United States General Accounting Office

GAO Report to the Chairman, Committee on

Government Operations, House of

Representatives

December 1994 OVERHEAD COSTS

Unallowable Costs

Charged by Rockwell

Corporation,

Rocketdyne Division

GAO/NSIAD-95-41

GAO United States

General Accounting Office

Washington, D.C. 20548

National Security and

International Affairs Division

B-257598 

December 9, 1994

The Honorable John Conyers, Jr.

Chairman, Committee on Government Operations

House of Representatives

Dear Mr. Chairman:

As you requested, we reviewed a major National Aeronautics and Space

Administration (NASA) contractor’s overhead cost submissions to

determine whether they included unallowable costs. We also attempted to

determine the extent to which questioned costs that the Defense Contract

Audit Agency (DCAA) identified in its audit of the contractor’s overhead

submissions were sustained.

This report contains the results of our work at Rockwell International

Corporation, Rocketdyne Division, Canoga Park, California. The results of

a prior review of another major NASA contractor were reported to you in

June 1994.1

Background Overhead cost submissions are used to establish final overhead rates that

determine reimbursements under cost-type contracts and to provide the

historical cost basis for overhead rates that are used to negotiate

fixed-price contracts. The Federal Acquisition Regulation (FAR) cost

principles require government contractors to identify and exclude

unallowable costs from overhead submissions.

The Department of Defense provides administrative contract support to

NASA at Rocketdyne. The overhead submissions are reviewed by DCAA for

allowability. About 80 percent of Rocketdyne’s sales are under

government cost reimbursable-type contracts.

Results in Brief About $222,000 of the costs we reviewed in Rocketdyne’s fiscal year 1990

and 1992 overhead submissions was unallowable. This amount represents

about 5 percent of the approximately $4.8 million of costs reviewed and

about 2.6 percent of the approximately $8.6 million charged in total to the

reviewed accounts. These percentages of unallowable costs cannot be

generalized to the total overhead charges of $866 million because we

1

Overhead Costs: Costs Charged By McDonnell Douglas Aerospace’s Space Station Division

(GAO/NSIAD-94-150, June 23, 1994).

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B-257598 

reviewed only those accounts that we believed were more susceptible to

unallowable charges. Rocketdyne included the unallowable costs in its

overhead submissions primarily because accounting personnel did not

have accurate instructions on allowable membership fees and because of

weaknesses in Rockwell and Rocketdyne procedures for handling costs of

outside legal services. Rocketdyne said it is implementing revised

procedures to ensure that unallowable costs are properly recorded in the

future.

Rocketdyne would have been reimbursed for the fiscal year 1990

unallowable costs in part because DCAA did not review the company’s legal

expenses and did not follow up on information it did obtain on certain

membership fees. At the time of our review, DCAA had not conducted its

audit of Rocketdyne’s fiscal year 1992 submission.

The extent to which DCAA-questioned costs were sustained was not an

issue because DCAA did not question any costs in its reviews of

Rocketdyne’s overhead submissions for fiscal years 1988 and 1989—the

most recent years for which final overhead rate negotiations were

complete.

Unallowable Costs At the time of our review, neither Rocketdyne’s fiscal year 1990 nor 1992

overhead submissions had been settled. Rocketdyne has agreed to

withdraw the approximately $222,000 we identified as unallowable costs

in its overhead submissions. The unallowable costs included costs for

legal fees, lobbying, public relations, contributions, employee education,

and training for consultants.

Legal Costs According to FAR 31.205-47, costs incurred in connection with any

proceeding brought by a state government alleging a violation of law or

regulation that results in civil penalties are unallowable. Rocketdyne,

however, paid civil penalties as a result of environmental lawsuits brought

by the State of California in fiscal years 1990 and 1992 and included the

outside legal expenses ($59,600) incurred in connection with these

lawsuits in its fiscal year 1990 and 1992 overhead submissions.

Also included in Rocketdyne’s overhead submissions was a double

payment of about $25,400 to the law firm that represented Rocketdyne in

one of the lawsuits. Rocketdyne has received a refund from the firm for

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B-257598 

the double payment and has agreed to remove the $25,400 from its

overhead submission along with the $59,600 in legal fees.

Lobbying FAR 31.205-22 states that costs incurred in attempts to influence the

introduction of legislation or the enactment or modification of pending

federal legislation through communication with any Member or employee

of Congress are unallowable. We identified about $42,000 of lobbying costs

that Rocketdyne included in its fiscal year 1990 and 1992 overhead

submissions. Rocketdyne has agreed to remove the $42,000 from its

overhead submissions.

The lobbying costs were incurred primarily for outside professional

services. For example, Rocketdyne paid a law firm about $33,200 to lobby

for Clean Air Act amendments. Rocketdyne has agreed to remove this

payment from its overhead submission.

Most of the remaining lobbying cost concerned membership fees paid to

an organization engaged in lobbying. Rocketdyne included $6,300 for

membership fees paid to the American Nuclear Energy Council in its fiscal

year 1992 overhead submission. Rocketdyne has agreed to remove the

$6,300 from its overhead submission.

Public Relations FAR 31.205-1 identifies unallowable public relations costs as those whose

primary purpose is to promote the sale of products and services by

stimulating interest in a product or product line or by enhancing a

company’s image. We identified about $25,100 in unallowable public

relations costs in Rocketdyne’s fiscal year 1990 and 1992 overhead

submissions. For example, Rocketdyne included in its fiscal year 1990

overhead submission $25,000 for dues it paid to the U. S. Council for

Energy Awareness. Representatives of Rocketdyne’s Atomics International

component, which conducts business in both the space and land-based

nuclear power arena, justified this membership on the basis that the

Council does “more than any other organizatin [sic] to educate Americans

on the absolute necessity of a U. S. energy policy. . . leading to the

construction and operation of many of these [nuclear] power plants as

soon as possible.” Furthermore, the Council’s own literature shows that its

mission is to foster public understanding of the advantages of nuclear

power plants through advertising and public relations. Rocketdyne has

agreed to remove $25,100 from its overhead submissions.

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B-257598 

Contributions Except for costs of participation in community service activities such as

blood bank or charity drives, contributions or donations, including cash,

property, or services, regardless of the recipient, are unallowable under

FAR 31.205-8. We identified contributions totaling about $21,800 that

Rocketdyne included in its fiscal year 1990 and 1992 overhead

submissions.

Rocketdyne made the majority of these contributions, $7,000 in fiscal year

1990 and $9,000 in fiscal year 1992, to California State University,

Northridge. As a result of our review, Rocketdyne has agreed to withdraw

the $16,000 from its overhead submissions.

Rocketdyne also included about $3,800 in its overhead submissions for

amounts it paid to a professional organization in excess of membership

fees. Rocketdyne paid $5,000 to the Institute for Space Nuclear Power

Studies of the University of New Mexico, which was $3,270 above the

membership fee for that organization. DCAA audit guidelines identify such

payments in excess of membership fees as contributions. Rocketdyne has

agreed to withdraw $3,800 from its overhead submissions.

Rocketdyne included about $1,890 in its fiscal year 1992 overhead

submission for food and beverage services provided to attendees of a

Department of Energy (DOE) conference held at Florida International

University. DOE held this conference to evaluate and monitor the progress

of grantee universities under two DOE educational programs for minority

students. Rocketdyne was under contract with DOE to help evaluate the

progress of the universities under their grants. However, the contract did

not require Rocketdyne to pay for food and beverage services for this

conference. Consequently, we believe this $1,890 is a contribution, since

Rocketdyne had no contractual obligation with DOE to pay for the services

and had no business interest with the DOE grantees. Rocketdyne has

agreed to remove this cost from its submission.

Employee Education Under FAR 31.205-44(d), costs associated with full-time education at the

undergraduate level are unallowable. We identified about $18,700 in the

fiscal year 1990 overhead submission for one employee’s full-time

education at the undergraduate level and $18,030 in the fiscal year 1992

overhead submission for another employee. Both of these employees were

on leave of absence from Rocketdyne for about 36 months to obtain

Bachelor of Science degrees. During this time, they attended school

full-time, and Rocketdyne reimbursed one a total of $18,700 and the other

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B-257598 

$30,220 (including $12,190 for an earlier period) for educational expenses.

Rocketdyne has agreed to remove these costs from its overhead

submissions, and it said it is revising its educational policy to discontinue

reimbursement of full-time education at the undergraduate level.

Training for Consultants According to FAR 31.205-44(i), training or education costs for other than

bona-fide employees are unallowable. However, Rocketdyne included

about $7,000 in its fiscal year 1992 overhead submission for costs

associated with training two Rocketdyne consultants. Rocketdyne has

agreed to withdraw the $7,000 from its overhead submission.

Other Unallowable Costs Rocketdyne agreed to remove other unallowable costs totaling about

$4,500 from its overhead submissions, including costs allocable to other

Rockwell divisions and other erroneous billings.

Factors Contributing

to Unallowable Costs

in Overhead Claims

FAR requires contractors to identify unallowable costs in their accounting

records and exclude them from any submission. Rocketdyne procedures

require that unallowable costs be recorded in an unallowables account.

However, Rocketdyne failed to identify certain costs as unallowable and,

therefore, recorded them as allowable. Also, inattention by DCAA

contributed to the unallowable costs going undetected.

Rocketdyne’s failure to record expenses as unallowable was primarily due

to erroneous instructions for recording the costs of membership fees and

weaknesses in procedures for handling the costs of outside legal services.

Improperly recorded membership fees totaled over $54,500 and, as

previously discussed, concerned lobbying, contributions, and public

relations. Improperly recorded legal expenses totaled over $118,000 and,

as previously discussed, concerned legal costs for environmental lawsuits,

lobbying, and duplicate payments.

The legal fees in question were paid by Rockwell International’s corporate

headquarters. For outside legal service fees, Rockwell sends each

benefiting division (including Rocketdyne) information on its share of the

cost. Each division then enters the cost in its accounting records,

including unallowable accounts. However, for the costs we questioned,

Rockwell did not advise Rocketdyne that the legal expenses were

unallowable until about a year after sending the divisions the initial cost

information, and then it did not identify how much was unallowable. As a

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B-257598 

result of our review, Rockwell said it has revised its procedures and now

provides information on unallowable legal costs at the time it advises its

divisions of their share of the legal expenses.

Rocketdyne also failed to properly record certain membership fees as

unallowable costs. Rocketdyne relies on Rockwell instructions to decide

which organization’s fee is an allowable cost and which is not. These

instructions stated that membership fees for the organizations we

questioned were allowable. Rocketdyne stated that Rockwell was

changing its instructions on the organizations we questioned as a result of

our review.

DCAA had reviewed membership fees but not legal expenses in its last two

audits of Rocketdyne’s overhead submissions. It also raised questions

about Rocketdyne’s failure to record certain membership fees as

unallowable. However, it dropped the questioned costs from its final

report on Rocketdyne’s overhead submissions because DCAA believed that

it would not be “cost effective” to settle “such subjective” issues.

Sustention of DCAA

Findings

NASA has delegated the authority for negotiating final overhead rates at

Rocketdyne to the resident administrative contracting officer. Since DCAA

questioned no costs in 1990, and for the previous 2 years, the sustention

rate on DCAA-questioned costs during the negotiation of final overhead

rates was not an issue.

DCAA Report on

Rocketdyne’s

Noncompliance

On September 26, 1994, subsequent to our review, DCAA issued a report on

its review of Rocketdyne’s compliance with Cost Accounting Standard

405. This standard, in part, requires a contractor to identify and exclude

from any billing, claim, or proposal applicable to a government contract

those costs that are expressly unallowable under FAR or mutually agreed to

be unallowable.

DCAA concluded that audits of Rocketdyne’s overhead claims for fiscal

year’s 1990 and 1993 disclosed that Rocketdyne’s failure to comply with

the standard resulted in an increased cost to the government. Thus,

according to DCAA, Rocketdyne was in noncompliance with the standard

and FAR.

DCAA recommended that Rocketdyne reassess the adequacy of its

screening process for unallowable costs and ensure that individuals

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B-257598 

responsible for the screening are fully trained. While Rocketdyne believes

it has an effective system to comply with the Cost Accounting Standards

and FAR, it has agreed to strengthen its screening process.

Scope and

Methodology

We selected Rocketdyne because about 80 percent of its sales are to NASA

under cost-reimbursable contracts. To select the overhead cost accounts

for review, we considered the sensitivity of the accounts—high probability

of unallowable charges—and the significance of expenditures, including

increases from year to year. In reviewing the accounts, we examined

source documents to determine the nature and purpose of the expenses in

relation to FAR’s cost principles in effect at the time.

The accounts selected had a total value of about $8.6 million, and we

examined transactions with a total value of about $4.8 million. Our

findings, however, cannot be generalized to the total fiscal year 1990 and

1992 overhead submissions (about $866 million) because we used a

judgmental sample selecting accounts that we believed were more

susceptible to unallowable charges.

We reviewed DCAA audit reports on overhead costs and related working

papers to determine the scope and depth of coverage and the adequacy of

transaction testing2

 necessary to establish allowability, allocability, and

reasonableness of expenses included in the overhead submissions. We

also reviewed Rocketdyne audits and related working papers to assess the

adequacy of Rocketdyne’s internal controls for preparing accurate

overhead submissions. In addition, we reviewed overhead negotiation

records the government contract administration office provided to

determine the extent to which DCAA-questioned costs were sustained in the

final indirect rate settlements.

We performed our review between July 1993 and June 1994 in accordance

with generally accepted government auditing standards. As agreed with

your office, we did not obtain written agency comments on a draft of this

report. However, we discussed our results with officials from DCAA, NASA,

and Rocketdyne and incorporated their comments where appropriate.

2

Transaction testing is a process that traces expenditures to supporting documentation to determine

whether the expenditures are allowable. It also assesses the adequacy of a contractor’s internal

controls.

Page 7 GAO/NSIAD-95-41 Overhead Costs
B-257598 

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 NASA Administrator; the Secretary of Defense; the

Directors, Defense Logistics Agency, DCAA, and Office of Management and

Budget; and other interested congressional committees. Copies will also

be made available to others upon request.

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

concerning this report. Other major contributors to this report are listed in

appendix I.

Sincerely yours,

David E. Cooper

Director, Acquisition Policy, Technology,

 and Competitiveness Issues

Page 8 GAO/NSIAD-95-41 Overhead Costs
Page 9 GAO/NSIAD-95-41 Overhead Costs
Appendix I 

Major Contributors to This Report

National Security and

International Affairs

Division, Washington,

D.C.

Charles W. Thompson

Los Angeles Regional

Office

Ronald A. Bononi

Larry Aldrich

Kenneth Roberts

George Vissio

(705028) Page 10 GAO/NSIAD-95-41 Overhead Costs
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