```
DOD Procurement: Overpayments and Underpayments at Selected Contractors
Show Major Problem (Letter Report, 08/05/94, GAO/NSIAD-94-245).

GAO testified in April 1994 that defense contractors were returning
millions in contract overpayments to the Defense Finance and Accounting
Service (DFAS). GAO was then asked to review whether all overpayments
were being returned.  A review of overpayments and underpayments to nine
major defense contractors revealed $118 million in inaccurate payments
that potentially could cost the government more than $20,000 a day in
lost interest or late payment penalties. Each contractor had returned
some overpayments, but the nine contractors were keeping some
overpayments.  Contractor officials gave several reasons for not
returning overpayments, but none of the reasons appeared to justify not
returning overpayments or delaying the resolution of discrepancies.
Neither the Defense Department nor the contractors were aggressively
trying to resolve the discrepancies, some of which had been outstanding
for years.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  NSIAD-94-245
     TITLE:  DOD Procurement: Overpayments and Underpayments at Selected 
             Contractors Show Major Problem
      DATE:  08/05/94
   SUBJECT:  Underpayments
             Overpayments
             Financial management
             Federal agency accounting systems
             Department of Defense contractors
             Defense procurement
             Accountability
             Military cost control
             Refunds to government
             Internal controls

             
**************************************************************************
* This file contains an ASCII representation of the text of a GAO        *
* report.  Delineations within the text indicating chapter titles,       *
* headings, and bullets are preserved.  Major divisions and subdivisions *
* of the text, such as Chapters, Sections, and Appendixes, are           *
* identified by double and single lines.  The numbers on the right end   *
* of these lines indicate the position of each of the subsections in the *
* document outline.  These numbers do NOT correspond with the page       *
* numbers of the printed product.                                        *
*                                                                        *
* No attempt has been made to display graphic images, although figure    *
* captions are reproduced. Tables are included, but may not resemble     *
* those in the printed version.                                          *
*                                                                        *
* A printed copy of this report may be obtained from the GAO Document    *
* Distribution Facility by calling (202) 512-6000, by faxing your        *
* request to (301) 258-4066, or by writing to P.O. Box 6015,             *
* Gaithersburg, MD 20884-6015. We are unable to accept electronic orders *
* for printed documents at this time.                                    *
**************************************************************************

Cover
================================================================ COVER

Report to the Chairman, Committee on Governmental Affairs, U.S. 
Senate

August 1994

DOD PROCUREMENT - OVERPAYMENTS AND
UNDERPAYMENTS AT SELECTED
CONTRACTORS SHOW MAJOR PROBLEM

GAO/NSIAD-94-245

DOD Procurement

Abbreviations
=============================================================== ABBREV

  DFAS - Defense Finance and Accounting Service
  DOD - Department of Defense

Letter
=============================================================== LETTER

B-256249

August 5, 1994

The Honorable John Glenn
Chairman, Committee on
 Governmental Affairs
United States Senate

Dear Mr.  Chairman: 

In April 1994, we testified before your Committee that defense
contractors are returning millions in contract overpayments to the
Defense Finance and Accounting Service (DFAS) within the Department
of Defense (DOD).\1 Our testimony was based on an earlier report
concerning $751 million in returns by contractors during a 6-month
period ending in April 1993.\2 Virtually all returned overpayments
were detected and returned by the contractors without a government
demand letter.  However, because of concerns as to whether
contractors are returning all overpayments, you asked us to determine
whether defense contractors were retaining overpayments. 

We initiated our work at nine major contractor locations.  The
magnitude and extent of overpayments not being returned, as well as
underpayments not being corrected, show a major problem requiring
immediate DOD attention.  Accordingly, as agreed, we are providing
this interim report and continuing to examine this issue. 

--------------------
\1 Financial Management:  Financial Control and System Weaknesses
Continue to Waste DOD Resources and Undermine Operations
(GAO/T-AIMD/NSIAD-94-154, Apr.  12, 1994). 

\2 DOD Procurement:  Millions in Overpayments Returned by DOD
Contractors (GAO/NSIAD-94-106, Mar.  14, 1994). 

   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

The nine contractor locations we visited had unresolved payment
discrepancies totaling about $118 million--$30.3 million in
overpayments and $87.7 million in underpayments.  These overpayments
and underpayments result in significant unnecessary costs to the
government.  At current interest rates, these identified overpayments
could cost the government about $5,800 per day.  Because the Prompt
Payment Act requires DOD to pay interest on valid invoices that are
paid late, the underpayments we identified could cost DOD about
$16,800 per day. 

Each contractor had returned some overpayments, but the nine
contractors were retaining some overpayments.  Contractor officials
gave several reasons for not returning overpayments; however, none of
the reasons appeared to justify not returning overpayments or
delaying the resolution of discrepancies.  The payments were made by
several different DFAS offices, and some discrepancies have been
outstanding for several years.  DOD officials had been notified of
some discrepancies but had not taken corrective action.  Neither DOD
nor the contractors appeared to be aggressively pursuing resolution
of payment discrepancies. 

DOD has not identified any comprehensive plans to mobilize resources
to identify and correct current payment discrepancies.  We believe
such action is necessary to reduce (1) the cost to the government,
(2) future payment discrepancies, and (3) the incidence of
uncollectable overpayments. 

   DISCREPANCIES INCLUDE BOTH
   OVERPAYMENTS AND UNDERPAYMENTS
------------------------------------------------------------ Letter :2

Our initial work, involving a review of payment records at nine
contractor locations, identified significant payment discrepancies on
DOD contracts.  We found that contractor records identified over $30
million in overpayments from DOD and over $87 million in
underpayments.  Table 1 lists the overpayment and underpayment totals
that we identified in each of the nine contractors' records during
our visits in February and March 1994. 

                           Table 1
           
              Overpayments and Underpayments by
                     Contractor Location

                                    Overpaymen  Underpayment
Contractor locations visited                ts           s\a
----------------------------------  ----------  ------------
AT&T Technologies, Greensboro,        $476,786   $24,101,282
 North Carolina
Bell Helicopter Textron,               181,127     1,285,712
 Incorporated, Fort Worth, Texas
Harris Corporation, Government       1,407,275     3,604,929
 Electronics Systems Division,
 Melborne, Florida
Hercules Aerospace Company,            159,820         1,017
 Missiles,
 Ordnance & Space Group, McGregor,
 Texas
Martin Marietta, Electronics,       19,820,679       417,994
 Information & Missiles Group,
 Orlando, Florida
Rockwell International                 250,661       682,477
 Corporation, Missile Systems
 Division, Duluth, Georgia
Rockwell International               1,381,643     7,596,595
 Corporation, Collins Systems
 International, Richardson, Texas
Texas Instruments, Incorporated,     6,254,756    47,766,941
 Dallas, Texas
Tracor, Incorporated, Austin,          339,312     2,210,530
 Texas
============================================================
Total                               $30,272,05   $87,667,477
                                             9
------------------------------------------------------------
\a Underpayments exclude current billings less than 30 days old. 

Both overpayments and underpayments result in unnecessary costs to
the government.  Overpayments increase the government's interest
costs because funds are needlessly disbursed.  Contractors are not
assessed interest on overpayments until 30 days after a demand for
repayment is made.  At current interest rates, these identified
overpayments could cost the government about $5,800 per day, or about
$2 million per year.  Overpayments also expose the government to a
greater risk of loss because some overpayments become uncollectable. 
In our March 1994 report, we noted that DFAS' reconciliation of 4,300
contracts had identified about $17 million that was owed the
government but could be uncollectable. 

Underpayments also increase costs because the Prompt Payment Act
requires interest to be paid on overdue amounts.\3 The late payment
penalty rate, which is set by the U.S.  Treasury, is currently 7
percent.  Late payment penalties on the underpayments at the nine
contractors we visited could cost DOD about $16,800 per day, and some
underpayments have existed for extended periods.  At one contractor,
about $5.4 million in underpayments had been outstanding for more
than a year.  Our review of the contractor's records showed that DOD
was notified of most of these underpayments. 

Contractor officials said that DFAS paying offices were not always
notified of payment discrepancies.  However, according to these
officials, even when DFAS was notified, DOD did not always take
action to collect the overpayments.  Our test of payment
discrepancies identified instances of the conditions described by
contractor officials.  In one instance, a contractor notified DFAS
officials on December 10, 1992, that the company had received
duplicate payments on four invoices totaling about $360,000.  When we
reviewed the contractor's accounts receivable as of February 1994,
over a year after DFAS was notified of the discrepancy, we found the
contractor still had the duplicate payments.  A contractor official
said that DOD had not requested return of the duplicate payments. 

In another instance, a contractor notified DFAS officials on December
15, 1992, that it had been underpaid and was owed about $155,000 on
two invoices.  The contractor said DFAS had incorrectly deducted
progress payments on one invoice and made an excessive price
deduction on the other because DFAS had not updated its records.  The
underpayment was resolved after our visit.  The final payment made in
May 1994 was about
2 years after the original payments.  In accordance with the Prompt
Payment Act, DFAS paid a late payment penalty of about $10,000. 

In another case, a contractor returned three overpayments totaling
about $160,000 identified during our review.  DOD had been formally
notified about one of the three overpayments.  DOD was notified in a
January 1994 letter of a $66,000 overpayment that occurred about 3
years earlier.  The other two overpayments, $28,000 and $66,000, had
been outstanding for
6 and 18 months, respectively.  There was no record of DOD being
notified of these two overpayments, but the contractor's accounting
manager believes he discussed the larger overpayment with a DOD
contracting official. 

Another contractor's long-standing overpayment was also resolved
during our visit.  According to DOD's records, in September 1993,
DFAS temporarily suspended payments on one contract because available
contract funding was not sufficient to pay the contractor's progress
payment billings.  DOD calculated that the contractor had been
overpaid by about $28 million on the contract, mostly because
progress payments on foreign military sales had been improperly
billed.  Our review of the contractor's accounts receivable records
in February 1994 showed about $15.7 million in overpayments on this
contract. 

During our visit, the contractor recalculated the payment status and
returned $5.4 million in overpayments and applied the balance, about
$10.3 million, against additional contract costs incurred between
August 1993 and March 1994.  The contractor's records showed that
most of the overpayments on this contract had been outstanding over
200 days and one overpayment of $670,000 had been outstanding 695
days.  The contractor sent a check to DOD in October 1992 for the
$670,000 overpayment, but the DOD contracting official did not
process the check and returned it because the contract was being
reconciled.  On another contract, this contractor had an overpayment
of about $5,000 that had been outstanding since February 1988, over 6
years. 

The contractors we visited, although retaining some overpayments,
returned a significant amount of overpayments between October 1,
1992, and March 14, 1994, to the DFAS Columbus Center, the primary
contract payment center for DOD.  (About 2,200 of the 26,000
contractors paid by the DFAS Columbus Center have returned
overpayments.) The amounts returned, as shown in table 2, are the
total for the contractor, not just the locations we visited, because
data on checks received by contractor location were not readily
available. 

                           Table 2
           
            Amounts Received by the DFAS Columbus
            Center from Selected Contractors from
              October 1, 1992, to March 14, 1994

                                       Number of
Contractor                                checks      Amount
--------------------------------  --------------  ----------
AT&T                                          66  $5,960,307
Bell Helicopter Textron,                      35   3,047,360
 Incorporated
Harris Corporation                            57   3,820,944
Hercules Aerospace Company                    21   5,207,666
Martin Marietta                              540  134,592,55
                                                           6
Rockwell International                       124  49,032,757
 Corporation\a
Texas Instruments, Incorporated               35  38,592,384
Tracor, Incorporated                          39   1,147,458
============================================================
Total                                        917  $241,401,4
                                                          32
------------------------------------------------------------
\a We visited two locations of this contractor. 

Contractor officials provided one or more of the following reasons
that they did not always return overpayments:  (1) DFAS was
reconciling the contract; (2) the amounts were relatively small; (3)
DFAS did not issue a demand letter; (4) the overpayments compensated
for underpayments; and (5) when overpayments were returned, DFAS did
not always correctly account for the returns causing fund shortages
on later contract payments.  Contractor officials said that each
payment discrepancy had a distinct cause that required research to
resolve.  The officials said that DFAS does not accept contractor
information by itself as evidence of a payment error; consequently,
the contractors often wait for DFAS to reconcile contract payments. 

None of the reasons provided appeared to justify not returning
overpayments or delaying resolution of discrepancies.  For example,
the DFAS Columbus Center policy is to collect all overpayments
offered without waiting for reconciliation to be completed, a process
that can take several months.  Additionally, the processing of demand
letters can unnecessarily delay return of overpayments.  Finally,
overpayments should not be used to compensate for underpayments
because the Prompt Payment Act provides contractors with interest on
late payments. 

--------------------
\3 The Prompt Payment Act requires the payment of an interest penalty
for payment made after the due date or 30 days after the presentation
of a valid invoice.  The act provides a 15-day grace period. 

   ACTION NEEDED TO IDENTIFY AND
   CORRECT PAYMENT DISCREPANCIES
------------------------------------------------------------ Letter :3

DOD officials previously told us a number of actions were being taken
to clarify and strengthen payment practices, reinforce prompt debt
collection procedures, and issue clearly stated and complete contract
documents to deal with future contractor overpayments.  While these
actions are needed, they do not specifically address existing payment
discrepancies.  On the basis of discrepancies identified by
contractors' records, some of which had existed for several years, we
believe unresolved discrepancies are significant and will continue to
adversely affect future payments. 

DFAS' primary method of resolving payment discrepancies is through
auditing or reconciling contracts with known or suspected problems. 
As of June 30, 1994, the DFAS Columbus Center had identified about
17,900 of its almost 400,000 contracts as requiring reconciliation. 
The Center had an additional 8,990 rejected transactions and
unmatched disbursements on hand that might require additional
contract reconciliations.  The number of additional reconciliations
required will not be known until the transactions are researched. 

In addition to those contracts already identified as needing
reconciliation, we believe that many of the other hundreds of
thousands of contracts being paid by DFAS could have payment
discrepancies similar to those we identified in the contractor
records.  However, unless DOD uses contractors' records as a means to
identify payment discrepancies, the extent of contracts requiring
reconciliation will continue to be based on problems identified at
DFAS. 

   RECOMMENDATION
------------------------------------------------------------ Letter :4

We recommend that the Secretary of Defense mobilize available DOD
contract, financing, and audit resources to identify, verify, and
correct payment discrepancies identified in contractors' records. 
Using contractor records, DOD can research the payment status of
contracts and use this information, along with government records, as
a basis for further actions to reconcile payment discrepancies. 

   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :5

As part of our efforts to determine whether contractors are returning
overpayments, we reviewed the open accounts receivable at nine
contractor locations.  All the contractors selected were in the top
100 defense contractors by revenue.  Contractors maintain billing
records that should agree with the DOD payment records when correct
transactions have been completed.  The contractor records should show
the status of billings and payments and any unresolved differences
between the contractor and DOD.  If a contractor receives payments in
excess of the amounts billed, the overpayments should be recorded in
the contractor's accounts.  Conversely, if payments received are less
than the amount billed, the underpayments should be recorded in the
accounts. 

The contractors' accounts receivables with DOD that were out of
balance were totaled by overpayments and underpayments as of the date
of our review.  Accounts were considered out of balance if the amount
paid by DFAS was more or less than the amount billed.  Unpaid
billings less than
30 days old were excluded from our payments analysis because they
were considered current accounts.  We discussed these amounts with
contractor officials responsible for the financial records.  In
addition, we examined invoice documentation to determine (1) why
there were discrepancies and (2) whether the government had been
notified of them.  We did not reconcile contracts. 

We used the DFAS Columbus Center's summary accounts receivable
records to compile a list of contractor checks received from the nine
contractors we visited.  As part of its accounting process, DFAS'
summary records include the name of the remitting contractor and the
amount of the check.  These records show the number and amount of
contractor checks received by the DFAS Columbus Center. 

In addition, we reviewed laws and regulations pertaining to the
administration and management of contracts and contract payments,
including those related to collection of contractor debts.  We also
discussed payment discrepancies with the Defense Logistics Agency,
the Defense Contract Management Command, and DFAS officials. 

We conducted our review between February and July 1994 in accordance
with generally accepted government auditing standards.  As agreed
with your office, we did not obtain written DOD comments on a draft
of this report; however, we discussed the results of our review with
officials from the DOD Comptroller Office, the DOD Inspector General,
the Defense Contract Audit Agency, the Defense Contract Management
Command, and DFAS.  We considered their comments in preparing this
report.  In general, they concurred with our report. 

---------------------------------------------------------- Letter :5.1

Unless you publicly announce its contents earlier, we plan no further
distribution of this report until 30 days from its issue date.  At
that time, we will send copies to the Secretary of Defense; the
Director, Office of Management and Budget; and other interested
congressional committees.  Copies will also be available to others
upon request. 

Please contact me at (202) 512-4587 if you or your staff have any
questions concerning this report.  Major contributors to this report
are listed in appendix I. 

Sincerely yours,

David E.  Cooper
Director, Acquisition Policy, Technology,
 and Competitiveness Issues

MAJOR CONTRIBUTORS TO THIS REPORT
=========================================================== Appendix I

   NATIONAL SECURITY AND
   INTERNATIONAL AFFAIRS DIVISION,
   WASHINGTON, D.C. 
--------------------------------------------------------- Appendix I:1

David Childress

   DALLAS REGIONAL OFFICE
--------------------------------------------------------- Appendix I:2

David W.  Frost
Joe D.  Quicksall
Seth D.  Taylor

   ATLANTA REGIONAL OFFICE
--------------------------------------------------------- Appendix I:3

George C.  Burdette
Arthur W.  Sager
```