oversight

Pricing of Modification to Air Force Contract with the Boeing Company

Published by the Government Accountability Office on 1977-11-25.

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

                         DOCUMENT RESUME
04399 - [B33245533

(Pricing of Modification to Air Force Contract with the Boeing
Company]. PSAD-78-42; B-168450. November 25, 1977. 3 pp. +
enclosure (19 pp.).

Report to Secretary, Department of Defense; by Jerome H.
Stolarow (for Richard W. Gutmann, Directo::, Procurement and
Systems Acquisition Div.).
Issue Area: Federal Procurement of Goods and Services:
    PRasonableness of Prices Under negotiated Contracts and
    Subcontracts (1904).
Contact: Procurement and Systems Acquisition Div.
Budget Function: National Defense: Department of Defense -
    Procurement & Contracts (058).
Organizaticn Concerned: Department of the Air Force: Electronic
    Systems Div., tlanscom AFB, MA; Eoeinq Co., Seattle, VA; Cost
    Accounting StaIdards Board.
Authority: P.L. 87-653.
          Modification P004r0, awarded by the Air Force's
Electronic Systems Division, is a fixed-price-incentive
successive target contract for the first production buy of
Airborne Warning and Control Systems and provides for the
production of six systems and related training equipment,
aerospace ground equipment, and data at a target price of
$293,300,0C0.   Findings/Conclusions: rhe initial target co.t of
the modification was overstated by about $2.4 million because
certain ..ost or pricing data the contractor provided the Air
Force i.. support of proposed costs we=e not accurate, complete,
and current. The overstatement will result in an estimated
$508,000 of excess cost to the Government. Also, the initial
target cost may require a reduction of about $1.7 million
because of the deferral and cancellation of the procurement of
certain aerospace ground -u:iprent and related data. ,he Cost
Accounting Standards (CAS) Board agreed that the modification
contract should have included the standard CAS clause which
would have required the contractor to follow certain uniform
costing accounting practices. Because this clause was omitted,
$1.3 million of potentially unallowable property tax cost was
not questioned during preaward audits of the contractor's
proposal. Recommendations: The Electronic Systems Division
should consider the information presented in this examination
ar.d any additional information available to determine whether
the Government is entitled to a price adjustmert under
modification P00450. (Author/HTW)
                             UNIE STATESD
                                       GENERAL ACCOUNTING OFFICE
                                    WASHINGTON, D.C. 204

     MOCURT'AND vYr'1M
                  UI·ITMIY
             I~Vluon
             IN                                                    2 5 NOV 1977

          B-16845')

CO        The Honorable
          The Secretary of Defense
                 Attention:      Assistant Secretary of Defense
                                      :Comptroller)

          Dear Mr. Secretary:
               We have examined the pricing of modification P00450 to
          Air Force contract F19628-70-C-0218 with The Boeing Company,
          Seattle, Washington. Modification P00450 is a Fixed-Price-
          Incentive Successive Target contract for the first produc-
          tion buy of Airborne Warning and Control Systems (AWACS).
          The modification, awarded by the Air Force's Electronic
          Systems Division, provides for the production of six systems
          and related training equipment, aerospace ground equipment,
          and data at a target price of $293,300,000.
                 This examination was part of our nationwide review
          of the pricing of Department of2 Defense negotiated non-
          competitive prime contracts. Individual contract reviews
          represent part of our efforts to monitor the Department's
          adherence to prescribed laws, regulations, and procedures
          in negotiating noncompetitive contract prices. Our objec-
          tives were to determine if the (1) price of the modifica-
          tion was reasonable based on cost or pricing data avail-
          able to the contractor at the time of negotiations and
          (2) contract modification should have been subject to cost
          accounting standards (CAS) requirements.
               We estimate that the initial target cost of the
          modification was overstated by about $2.4 million because
          certain cost or pricing data the contractor provided the
          Air Force in support of proposed costs was not accurate,
          complete, and current. We estimate that the overstatement
          of the target cost will result in approximately $508,000 of
          excess cost to the Government. In addition, the initial

                                                           PSAD-78-42
                                                            (950385)
B-168450


target cost may require a reduction of about $1.7 million
because of the deferral and cancellation of the procurement
of certain aerospace ground equipmert and related data.

     We also believe, and the Cost Accounting Standards
Board agrees, that the mcdification contract should have
included the standard CAS clause which would have required
the contractor to follow 'ortainuniform cost accounting
practices. Because the CAS clause was omitted, $1.3 million
of potentially unallowable property tax cost was not ques-
tioned during preaward audits of the contractor's proposal.
Details of our review are provided in the enclosure.

Contractor and agency comments

     Boeing advised us that data used to support modification
P00450 was accurate, current, and complete and that no basis
for a reduction of the contract price exists. Boeing officials,
however, did not provide adequate explanations of the nondis-
closure of the data discussed in this report or why it should
not have been considered in establishing a price for this
modification.

     The Electronic Systems Division was in general agreement
with the facts concerning potential overpricing. On whether
the CAS clause should have been included ir the contract, the
Electronic Systems Division told us that tne primary reason
fo; not including CAS provisions in the contract was the
potential impacts on contract cost. We believe, however, that
since the CAS clause was required to be included by CAS regala-
tions, the cost impact was not a matter for consideration.

Recommendations

     We recommend that you have the Electronic Systems Division
consider the information presented herein, along with any addi-
tional information available, to determine whether the Government
is entitled to a price adjustment under modification P00450.

     In regard to the omission of the CAS clause from this
modification, we are not making a recommendation because interim
guidance on the application of the CAS clause to contract modifi-
cations has been incorporated into the Armed Services Procurement
Regulation.



     We are sending copies of this letter to The Boeing
Company; the Director, Office of Manangement and Budget;

                                 -2-
B-168450


the Secretary of the Air Force; the Commander, Electronic
Systems Division, Air Force Systems Ccmmaznd; the Director,
Defense Contract Audit Agency; and the Chairman, Renegotia-
tion Board. We are also sending copies to the Chairmen.
House and Senate Committees on Appropriations and Armed
Services, the House Committee on Government Operations;
and the Senate Committee on Governmental Affairs.


     As you know, section 236 of the Legislative Reorgani-
zation Act of 1970 requires the head of a Federal agency to
submit a wr-tten statement on actions taken on our recom-
mendations to the House Committee on Government Operations
and the Senate Committee on Governmental Affairs not later
than 60 days after the date of the report and to the House
and Senate Committees on Appropriations with the agency's
first request for appropriations made more than 60 days
after the date of the report.

     We would appreciate receiving your comments on the
matters discussed in this report and would be happy to
discuss any questions that you may have.

                                    Sincerely yours,




                             ~ 'R. W. Gutmann
                                    Director




Enclosure




                             -3-.
ENCLOSURE                                          ENCLOSURE


                REVIEW OF TARCET PRICING OF
             MODIFICATION P004!0 TO AIR F6RfE
              CONTRACT F190    fT10--C-0218 WITH
                    THE BOEING COMANY


BACKGROUND

     Modification P00450, awarded by the Air Force's Electronic

Systems Division (ESD), was established as a Fixed Price Incen-

tive Successive Targets (FPIS) type of contract.     The initial

target prics was negotiated on September 9, 1975.     This target

is scheduled to be reset in calendar year 1977.     Boeing receives

an initial target profit of 10.68 percent (shown as 10.7 percent

in contract) and may share in cost overruns or underruns.      If

the firm target cost is more than the 'nitial target cost by
more than $15 million, the initial target profit will be

decreased oy iC percent of the difference between the initial

targ-t cost plus $15 niillion and the firm tarqet cost.    If the

firm target cost is less than the initial target cost, the

initial target profit will be increased by 20 percent of the
difference between the initial target cost and the firm target

cost. Also, there is a maximum firm target profit of 12.5 per-
cent of the initial target cost and a minimum of 0 percent.
     Public Law 87-653 requires prime contractors to submit

cost or pricing data in support of proposed prices for
noncompetitive contracts expected to exceed $100,000 and to
certify that this data is accurate, complete, and current.

Contract prices can be adjusted when the price to the
Government has been increased significantly because the
contractor furnished data that was inaccurate, incomplete,

or noncurrent i's of the effective date of the certificate.
     The modification was negotiated based on Boeing's cost
proposal of August 29, 1975, for $328.792 million.       The cost
or pricing data submitted was certified to be accurate, cur-

rent, and complete as of September 9, 1975.     There was a lump
sum settlement. of $265 million on September 9, 1975.     The Air
Force and Boeing did not allocate the difference to cost

elements.     The negotiated target price for modification P00450

was as follows:

     Initial   target cost                $265,000,000
     Initial   target profit                28,300,000
     Initial   target price                293,300,000
     Initial   ceiling price               344,500,000
     At the time of cur review, with 75 percent of estimated
final costs incurred, Boeing was projecting an initial target

cost overrun of about $25 million.
OVERPRICING

     In our review we examined estimated prime contract target
costs for subcontracts with Westinghousec Electric Corporationi.
International Business Machines Corporation (IBM), and the
Hazeltine Corporation, and a purchase order issued to Hughes

Aircrajc Company.
     We estimate that the initial target cost for modification
P00450 was overstated by about $2.4 million because :ertain



                                2
cost o: pricing data the contractor provided to the Air
Force in support oi initial target cost proposals was not
accurate, complete, and current.   Unless the contract price
.,s adjusted, we estimate that this overstatement will result
in excess costs to the Government of about $508,000.




                             3
      The following table shows the overstated costs included
irn :e negotiated initial target cost, and our compautation of
ex., ss costs to the govw:nment.
                                                    Amount
                            Overstatemeh-
                               in Boeing
                              proposal      Negotiated        Net
     Cost element            of 8/29/75   a/reductions   overstatement
Westinghouse--change in
delivery schedule            $1,767,000     $1,010,000     $ 757,000
IBM:
   Price adjustment clause     608,000           63,797        544,203
   Data                        345,446           33,957        311,489
   Technical support           114,821           11,287        103,534
   Technical orders
     and manuals                   95,540          9,392        06,148
   Total                      1,163,807          118,433     1:045,374
Hazeltine--data                    840,000       500,000       340,000
Hughes--data and
  equipment                        180,679        15,770       164,909
Totals                       $3,951;486        $1,644,203   $2,307,283

Indirect costs
     Subcontract costs:
          Spares and allowance for
            changes:  4.35% b/ of $2,142,374                    93,193
          Direct charges and-GSA expense on
            direct charges: 2.05% b/ of
            ($2,142,374 + $93,193)                              45,829
     Purchase equipment:
          Spares and allowance for changes:
            5.35% b/ of $164,909                                 8,823
          Direct charges and GSA expense on
            direct charges: 2.05% b/ of
            $164,909 + 8,823)                                    3,562
Total overstated initial target cost                        $2,458,690
Excess cost to the Government
     Target profit:  10.68% of 2,458,690                      $262,588
     Incentive profit: 10% of 2,458,690 c/                     245,869
Total excess cost to the Government                           $508,457

a/ The computations were developed from Boeing and Air Force data.
b/ Air Force opinion of rates negotiated.
c/ This computation assumes that the negotiated firm target cost
   will exceed the initial target cost by more than $15 million
   as indicated by a recent Boeing estimate (see page 1).

                               4
 Westinghouse Cost Element

      Westinghouse is the supplier of surveillance radar.
 Boeing's final target cost proposal was segregated into
                                                         cost
 elements which had been negotiated and elements which were
                                                            to
 be negotiated.

     Included in Boeing's proposal were estimated costs of
$6,416,000 to be negotiated with Westinghouse for a change
                                                              in
the scheduled delivery rate of the surveillance radar.
                                                         On
August 28, 1975, Boeing negotiated a price of $4,704,000
                                                         for
this schedule revision, or $1,712,000 less than the $6,416,000
included in its final target cost proposal.   In addition,
Westinghouse advised Boeing that Westinghouse would reduce
certain labor adjustment factors for 1975, but the amount
                                                             of
the reduction was unknown at that time.   Boeing estimated that
this adjustment would decrease the schedule revision settlement

with Westinghouse to $4,649,000.   Accordingly, estimated costs
included in Boeing's proposal for the schedule revision exceeded

latest available data by $1,767,000 f$6,416,000 - $4,649,000).

     Boeing officials told us that this data on the price settle-
ment with Westinghouse was provided to the Air Force contracting

officer in Handout 51.

     Handout 51, a 17-page document, contains a stamp, signed
                                                               by
Boeings chief negotiator, showing that it was given to the
                                                            con-
tracting officer on September 16, 1975. However, Boeing
                                                         told
us that two pages of this handout were initially submitted
                                                            to
the Government on September 9, 1975, prior to agreement
                                                        and


                               5
  certification.  Boeing further stated that at that
                                                     time the Air
 Force (Price Analyst) requested additional
                                             backup data to the
 summaries. Accordingly, backup detail
                                         was provided in the
 September 16, 1975, document.

      The contractor provided no documentation
                                                showing th.at the
 two pertinent pages were given to the
                                       Air Force price analyst
 on September 9, 1975. We found no
                                    record of this document in
 the Air Force contract files, and Air
                                       Force officials at ESD
 told us that they had no knowledge of
                                       having received the
summary prior to the completion of
                                   negotiations. Furtner, the
Air Force price negotiation memorandum
                                       does not show that this
document was considered in the final
                                     target price negotiations.
We, therefore, believe that the cost
                                     proposed by Boeing for the
subcontract item was overstated by
                                   $1,767,000.
IBM Cost Elements

     Price adjustment clause
     Agreement was reached between Boeing
                                            and IBM in September 4,
1975, to eliminate Special Clause 1
                                     (contract price adjustment
for possible fluctuations in the economy).
                                              They agreed to a
price of $41,000 or $608,000 less
                                  than the estimate of $649,000
included in Boeing's final target cost
                                        propcsal to the Air Force.
     Data
     IBM submitted a price proposal to
                                        Boeing dated August 27,
1975, which reduced the subcontractor's
                                         total proposal price
for data to $1,013,554 or $345,446
                                   less than the estimate of

                                6
$1,359,000 included in the contractor's final target cost pro-

posel to the Air Force.

    Technical support     ~-

    Boeing included an estimate of $395,000 for IBM technical
support based on an IBM program office estimate.     This was for
42 man-months at about $9,399 per month.
    The GAO estimate for ahe technical support function is

$280,179 ($114,821 decrease).     Our estimate was based on cur-
rent information supplied by the IBM finance office prior to

contract negotiaions of approximately $6,371 3er man-month.
This included a $6,398 cost per man-month plus annual wage
rate increases based on IBM proposal data.

    Technical orders and manuals
    Boeing's final target cost proposal included $1,546g000
for technical orders and manuals to Le supplied by IBM.     This
proposal was based on an IBM price proposal dated August 15,
1975.   We found, however, that, as a result of a Boeing audit

which disclosed a duplication in IBM's proposal, IBM reduced its
pronosed price by $95,540.     Since Boeing's proposal of $1,546,000
was based on data that was inaccurate, the cost proposed for
technical orders and manuals was overstated by $95,540.

Hazeltine Cost Element
    Hazeltine is the supplier of data display and control func-
tional group equipment.    Boeina's final target cost proposal for
the Haze~tine subcontract included $1 million for data.     On Octo-
ber 9, 1975, 1 month after the prime contract target price was

agreed on, Hazeltine proposed $104,819 as a price for the data.

                                 7
      Boeing officials told us that no support was provided for
the $1 million estimate and that the amount was presented as

a Boeing material estimate.     They said that this estimate for
Hazeltine was based on an IBM price proposal of $1,359,0U0 for

data because of the similarity of Hazeltine and IBM contract
requirements.

      Data to be developed by IBM was significantly greater than
that for Hazeltine because of the requirements under SD-E-109-3,

paragraph if (item I below).
     IBM's proposal. as adjusted to August 27, 1975, was for the

following data items.

1.   SD-E-109-3 - Engineering Data for as Designed
     Baseline, paragraph lf. This requirement was
     for preparing and submitting performance
     specifications.                                       $854,047
2.   Remainder of SD-E-109-3 requirements
     'Engineering drawings, diagrams, parts
     lists, material specs, etc.)                           119,632
3.   All other data items                                    39,875

                                                         $1,013.,554

     Our review at the Hazeltine Corporation indicated that
Hazeltine's proposed costs     ' re   not for item 1 as in the IBM
proposal.   They were for providing microfilm of drawings pre-
viously developed by Hazeltine and its parts sup;f'iers and

for items 2 and 3 as stated in the IBM proposal.        Further, the
data supporting the cost to perform the requirements of the
Hazeltine contract were available by A.ugust 1975.       This data

                                      8
showed that the requirements of the Hazeltine contract coual

be psEformed at a cost of about $105,000 including profit or

for about $895,000 less than the $1,000,000 proposed by Boeing.
However, had Boeing used the IBM proposal as a basis for propos-

ing a cost for the Hazeltine subcontract, the IBM proposed price
of $1,013,554 should have been reduced by $854,047, (the cost of

the SD-E-109-3, paragraph lf, requirement) to $159,507.     Therefore,

the price proposed by Boeing for the Hazeltine contract was
overstated by $840,493, $1,000,000 minus $159,507.

Hughes Cost Elements
    Hughes Aircraft Company is the supplier of the audio

distribution system.   Estimated costs included in Boeing's

target cost proposal to the Air Force of August 29, 1975, for

data to be provided oy Hughes were overstated by about $196,636,

however, this amount is reduced to $180,.79 because certain
costs in Boeing's proposal were excluded.
    The overpriring occurred because, prior to the completion

of target price negotiations, certain data items which were can-
celed, rellaced, or transferred for purchase under another pri1me
contract, weLe included in Boeing's proposal.
     Data items canceled, replaced,
     transferred, or addt~
      A March 7, 1975, Hughes letter to Boeing transmitted a

 proposal for the audio distribution system at a price of

 $5,678,397 which included data and technical order requirements.



                                9
On two occasions, April 11, 1975, and May 1, 1975, Boeing

changed the data requirements from those shown in Hughes'

March 7, 1975, proposal.   These changes reduced Hughes'

proposal price by about $142,745., but Boeing only reduced

its proposal by $17,799.   The remaining reduction of

$124,946 was not recognized in Boeing's proposal to the
Air Force.

     On August 21, 1975, Boeing increased its proposal to
add a replacement data item but did not reduce the proposal

for the value of the item replaced.    The obsolete data item

was included in the March 7, 1975, Hughes proposal and in

Boeing's final target cost proposal at $10,037.    Hughes'

March 7, 1975, proposal also included $61,653 for spares,
however, prior to the prime contract negotiation, a decision
was made by Boeing so purchase these spares under a separate

contract. As Boeing did not recognize this decis=.n in its

target-cost proposal of August 29, 1975, the proposal was
overstated by $61,653.
     Additional mission simulator equipment purchased on

March 12, 1975, as item 2 of Boeing's subcontract with Hughes,
A-889209-7070, change 1, for $15,957 was not included in Boeing's

initial target cost proposal of August 29, 1975.    The contractor

advised us that this additional equipment should have been

included in the proposal because engineering change proposal

(ECP) 164R which authorized the equipment was included in the
contract change proposal (CCP) 0250.

                               10
      Boeing AWACS engineering change memo dated February 10,
 1975, discusses CCP-0250 preparation and pricing.   This memo
 shows that ECP 164R was included for production.

     We found that a purchase requisition dated January 9, 1975,
for additional mission simulator equipment was issued in
                                                         accord-
ance with ECP 164. Therefore, the $15,957 of cost should
                                                         have
been included in the Hughes subcontract cost.

Conclusion and recommendation

     Unless the price of the contract modification is reduced
to adjust for the overstatement described in this report,
                                                          the
Government will incur excess costs of about $508,457. Accord-
ingly, we recommend that ESD take appropriate action to
                                                        adjust
the contract price.
OTHER ISSUES

    Automatic Test Equipment
    and Related Data
     Boeing's April 7, 1975, audit/analysis report states that
Hughes' proposal costs for depot aerospace ground equipment
                                                            (AGE)
and data item UT-01-MCM, test requirements documents, were
                                                           being
deferred and that the costs as quoted were deleted in
                                                      Boeing's
analysis.

     Boeing's April 11, 1975, letter to Hughes stated that
                                                           dkta
item UT-01-MCM was deferred. This item was priced at $932,555

in Hughes' March 7, 197', proposal and in Boeing's final
                                                         proposal
to the Air Force. Boeing advised us that the decision
                                                       to defer
this data item was based on an internal Boeing recommendation
                                                              to

                                11
delay until such time as AGE requirements were more definitive.

Boeing also stated that the Air Force was not formally advised
that this data item was deferred.

     Boeing advised us that this data item was deferred from
the Hughes subcontract because the automatic test equipment
was not sufficiently defined.     This specifically included the
audio distribution system test set, which is organizational
and intermediate AGE.   Boeing also said that this data item
was required for the audio distribution system test set.
     Boeing's initial target price proposal included an

estimated cost of $1.322 million for one audio distribution

system test set.   Subsequent to prime contract negotiations,
the Air Force disapproved development of the audio distribu-

tion system test equipment.     Accordingly, there was no need
for data for this test set.

     A test station was purchased from Hughes at a cost of
$320,000 and, in March 1977, Boeing proposed that a test station
be provided in place of the audio distribution system test set

and that test requirement documentation not be provided for the

test station.   Substitution of the test station for the audio
distribution system test set appears to be a change requiring

adjustment of the prime contract initial target price since

this change would require a waiver of requirements.

     Boeing provided several reasons why data item UT-01-MCM
was included in the prime contract's initial target price.

We were unable to substantiate the validity of the issues
raised because of the lack of complete documentation and the


                                 12
status of the procurement of organizational and intermediate

AGE.     However, our review indicates that the initial target

direct costs may be excessive by as much as $1.732 million
as shown below.     These costs are not included in our computa-
tions on page 4 which show excess costs to the Government.
                                                       Amount

                                                (000 omitted)
   Deletion of ADS Test Set requirement
    ($1,322,000 less 9.66% a/ negotiation
     reduction)                                    $1,194
   Deletion of data for ADS Test Set
     ($932,555 less 8.02% negotiation
     reduction)                                          858

                                                   $2,052
   Addition of Test Station b/                     (     320)
   Net reduction                                       $1,732

a/ Estimated reduction for proposed costs not firmly
   priced of $5,175,000 was $500,000.

b/ This reduction assumes that the Air Force will approve
   the Test Statirn.
       We recommend that this area be examined by ESD and the con-

tract price be adjusted if warranted.

       Cost Accounting Standards
        Modification P00450 to the contract did not include the

required cost accounting standards' (CAS) clause.

        CAS rules and regulations promulgated by the Cost Account-
ing Standards Board carry the full force and effect of law;

They are binding on all Federal agencies making national

defense procurements.


                                   13
        Procurement agencies within the Department of Defense are

responsible for securing contractor compliance with the Cost
Accounting Standards Board's requirements.     This responsibility

includes incorporating a pirescribed CAS contract clause in all
covered contracts.

        The CAS contract clause was not included in the basic
AWACS contract or modification P00450 to this contract.

Because the basic contract was issued before the effective

date of CAS, it appropriately did not include the clause.

Modification P00450, however, was negotiated in September 1975
after the effecti.     date of CAS.

        The Defense Contract Audit Agency, in its preaward audit
report on evaluation of the contractor's price proposal for

modification P00450 (Report No. 7381-04-6-0058 dated August 5,

1975), concluded that the modification was subject to CAS require-
ments an. recommended that CAS provisions be incorporated into
the contract.     The DCAA report provided the foilowing rationale

for its conclusion.

        "With respect to contract modifications the CAS Board
        stated in the prefatory comments (See volume 37, pages
        4140 and 4141, Paragraph 6 of the Federal Register of
        February 29, 1972) that it had addressed the question
        and for the time being rejected the application of CAS
        to contract changes except for renewals of annual con-
        tracts and similar cianges for new work. Their reason
        for doing so was based on the inability of most con-
        tractors to segregate cost of changes from other work."

        The DCAA report concluded that the modification was for new

work.     The report said that while the basic contract provisions

included options for additional AWACS aircraft, the Government


                                  14
did not exercise these options and they were allowed to expire.

DCAA also said that the contractor intends to segregate the

costs applicable to the modification.
     In view of the foregoing circumstances, we asked the ESD

for the rationale they used to conclude that modification P00450

should not be subject to ¢he standards.    ESD said that the primary

reason for not including 7AS provisions in the contract was the

cost and other impacts associated with changing this contract

from "uncovered" to "covered" during the negotiation of modifi-
cation P00450.   The letter said that "the contIactor estimated

an additional cost impact of at last $3 million, associated
with changing accounting procedures and reopening of previously

negotiated subcontracts to flow CAS requirements to subcontracts."
However, we were told by the Air Force contracting officer that

the contractor did not proivide any backup documentation to support

this alleged cost impact.   Since the Boeing Aerospace Company

1/ accounting system was already under CAS requirements, we doubt

whether there would have been a significant cost impact to change

accounting procedures for this contract.    Further, we believe

that most, if not all, of Boeing's subcontractors were also

required to follow the standards.




1/The division within the Boeing Company responsible for this
  contract.




                                15
     ESD also stated that there was no requirement for the
inclusion of CAS in the contract, citing an Air Force Systems

Command letter dated September 26, 1973.    This letter stated
as criteria the following:

     "AFSC's position is that once a contract has been
     determined not to be covered, future negotiated
     changes in excess of $100,000 will not make it a
     covered contract. DOD has informally indicated
     their approval of this position provided that the
     change did not add new work or quantities which
     would, in effect, make it a new contract."
     We asked the CAS Board, by letter dated March 11, 1977,
whether they agreed with our conclusion that the CAS provisions
should have been incorporated into the contract for the initial

production buy.    The CAS Board concurred that the CAS provisions
should have been incorporated into the contract for the initial
production buy under modification P00450 for the following

reasons:

     1.    Paragraph 6 of Appendix A in the Board's regulations
           states that the Board intends that the annual extension

           of existing negotiated contracts and similar contract

           modifications would not be exempt from the Board's
           rules, regulations, and cost accounting standards.
           Modification P00450 definitized the separate procure-

           ment of six systems which was similar to an annual

           extension of an existing negotiated contract.

     2.    Modification P00450 was not for an "instead of" type

           change which, the Boa'd indicated in the aforementioned
           paragraph 6, should je exempt from the standards where


                                 16
          the cost/price adjustment would only be for the incre-

          mental effect of the change and it would bo difficult

          to separately identify tire incremental costs.
     3.   The prices negotiated for the six units resulted from

          a new propcsal being submitted, evaluated, and nego-
          tiated.

     4.   The specific quantity of units purchased (6) under
          modification P00450 for the initial production was

          not contemplated under the options contained in the
          basic contract.   Hence, P00450 was a new procurement

          and should have had the required terms and conditions
          of a new contract.

    We provided the CAS Board with (1) summary data on
pertinent contract option provisions from the original con-

tract award through modification P00450; (2) our letter
to ESD; (3) ESD's letter response;    (4) excerpts from the

DCAA report; (5) Office of Assistant Secretary of Defense

(OASD) letter dated March 18, 1976, transmitting OASD, CAS
Working Group Interi.,i Guidance dated February 24, 1976;

(6) the options section of the basic contract; and (7) the
Air Force Systems Command's guidance dated September 26, 1973.
     The CAS Board advised us by letter dated March 28, 1977,
that the CAS provisions should have been incorporated in the
modification.   They commented, in part, as follows:

     "The original AWACS contract contains several provisions
     characterized as options. Modification P00450, however,
     was not made pursuant to any of those provisions. There-
     fore, the question of whether this modification represented
     the exercise of a bona fide option does not appear to be
                                 17
     involved. Instead, the modification appears to be similar
     to an annual contract extension which the Board believes
     should be subject to its Standards, rules, and regulations.

     "Were the option question to arise, it would be necessary
     to look beyond the label and examine the nature of the
     transaction. Many so-called options would, in our view,
     constitute contract modifications of the type which should
     be deemed to require application of the CAS clause even
     though the clause was not included in the basic contract.
     Among these are provisions characterized as options which
     declare, in essence, that the Government has a right to
     order additional quantities under a contract, and if it
     exercises that right, the parties will negotiate the terms
     and conditions which shall govern the delivery and price of
     the additional quantities. We would not regard a provision
     of this type as an option or as any other kind of contractual
     commitment that would justify the failure to include the CAS
     clause in the contract modification. Consequently, when the
     parties negotiate the terms and conditions for the additional
     quantities, CAS clause applicability must be determined as it
     would be determined for a new procurement."

     DCAA reported that "the contractor has made several
voluntary accounting changes that have affected the amount of

adjustment of F0218 [contract]   for the effect of the changes."

     Also, DCAA reported that the Boeing price proposal for
the modification included $1.3 million of potentially unallow-

able property taxes which they did not question in the absence
of the CAS clause.   This issue involved the method of allocating
taxes to U.S. Government contracts and to non-Government con-
tracts.   The case was eventually determined in favor of the

Government by the Armed Services Board of Contract Appeals;

however, the contractor can allocate and the Government will
pay for these costs applicable to modification P00450 because

the CAS clause was not included in the contract modification.

     These cost savings may have been offset to some extent
by additional costs to implement CAS.   However, cost was not


                                 18
the governing guideline in this jnstance--CAS provisions
were required to be included in the contract modification.

     Apparently in recognition of this problem, Defense
Procurement Circular 76-11, dated September 30, 1977, was

issued to provide interim guidance on the application of
CAS requirements to contract modifications.    We believe
this interim guidance will help prevent unwarranted

omissions of the CAS clause.
Conclusion

     In our opinion, the Air Force did not take adequate
action to include cost accounting standards in the provisions

of modification P00450 to the contract.   Since the contract
modification of $293,300,000 was not made pursuant to exist-
ing contract provisions, we believe it was "new work" and

apparently was similar to an annual contract extension.

     ESD has stated that the primary reason the CAS clause
was not included in this contract modification was the cost
impact associated with complying with CAS.    We believe,
however, that since the CAS clause was required by CAS Board
regulations, the cost impact was aot a matter for consideration.




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