oversight

Reasonableness of Noncompetitive Contract Prices Proposed and Negotiated for 1976 Deliveries of 111 TF-41 Engines

Published by the Government Accountability Office on 1977-01-31.

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

                         DOCOBMET RESUME
01116 - [A0751128]

(Reasonableness of Noncompetitive Contract Prices Proposed and
Negotiated for 1976 Deliveries of 111 TF-41 Engines].
PSAD-77-'77; B-133341. January 31, 1977. 3 pp.
Report to Secretary, Departmdnt of Defense; ty Richard V.
Gutmann, Director, Procurement and Systems Acquisition Div.
Issue Area: Federal Procurement of Goods and Services (1900);
    Federal Procurement of Goods and Services: Reasonableness of
    Prices Under Negotiated Contracts and Subcont:acts (1904).
Contact: Procurement and S-ytems Acgquistion Div.
Budget Function: National Defense: Department of Defense -
    Procureaent & Contracts (058).
Organization concerned: Department of the Air Force:
    Aeronautical Systems Div., Uright-Patterson FPB, OC; General
    Motors Corp.: Detroit Diesel Allisou Div., Indianapolis, IN;
    Rolls-Royce, Ltd.
Congressional Relevance: House Committee on Armed Services;
    Senate Committee cn Armed Services.
Authority: P.L. 87-653.
          The primary objective of a review of noncotpt.lItive
contract prices was to determine whether the negctiated price
was reasonable and based c, cost and pricing data available to
the contractor when the pi-ice was established. The Government's
evaluation of the contractor's proposal, the cost or pricing
data submitted in support of proposed costs, the negotiation
process and, on a selected basis, the cost incurred were
examined. Findings/Conclusions: No apparent defective pricing
on the subject contracts was found; Howveer, GAO noted that Air
Force negotiations apparently failed to consider established
overhead and profit factors when negotiating a contract price
adjustment clause for foreign exchange rate fluctuation. As a
result, the contractor may receive an unintended economic
benefit due to the fluctuation in the exchange rate between the
U.S. dollar and the BritIch pound sterling. The Air Force and
the contractor recognized that currency exchange r.tes fluctuate
and that the amount of overhead costs and profit assigned to the
contracts yas based on material costs, The net result was an
increase of 24 percent on the material costs. GAO thinks that
the negotiated 15 percent overhead and profit factor does not
satisfy the intent of the price adjustment clause in the
contracts, and the apparent failure to recognize the intent of
the price adjustment clause could have an impact on negotiations
for future commodities purchased from foreign companies,
Eecoamendations: The Air Force should attempt to get full
recovery of the 24 percent increase during the final currency
fluctuation pricing settlement. 2he Air Force should also give
particular attention to chle'slar year 1977 TP-41 engine pricing
negotiations and future purchases of other foreign equipment to
preclude contractors from gaining windfa!1: from foreign
exchange rate fluctuations,   (Author/SS)
  z           ($(X)^UJUNITED   STATES GENERAL ACCOUNTING OFFICE
                                  WASPINGTON, D.C.   20548

PROCUREMENT AND SYSTEMS
  ACQUISITION DIVISION
                                                        JAN 3:   1977
       B--133341

       The Honorable
       The Secretary of Defense

       Dear Mr. Secretary:

            As part of a review of the reasonableness of
                                                         noncompetitive contract
      prices negotiated under provisions of Public
                                                    Law 87-653, we examined the
      price proposed and negotiated for 1976 deliveries
                                                         of 1   TF-41 engines.
      Tle engines were purchased by Aeronautical Systems
                                                          Division (ASD), Air
      Force Systems Command, from Detroit Diesel
                                                  Allison Division of General
      Motors (Allison), l.dienapolis, Indiana, under
                                                      fixed price-redeterminaole
      contracts F33657-73-C0005, F33657-75-C0154,
                                                   F33657-75-C0155, and
      F33657-75-C0156.   The 1976 engine deliveries were priced on December
      1975.                                                                 19,

            Our primary objective was to determine whether
                                                             the negotiated price
       was reasonable and based on ccst and pricing
                                                     data available to the
       contractor when the price was established.
                                                    We examined the Government's
       evaluation of the contractor's proposal, the
                                                     cost or pricing data submitted
       in support of proposed costs, the negotiation
                                                      process and on a selecctive
      basis, the cost incurred.   Our review disclosed no apparent defective pricing
       In the subject contracts, however, we noted
      failed to consider established                that ASD negotiators apparently
                                      overhead and profit factors when negotiating
      a contract price adjustment clause for foreign
                                                       cxchang2 rate fluctuation.
      As a result, Allison may receive an unintended
      be about $265,800 due to the fluctuation in      economic benefit expected
                                                    the exchange rate between the to
      U.S. dollar and the British pound sterling.

           The TF-41 engine was developed jointly by Allison
                                                              and Rolls-Royce
      Limited in Derby, England. Allis)n purchases
                                                     a major portion of the
      engine from Rolls-Royce and negotiates the
                                                  price for these parts in
      British pounds sterling. Allison, in turn,
                                                   prices such parts to ASD
      in United States dollars. During the negotiations
                                                          completed in December
      1975, Allison and ASD agreed to a $2.10 per
                                                   British pound exchange rate
      to price the parts. The Rolls-Royce parts
                                                  represent 424 million of the
      $68.6 million total price.




                                                                   PSAD-77-77
  B-133341



      Allison and ASD recognized that currency exchange rates fluctuate
 ano agreed to a contract price adjustment following delivery of the
 engines if the exchange rate varied from the established $2.10 rate.
 TV- intent of the agreement was that the contractor would not realize
 economic benefit or incur economic losses by reason of currency
                                                                  fluctuations.
 The parties further recognized that the amount of overhead costs and
 profit assigned to the contracts was based on material costs and
                                                                   that a
 percentage factor must be added to any exchange rate variance to account
 for these cost elements. The factor agreed upon was 15 percent.

      The records are clear as to the specific overhead and profit rates
 applied to material costs during Lhe negotiations. These factors
                                                                    increase
 material cost by over 24 percent. A review of the negotiation records
 disclosed no ba.sis or formula for establishing the 15 percent overhead
 and profit factor and the ASD negotiator informed us no clear basis
                                                                      or
 formula was used. Allison officials, while declining to comment
                                                                   on our
 conclusions, agreed that our computations were accurate and that
                                                                   historically
 overhead and profit have been determined as a percentage of material
                                                                       cost,
     Allison officials expect the actual average exchange rate to be about
$1.85 per British pound. Assuming this rate, the material cost variance
will be about t2,866,000 and related overhead arnd profit of over
                                                                  24 percent
would be about $695,700. The negotiated 15 percent factor applied
                                                                    to the
material cost variance amounts to only about $429,900 and Allison
                                                                   may
receive the windfall difference of $265,800.

     We believe t. Legotiated 15 percent overhead and profit factor
does not satisfy the intent of the price adjustment clause in the
contracts because Allison could thus realize an unintended eccnomic
benefit from the fluctuati.. currency exchange rate. We further believe
the apparent failure to recognize the intent of The price adjustment
                                                                     slause
could impact on negotiations for future TF-41 engines or other commodities
purchased from foreign companies.

     In view of the intent of the Drice adjustment clause, we recommend
that you instruct the Air Force to pursue full recovery of the 24
                                                                    percent
overhead and profit increase during the final currency fluctuation
settlement. We also recommend that the Air Forcc give particular pricing
                                                                    attention
to calendar year 1977 TF-41 engine pricing negotiations and futi're
                                                                     purchases
of other foreign equipment to preclude contractors from gaining windfalls
from foreign exchange rate fluctuations.

     We would appreciate being advised of any actions you intend to
take on this matter. As you know, section 236 of the Legislative
Reorganization Act of 1970 requires the head of a Federal agency
                                                                  to
submit a written statement on actions he has taken on our recommendations
to the House and Senate Comnittees on Government Operations not
                                                                 later
than 60 days after the date of the report and to the House and Senate
Committees on Appropriations with the agency's final request for
                                                                  appropria-
tions made more than 60 days after 'h- d'ce of the report.
B-133341




     We are sending copies of this report to the Director, Office of
Management and Budget; the Chairmen of the Senate and house Committees
on Appropriations, Armed Services, and Government Operations; and the
Secretary of the Air Force.

                                   Sincerely youls,




                                   R. W.      tmann
                                   Director