1989 in contractor reports to the ACO. By June 1993, the reported
                        overpayment totaled about $8.5 million. Partial refunds of about
                        $2.9 million and $4.4 million were made in 1994 and late 1997, respectively.
                        According to government officials, the total amount of overpayment was
                        not determined until November 1997 due to staffing constraints, priorities
                        given to new contracts, and unknown requirements that could surface
                        during contract performance. Production requirements, however, had
                        been completed in March 1990.

                        The timeliness of obtaining refunds of overpayments is not a new issue. In
                        March 1994, we reported that the Center did not collect overpayments
                        promptly when reported. In some cases, contractors planned to return
                        overpayments but were told to hold the money until the contracts could be
                        reconciled and demand letters issued.3 We found similar problems in 1995
                        and estimated that delays in recovering about $84 million in overpayments
                        cost the government about $10.6 million in interest.4 In that review, we also
                        found that the Center did not pursue timely recovery even after a contract
                        reconciliation identified overpayments.


DCAA Did Not Identify   A key procedure for identifying overpayments is to have the contractor
Overpayments            periodically reconcile its billings to the government with its accounting
                        data and with the payments it receives from the government. Since June
                        1994, DCAA, as part of its periodic review of contractor billing systems, has
                        been required to ensure that a contractor (1) has written procedures for
                        periodically reconciling its billing and accounting data and notifying the


                        3
                          DOD Procurement: Millions in Overpayments Returned by DOD Contractors (GAO/NSIAD-94-106,
                        Mar. 14, 1994).
                        4
                         DOD Procurement: Millions in Contract Payment Errors Not Detected and Resolved Promptly
                        (GAO/NSIAD-96-8, Oct. 6, 1995).




                        Page 7                                        GAO/NSIAD-99-131 DOD Contract Management
                           B-280329




                           government of overpayments and (2) is effectively implementing these
                           procedures. At two locations, we noted that DCAA auditors did not
                           identify overpayments.

                           For example, in September 1997, while reconciling its accounts in
                           preparing its final billing on the contract, one contractor discovered it had
                           erroneously billed and been overpaid $591,000 in March 1994. The
                           contractor said that its procedures in effect at the time did not catch the
                           overbilling or the resulting overpayment and that it has since established
                           stronger controls that provide for periodic reconciliation of billing and
                           accounting data. However, we noted that in reviewing the contractor’s
                           billing system in 1996, DCAA did not identify the overpayment and
                           concluded that the system was adequate.

                           At another contractor location, the company’s practice was to keep
                           overpayments in an advance payment account until it received a demand
                           letter or the contract was completed. The advance payment account had a
                           balance of at least $6.1 million that had been accumulating since 1992
                           before the contractor refunded it in December 1997. DCAA auditors said
                           they were unaware of the overpayments in that account. Moreover, DCAA
                           did not test the contractor’s comparisons of amounts received to amounts
                           billed for each invoice and did not determine if the contractor had a policy
                           of timely notifying the paying office of overpayments, which it should have
                           based on its audit guidance. According to the auditors, they used the
                           standard DCAA billing system audit program, dated October 1993, to
                           conduct their audit in October 1994. This audit program did not require
                           DCAA to evaluate the contractor’s controls for identifying and notifying the
                           government of any overpayments. However, in June 1994, DCAA had
                           revised its audit program to require such an evaluation. The revised
                           program was provided to DCAA regional directors and field detachments in
                           September 1994, before DCAA began its review of this contractor.



Growing Backlog of         In our March 1994 report, we pointed out the large backlog of contracts
                           requiring reconciliation and the large sums of money owed the government
Unreconciled               that come about through reconciliation. For example, we noted that the
Contracts Precludes        reconciliation results of a public accounting firm employed by the Center
                           showed that from October 1990 through November 1993, about $208
Timely Identification of   million had been identified as being owed to the government.
Overpayments
                           The Center continues to have a sizable and growing backlog of contracts to
                           be reconciled. As of January 1999, the Columbus Center had a backlog of



                           Page 8                                GAO/NSIAD-99-131 DOD Contract Management
B-280329




2,453 contracts requiring reconciliation. About 38 percent of these
contracts have been waiting reconciliation for more than a year. (See
fig. 3.)



Figure 3: Contracts Waiting Reconciliation

Number of contracts

1000
  900
  800
  700
  600
  500
  400
  300
  200
  100
     0
              0-90            91-180          181-360           >360
                                Days outstanding

The January backlog of 2,453 contracts had increased from 1,660 contracts
a year earlier. The number of unreconciled contracts may increase before
it gets better. According to the Center, while the number of contracts
requiring reconciliation has increased, the number of staff available to
perform contract reconciliation has decreased. The number of Center
contract reconciliation employees decreased from 156 in March 1998 to
109 in January 1999, and staff obtained from a public accounting firm to
assist in reconciling contracts decreased from 60 staff years in 1997 to
40 staff years in 1998. The Center estimates that it will take 387 staff years
to reconcile the January backlog.



Page 9                                  GAO/NSIAD-99-131 DOD Contract Management
                  B-280329




                  In June 1998, DFAS revised its contract reconciliation procedures to
                  improve the timeliness and the accuracy of its payments and reduce
                  problem disbursements. According to the Center, these revised
                  procedures, issued in January 1999, are intended to improve resource
                  efficiency and provide for more timely reconciliation.



Conclusions       Contractors return overpayments to the Columbus Center amounting to
                  hundreds of millions of dollars a year. However, this represents only the
                  amount that has been identified and returned. There are likely more
                  overpayments that have yet to be identified and returned. We found 4 of
                  the 13 contractors were retaining overpayments of about $1.1 million. In
                  addition, there are likely to be substantial overpayments in the Center’s
                  backlog of contracts that are waiting to be reconciled.

                  Given the past problems that the Center has had making accurate
                  payments, and the Center’s backlog of contracts waiting to be reconciled, a
                  number of steps can be taken to identify overpayments and obtain timely
                  refunds. These steps involve actions by both the contractor and the
                  government contracting and payment personnel and should not place an
                  unreasonable burden on either the contractor or government personnel.
                  These steps would require (1) contractors to immediately notify the
                  government when they have been overpaid, (2) DOD to reemphasize the
                  need for government contracting or payment personnel to request refunds
                  immediately upon becoming aware of overpayments and not wait for the
                  more formal demand letter, and (3) the Center to consider periodically
                  requesting contractors to provide the Center with the status of their
                  accounts with the government.

                  The increasing backlog of unreconciled contracts is of particular concern.
                  The longer a contract remains unreconciled, the longer any overpayments
                  identified through reconciliation will remain undetected and in the
                  contractors’ possession and the greater will be the government’s loss of the
                  use of these monies. Further, the longer a debt remains outstanding, the
                  greater may be the difficulty in collection and the chance that the debt will
                  become uncollectible.



Recommendations   We recommend that the Secretary of Defense




                  Page 10                              GAO/NSIAD-99-131 DOD Contract Management
                      B-280329




                      • require contractors to promptly notify the government of overpayments
                        made to them;
                      • direct the Director, DFAS, and the Commander, DCMC, to reemphasize
                        the need to request refunds of overpayments promptly and to perform
                        timely reconciliation; and
                      • direct the Director, DFAS, to examine the cost-effectiveness of requiring
                        contractors to periodically provide a status of their accounts with the
                        government.



Agency Comments and   In commenting on a draft of this report, DOD concurred with our
                      recommendations and agreed that it could strengthen its ability to identify
Our Evaluation        overpayments. However, DOD stated that it believes the Federal
                      Acquisition Regulation (FAR) and the Defense Federal Acquisition
                      Regulation Supplement (DFARS) contain appropriate procedures to
                      recover overpayments.

                      While the FAR and DFARS require that debts be collected as rapidly as
                      possible, they do not require contractors to notify the government when
                      they have been overpaid. In addition, we noted instances where
                      government personnel, when made aware of overpayments, were not
                      requesting refunds in a timely manner. DOD should reemphasize to its
                      contracting and payment personnel the need to make timely requests for
                      overpayment refunds. If, upon final debt determination, these refunded
                      amounts are found to be in error, the erroneous amounts can be refunded
                      to a contractor.

                      DOD took exception to our comment that DCAA failed to perform the
                      required audit steps and commented that the cited overpayment was due to
                      an inadvertent contractor error. We have revised our report based on
                      DCAA’s comments. The key point is that DCAA’s audit procedures did not
                      identify the overpayment at the subject contractor location.



Scope and             To update our prior data on checks received by the Columbus Center and
                      the reasons for them, we analyzed the Center’s database of checks
Methodology           received, but did not verify the accuracy of the data. To ascertain the
                      reasons for the increase in checks received due to the Center’s errors, we
                      reviewed the Center’s policies and procedures to ensure payment accuracy.
                      We also discussed with Center officials the controls to ensure that the
                      policy to obtain timely refunds is followed. We did not examine any



                      Page 11                              GAO/NSIAD-99-131 DOD Contract Management
B-280329




underpayments that may have resulted from the Center’s payment
activities.

To ascertain if contractors were retaining overpayments, and how quickly
overpayments were refunded, we selected 13 contractor locations that had
returned overpayments from October 1, 1997, through March 31, 1998, for a
detailed review. These contractors were selected to represent the various
reasons, as determined by the Center, for the overpayments, as well as to
reflect differences in contractor size and geographical location. We visited
each contractor location to obtain a better understanding of the reasons for
the overpayments and to ascertain the contractors’ controls to prevent
erroneous billing and to ensure prompt refunds. We also asked each
contractor to provide us a reconciliation of its accounts with the
government to determine if it was retaining overpayments. At each
contractor location, we reviewed contract documents, billing records,
contractor billing policies and procedures, and discussed with contractor
officials their policies or practices for identifying and returning
overpayments. We also discussed with DOD contracting officials and
government auditors the controls used to monitor contractor billings and
payment accuracy. We conducted our review between April 1998 and
February 1999 in accordance with generally accepted government auditing
standards.

Because the backlog of unreconciled contracts was a problem we had
identified previously, we obtained information from the Center on the
current status of the backlog and its progress in reducing the backlog.


As agreed with your office, we plan no further distribution of this report
until 30 days from its issue date unless you publicly announce its contents
earlier. At that time, we will send copies to the Honorable William Cohen,
Secretary of Defense; the Honorable Jacob Lew, Director, Office of
Management and Budget; Major General Timothy P. Malishenko,
Commander, Defense Contract Management Command; and Mr. William
Reed, Director, Defense Contract Audit Agency. We will make copies
available to others upon request.




Page 12                              GAO/NSIAD-99-131 DOD Contract Management
B-280329




Please contact me at (202) 512-4587 if you or your staff have any questions
concerning this report. Major contributors to this report are Charles W.
Thompson, Odi Cuero, and Kenneth Roberts.

Sincerely yours,




David E. Cooper
Associate Director
Defense Acquisitions Issues




Page 13                             GAO/NSIAD-99-131 DOD Contract Management
Appendix I

Contractors Reviewed                                                                       Appenx
                                                                                                Idi




              Lockheed Martin, Tactical Aircraft Systems, Fort Worth, Tex.

              Allied Signal, Inc., Electronic Systems, Teterboro, N.J.

              Sikorsky Aircraft Corporation, Stratford, Conn.

              Bell Helicopter, Textron, Fort Worth, Tex.

              Hughes Aircraft (now Raytheon), Fullerton, Calif.

              TRW, Sunnyvale and Redondo Beach, Calif.

              Raytheon, Bedford, Mass.

              Earth Tech, Long Beach, Calif.

              Northrop Grumman Electronics & Systems Integration, Melbourne, Fla.

              Primex Technologies, Inc., Downey, Calif.

              Lockheed Martin Electro-Optical Systems, Pomona, Calif.

              Harris Corporation, Electronic Systems Sector, Melbourne, Fla.

              Boeing, Long Beach, Calif.




              Page 14                               GAO/NSIAD-99-131 DOD Contract Management
Page 15   GAO/NSIAD-99-131 DOD Contract Management
Related GAO Products


                   Contract Management: DOD Is Examining Opportunities to Further Use
                   Recovery Auditing (GAO/NSIAD-99-78, Mar. 17, 1999).

                   Contract Management: Recovery Auditing Offers Potential to Identify
                   Overpayments (GAO/NSIAD-99-12, Dec. 3, 1998).

                   DOD Procurement: Funds Returned by Defense Contractors
                   (GAO/NSIAD-98-46R, Oct. 28, 1997).

                   Contract Management: Fixing DOD’s Payment Problems Is Imperative
                   (GAO/NSIAD-97-37, Apr. 10, 1997).

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

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

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




(707358)   Leter   Page 16                            GAO/NSIAD-99-131 DOD Contract Management
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