United States General Accounting Office

GAO Report to Congressional Requesters

December 1998 CONTRACT

MANAGEMENT

Recovery Auditing

Offers Potential to

Identify Overpayments

GAO/NSIAD-99-12

GAO United States

General Accounting Office

Washington, D.C. 20548

National Security and

International Affairs Division

B-280221 

December 3, 1998

Congressional Committees

The Fiscal Year 1996 National Defense Authorization Act required the

Secretary of Defense to conduct a demonstration program to evaluate the

feasibility of using private contractors to identify overpayments made to

vendors by the Department of Defense (DOD). Authority to continue and

expand the program was provided in the Fiscal Year 1998 National

Defense Authorization Act. The fiscal year 1998 act also directs us to

review the results of the program. Specifically, it requires us to (1) assess

the success of the methods used to identify overpayments and

(2) determine the types of overpayments identified and the amounts

recovered. We also identified factors limiting the identification or recovery

of overpayments and developed recommendations for improving the

process.

Background For both private industry and government agencies, some payments are

processed incorrectly for a variety of reasons. For instance, vendors make

pricing errors on their invoices, forget to include discounts that have been

publicized to the general public, neglect to offer allowances and rebates,

miscalculate freight charges, and so forth. These mistakes, when not

caught, result in overpayments.

Identifying and recovering overpayments is referred to as recovery

auditing. Recovery auditing started about 30 years ago, and it is used in

several industries, including the automobile, retail store, and food service

industries, and within DOD, by the Army and Air Force Exchange Service

and the Navy Exchange Service. An external audit recovery group may be

the only group used by an organization or it may be used in combination

with an internal group that examines invoices for overpayments prior to

an external group’s review.

The demonstration program began in September 1996, when the Defense

Supply Center, Philadelphia (DSCP), competitively contracted with Profit

Recovery Group International (PRGI). The contract, which has been

extended twice and will end in May 1999, covers purchases made during

fiscal years 1993-95. It requires PRGI to identify and document

overpayments and to make recommendations to reduce future

overpayments. PRGI receives a fee of 20 percent of net collected funds.

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B-280221 

DSCP is the Defense Logistics Agency inventory control point that procures

subsistence items, clothing and textiles, and medicines and medical

supplies for the U.S. Armed Forces and other non-DOD customers, such as

the Veterans Administration and Job Corps centers. Payment for the

commodities bought by DSCP and covered under the demonstration

program are made by the Defense Finance and Accounting Service (DFAS),

Columbus, Ohio. DFAS does not typically review these types of items for

overpayments.

In late 1997, Congress authorized expansion of the program to other

payments managed through the Defense Business Operations Fund and

DOD is examining how to implement the congressional direction. In an

August 1998 memorandum, the DOD Comptroller encouraged DOD agencies

to use recovery auditing as a way to identify and correct payment

problems.

Results in Brief The methods used by the Profit Recovery Group International to perform

recovery auditing resulted in the identification of $19.1 million in

overpayments, as of August 14, 1998, and efforts to identify additional

amounts continue. However, recoveries of overpayments amounted to

only $1.9 million, in large part, because vendors took issue with some of

the overpayments identified by Profit Recovery Group International. This

caused the recovery process to virtually stop for 8 months while the

Defense Supply Center, Philadelphia reviewed the merits of the vendors’

issues. The Defense Supply Center, Philadelphia has concluded that the

claims of overpayment are valid, but it has not yet notified vendors of the

final decision regarding their indebtedness.

Of $19.1 million in overpayments, $12.4 million was related to cash

discounts not taken or received or deducted at the wrong rate, $2.2 million

related to most favored customer terms not received, $1.3 million related

to duplicate payments made, and $1.2 million related to credits for

returned merchandise not taken. As of August 14, 1998, according to Profit

Recovery Group International, it had audited about 80 percent of the

$7.2 billion audit base.

The fact that the overpayments were made 4 to 6 years before audit

recovery began also made overpayment identification or recovery

challenging. Documentation was difficult to retrieve for both Profit

Recovery Group International and vendors, and sometimes it was not

available. The Profit Recovery Group International also had considerable

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difficulty identifying duplicate payments because the needed information

was not retained in the Defense Finance and Accounting Service payment

files. Finally, according to Profit Recovery Group International, even

though its contract was awarded in September 1996, it was slow to begin

audit work because of delays in obtaining Defense Finance and

Accounting Service computerized payment files and the time the Profit

Recovery Group International needed to understand DOD’s procurement

and payment processes.

The Profit Recovery Group International has made recommendations to

the Defense Finance and Accounting Service and the Defense Supply

Center, Philadelphia to reduce future overpayments, but none have been

implemented. In addition, the Profit Recovery Group International

identified about $1.8 million in overpayments that were outside the scope

of its contract, either because they were not within the fiscal year 1993-95

contractual review period or because they involved other government

agencies. Neither the Defense Finance and Accounting Service or the

Defense Supply Center, Philadelphia chose to pursue payment recovery or

inform the other government agencies of the overpayments so that they

could pursue recovery and take steps to avoid future overpayments.

Success of the

Methods Used to

Identify

Overpayments

PRGI’s methodology involves four key steps. These steps are (1) understand

the procurement and payment processes for all transactions; (2) identify

the data needed to establish an audit trail, such as purchase

orders/agreements, paid history files, invoices, receiving information,

vendor term files, and data from procurement files, such as price lists,

promotional allowances, and volume allowances; (3) examine the data

using proprietary software to identify missed discounts, price

discrepancies, duplicate payments, and other overpayments; and

(4) generate a hard copy claim, with supporting documentation, for each

potential overpayment.

In applying this methodology to DFAS payments, PRGI initially focused on

identifying missed discounts and price discrepancies. PRGI compared cash

discounts and prices offered to commercial customers to the cash

discounts offered to and prices paid by DSCP. It also sent letters to vendors

requesting current statements of their accounts with DSCP. Between

March 1997 and July 1998, two separate mailings were made asking

vendors to provide statements of their accounts. About 20 percent of the

vendors responded, resulting in the recovery of $1.2 million. One recovery

Page 3 GAO/NSIAD-99-12 Contract Management
B-280221 

of $957,000 related to the recall of a withdrawn immunization serum for

which DOD had not taken credit.

As of August 14, 1998, according to PRGI, it had audited about 80 percent of

the $7.2-billion audit base and identified about $19.1 million in

overpayments. Table 1 shows the types and amounts of overpayments

identified by PRGI and recovered by DOD.

Table 1: Types and Amounts of

Overpayments Identified and

Recovered as of August 14, 1998

Type Identified Recovered

Cash discounts

1) Not offered (Discount not offered DSCP but offered

to commercial customers.) $7,477,454 $15,840

2) Earned but not taken (DFAS payment system did

not override cash discount terms specified in

contract with more liberal terms specified in invoice.) 4,346,307 34,266

3) Deducted at wrong rate 561,731 38,423

Subtotal $12,385,492 $88,529

Overcharge by comparison (Vendor charged DSCP

more than its most favored customer.) 2,170,909 6,708

Duplicate payment 1,283,088 246,820

Unposted credit memorandum (As a result of

returned merchandise, vendor sent a credit memo

that remained outstanding.) 1,174,748 1,171,514

Accounting error 377,866 281,182

Unapplied payment (Payment that the vendor cannot

match to an invoice.) 118,837 72,566

Price protection (Losses to the value of a retailer’s

inventory, should a vendor reduce prices to other

retailers.) 58,571 0

Allowances (The vendor gave financial

considerations in exchange for meeting specific

requirements, such as advertising or promotional

sales.) 13,755 0

Interest paid in error 8,681 2,866

All other errors 500 500

Shortage discrepancy (Vendor sent less than the

quantity ordered.) 421 421

Pending claims (Written, not yet approved by DSCP.) 1,512,535 0

Total $19,105,403 $1,871,106

Source: PRGI.

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Factors Limiting the

Identification or

Recovery of

Overpayments

A number of factors have inhibited the identification or recovery of

overpayments. Foremost, vendors disagreed with DSCP claims that it did

not receive most favored customer status because it was not offered cash

discounts offered to commercial customers. As a result, the recovery

process was virtually halted for 8 months while DSCP reviewed the basis of

the vendors’ claims. In addition, because of the time between the

purchases by DSCP (fiscal years 1993-95) and the audit recovery (fiscal

years 1997-98), both PRGI and the vendors had difficulty finding supporting

documentation. PRGI also had considerable difficulty identifying potential

duplicate payments because its proprietary software was incompatible

with the payment systems. Finally, according to PRGI, even though the

contract was awarded in September 1996, PRGI could not begin audit work

in earnest until June 1997, due to delays in obtaining computerized

payment files. This, in combination with the time required to become

knowledgeable of DSCP procurement processes and DFAS payment systems,

delayed the progress of the demonstration program.

Vendors Disagreed With

Claims and Process

Certain subsistence vendors are designated brand name suppliers because

only the vendors’ products are specified for procurement, precluding

competition. This practice is authorized for purchases of products bought

by DSCP and resold to other government agencies, such as the Defense

Commissary Agency. In short, a brand name product is a product desired

or preferred by a customer. Kellogg’s Corn Flakes is an example of a brand

name product.

Because there is no competition, brand name contracts require that all

prices offered the government be as advantageous as the prices offered

the vendor’s most favored customer. This provision expressly includes

quantity discounts, allowances, rebates, special promotions, and billing

advantage. PRGI interpreted the term billing advantage to mean that

vendors are required to offer the government cash discounts for prompt

payment similar to those offered the vendor’s most favored customer. PRGI

identified cases where the government was not offered the same “billing

advantage,” or discount for prompt payment, as was offered the vendor’s

most favored customer. As a result, claims were written against vendors

for cash discounts not offered.1

 For example, according to PRGI, one

vendor routinely offered a 2-percent discount to its commercial customers

if payment was made within 10 days, but this discount was not offered to

1

Under the Prompt Payment Act of 1982, agencies generally are not to pay earlier than 7 days prior to

the due date unless vendors offer a discount for early payment.

Page 5 GAO/NSIAD-99-12 Contract Management
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the government. As a result, a claim of about $187,000 was made against

this vendor.

As PRGI identified potential overpayments made to brand name subsistence

vendors, it sent letters of indebtedness to them. Many vendors protested

both individually and through their trade association, the American

Logistics Association (ALA). The brand name vendors and the ALA made the

following arguments.

• The claims process did not follow the Federal Acquisition Regulation

(FAR). Many of the letters of indebtedness were signed by the government

contracting officer’s representative, and PRGI responded to vendor

questions. The vendors and ALA argued that, according to the FAR, only a

contracting officer can sign letters of indebtedness and that PRGI should

not respond to vendor questions.

• Cash discounts were not offered because, historically, DSCP did not pay its

bills within the discount period.

• DOD did receive most favorable customer prices. During the 1993-95 time

frame, DSCP contracted for subsistence items that it resold to the Defense

Commissary Agency for sale in commissaries in Europe. Even though the

prices charged by the vendors to DSCP may not have reflected most

favorable customer prices, the vendors and ALA contend that subsequent

voluntary price reductions provided by vendors to the Defense

Commissary Agency for promotional purposes effectively reduced item

costs to most favored customer prices after items were received by the

commissaries.

In addition, vendors complained that the tone of the demand letters, which

cited interest penalties, automatic offsets within 30 days, and liability for

civil and/or criminal prosecution under the False Claims Act, was

threatening. They also believed the 30-day time period provided to review

claims was unreasonable.

As a result of these concerns, the process of recovering PRGI-identified

overpayments was virtually halted. PRGI continued to look for

overpayments, but no letters of indebtedness, regardless of the cause,

were sent to vendors. DSCP spent the next 8 months reviewing complaints

by brand name subsistence vendors. On April 15, 1998, DSCP concluded

that the vendors’ concerns were not valid. As a result, DSCP decided to

pursue the cash discount claims identified by PRGI. However, letters

representing the final decision on amounts owed have not been sent to

vendors.

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Time Between Payment

and Audit Recovery Efforts

Create Documentation

Problems

The time between the years the payments were made by DSCP (fiscal

years 1993-95) and the date of the recovery audit (fiscal years

1997-98) made finding supporting documentation difficult for both PRGI

and the vendors. In some cases, documentation was unavailable; in others,

the vendors needed additional time to locate files.

Although typical recovery auditing occurs within 6 months to a year of a

transaction, the legislative mandate required the audit of purchases during

the fiscal year 1993-95 time frame, 4 to 6 years before the demonstration

program. As a result, PRGI had difficulty obtaining documentation from

DFAS. For example, PRGI was unable to verify any fiscal year 1993

transactions from one payment system because supporting

documentation, including vendor invoice copies, had been discarded prior

to storage. Consequently, the audit base for the demonstration program

was reduced from $8.9 billion to $7.2 billion.

Because of the age of the payments, some vendors said that their

documentation had been sent to storage. Consequently, vendors received

up to 90 days to review DSCP’s claims of indebtedness.

PRGI Had Difficulty

Identifying Duplicate

Payments

PRGI had difficulty identifying potential duplicate payments because of

limitations with its proprietary software. According to PRGI officials,

payments in the private sector are invoice based, and PRGI software was

developed based on private sector practices. However, the DOD payment

systems do not retain invoice numbers or invoice dates. The DFAS payment

systems pay by contract or contract line item number. To compensate for

these limitations, PRGI manually sorted through records sent to storage to

identify potential duplicate payments. According to PRGI, its proprietary

software is being modified to identify duplicate payments given the

specialized nature of DFAS payment systems.

Delays in Beginning the

Demonstration Program

According to PRGI, even though the contract was signed in September 1996,

PRGI did not begin audit work in earnest until June 1997, due to delays in

obtaining computerized payment files. Further, PRGI personnel needed

time to understand DOD’s unique procurement and payment processes,

according to PRGI. For example, one payment system contains data on

about 384,000 contracts and disburses about $5.7 billion each month.

These affected how quickly PRGI was able to identify overpayments.

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Recommendations to

Reduce Overpayments

Not Implemented

According to the contract, PRGI is required to make recommendations to

reduce future overpayments. In November 1997, and again in April 1998,

PRGI published interim reports, with recommendations ranging from

reprogramming payment systems to providing contracting personnel

additional training to help them determine price reasonableness. For

example, PRGI recommended that DSCP periodically review all vendor

activity by asking vendors the status of their accounts with DSCP. PRGI used

this technique and recovered $957,000 from one vendor. Currently, neither

DFAS nor DSCP periodically ask vendors the status of their accounts. PRGI

also recommended that additional training be given to contracting

personnel to ensure that the types of discounts and allowances available in

the private sector are provided to the government. According to PRGI,

private sector organizations are able to reduce future overpayments and

strengthen payment processes and controls by implementing procedures

such as those recommended by PRGI. To date, the recommendations do not

appear to have received a critical review and none have been implemented

by either DSCP or DFAS.

DFAS claims that recommendations requiring the reprogramming of

payment systems to reduce overpayments are not feasible due to funding

limitations. Also, DFAS is consolidating its payment systems into one

payment system, the Defense Procurement Payment System, and DFAS said

that the PRGI recommendations will be incorporated in that system,

currently targeted to come on-line in 2002. DSCP said it is waiting until the

end of the program before it reviews the feasibility of implementing PRGI

recommendations.

Action Not Taked to

Recover Potential

Out-of-Scope

Overpayments

One of PRGI’s steps in identifying overpayments was to send letters to DSCP

vendors requesting that they provide a statement of their accounts with

the government. Vendor responses surfaced an estimated $1.75 million in

overpayments that were outside the scope of the PRGI contract either

because they were not within the contractual review period ($484,000) or

the overpayments were related to another government contract (estimated

by PRGI to be $1.27 million).

Both DFAS and DSCP officials said they had not taken action to pursue

recovery or to inform the other government agencies so that they could

pursue recovery and take steps to avoid future overpayments for a number

of reasons. Reasons included not knowing the extent of these

overpayments, not having the staff to substantiate their validity, not having

Page 8 GAO/NSIAD-99-12 Contract Management
B-280221 

procedures for notifying other federal agencies, and waiting for possible

expansion of PRGI’s contract beyond the fiscal year 1993-95 time frame.

Conclusions PRGI, through its methodology, has identified overpayments of

$19.1 million and is continuing its efforts to identify additional

overpayments. This magnitude of overpayments would likely not have

been identified by DFAS without the demonstration program. However,

government efforts to collect these overpayments have been slow—only

$1.9 million has been recovered—largely because the recovery process

virtually stopped for 8 months, while DSCP reviewed the merits of the

vendors’ complaints. While DSCP has concluded the government’s claims

are valid, it has not yet issued letters notifying vendors of the final decision

regarding amounts owed.

There are a number of steps DOD can take to improve its use of audit

recovery, particularly as it considers using audit recovery at other DOD

activities. For example, DOD can implement some of the PRGI

recommendations that do not require costly reprogramming of payment

systems and that could preclude future overpayments. It could

periodically review all vendor activity by asking vendors the status of their

accounts. PRGI used this technique and recovered $957,000 from one

vendor. DOD could also provide additional training to contracting

personnel to ensure that the types of discounts and allowances available in

the private sector are provided to the government. According to PRGI,

private sector organizations are able to reduce future overpayments and

strengthen payment processes and controls by implementing procedures

such as those recommended by PRGI. Until DOD gives more serious and

timely consideration to PRGI’s recommendations, it will likely incur the

same types of overpayments.

Recommendations We recommend that the Secretary of Defense direct the Comptroller to:

• Focus future audit recovery efforts on the most recent purchases to

maximize the likelihood that government and vendor documentation is

available to support overpayment identification and recovery.

• Critically review PRGI’s recommendations and implement those that are

cost-effective.

• Consider the extent to which it may be cost-effective to undertake

moderate internal efforts to identify overpayments before turning audit

recovery efforts over to an external group. One technique that DOD might

Page 9 GAO/NSIAD-99-12 Contract Management
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find cost-effective is to periodically request status of accounts from its

vendors.

• Establish a process for dealing with overpayments due other agencies.

Agency Comments

and Our Evaluation

In commenting on a draft of this report, DOD concurred with our

recommendations. DOD said that DFAS has reviewed PRGI’s

recommendations to reduce overpayments, and it is in the initial stages of

efforts to implement them. As we stated in the report, we believe some of

the PRGI recommendations are worthy of immediate consideration, do not

require costly reprogramming of payment systems, and if implemented,

could reduce future overpayments. We urge DFAS to move quickly to

implement these recommendations. (DOD’s comments appear in app. I.)

Scope and

Methodology

To assess the methods used to identify overpayments, we reviewed PRGI’s

methodology for determining overpayments and interviewed PRGI, DFAS,

and DSCP officials. We also obtained the views of recovery audit users and

the vendor community through their trade association, the ALA. To

determine the types and total amount of overpayments identified and

recovered, we reviewed DFAS and PRGI records.

To develop recommendations for improving the process by which

overpayments are recovered by DOD, we reviewed the private sector

practices for identifying and recovering overpayments and the

recommendations PRGI made, and considered the factors limiting the

identification or recovery of overpayments.

We performed our work at the Office of the Secretary of Defense,

Washington, D.C.; DFAS Headquarters, Arlington, Virginia; DFAS Columbus,

Ohio; the Defense Commissary Agency, Fort Lee, Virginia; the Army and

Air Force Exchange Service, Dallas, Texas; the American Logistics

Association, Washington, D.C.; Wal-Mart Stores, Incorporated, Bentonville,

Arkansas; and the S.C. Johnson Company, Racine, Wisconsin.

We performed our work from March 1998 through November 1998 in

accordance with generally accepted government auditing standards.

We are sending copies of this report to the Secretary of Defense; the

Director of the Office of Management and Budget; the Commander,

Defense Logistics Agency; the Director, Defense Finance and Accounting

Page 10 GAO/NSIAD-99-12 Contract Management
B-280221 

Service; the Commander, Defense Contract Management Command; and

appropriate congressional committees. Copies will also be made available

to others on request.

Please contract me at (202) 512-4587 if you or your staff have any

questions concerning this report. Major contributors to this report were

Charles W. Thompson, Daniel J. Hauser, and Myra W. Butler.

David E. Cooper

Associate Director

Defense Acquisitions Issues

Page 11 GAO/NSIAD-99-12 Contract Management
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List of Congressional Committees

The Honorable Strom Thurmond

Chairman

The Honorable Carl Levin

Ranking Minority Member

Committee on Armed Services

United States Senate

The Honorable Ted Stevens

Chairman

The Honorable Daniel K. Inouye

Ranking Minority Member

Subcommittee on Defense

Committee on Appropriations

United States Senate

The Honorable Floyd D. Spence

Chairman

The Honorable Ike Skelton

Ranking Minority Member

Committee on National Security

House of Representatives

The Honorable C. W. Bill Young

Chairman

The Honorable John P. Murtha

Ranking Minority Member

Subcommittee on National Security

Committee on Appropriations

House of Representatives

Page 12 GAO/NSIAD-99-12 Contract Management
Page 13 GAO/NSIAD-99-12 Contract Management
Appendix I 

Comments From the Department of Defense

Note:GAO’s comment

supplementing those in

the report text appear at

the end of this appendix.

See comment 1.

Page 14 GAO/NSIAD-99-12 Contract Management
Appendix I 

Comments From the Department of Defense

Page 15 GAO/NSIAD-99-12 Contract Management
Appendix I 

Comments From the Department of Defense

The following are GAO’s comments on the Department of Defense’s (DOD)

letter dated November 4, 1998.

GAO Comments 1. DOD recommends that our planned follow-on expansion of this audit

discuss whether there are any impediments in law or regulation to the

government’s adoption of commercial audit recovery practices. We are in

the planning stages of the follow-on assignment and will consider DOD’s

recommendations as we plan our audit work.

(707315) Page 16 GAO/NSIAD-99-12 Contract Management
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