Page 1 GAO-14-107R DOD Contract Termination

441 G St. N.W.

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November 12, 2013

Congressional Committees

Preliminary Observations on DOD Estimates of Contract Termination Liability

This report responds to Section 812 of the National Defense Authorization Act (NDAA) for Fiscal 

Year 2013, which mandates that we report to the congressional defense committees on the 

extent to which the Department of Defense (DOD) is considering potential termination liability as 

a factor in entering into and terminating covered contracts.1 Section 812 also mandates that 

DOD assess its relevant acquisition guidance and take appropriate actions to ensure that 

program managers for major defense acquisition programs (MDAP) are preparing estimates of 

potential termination liability for covered contracts.2

To conduct this work, we reviewed DOD’s assessment, in which DOD reviewed relevant 

acquisition guidance and collected information on a sample of six MDAPs. We also interviewed 

DOD officials responsible for conducting the assessment. In addition, we leveraged our ongoing 

work looking at program cancellations to further assess DOD efforts to consider potential 

termination liability. We interviewed DOD officials, obtained documentation on guidance and 

directives, and analyzed termination cost data for selected MDAP contracts terminated from 

2004 through 2011. We are also collecting information on whether selected DOD programs 

have been requiring contract termination liability estimates before award and during the course 

of a contract. As part of our annual weapons assessment, we selected a non-generalizable 

sample of weapons programs that represent Air Force, Army and Navy, that cover a range of 

platforms including aircraft, ships and satellites, and that represent programs in both 

development and production phases. We requested answers to a standard set of questions to 

determine how DOD officials consider termination liability costs prior to contract award and 

before contract termination, and to identify guidance used in making those decisions. We will

report on these and other findings in our early 2014 report on program cancellations.

This is the first of two reports we plan to 

issue in this area for these committees. The second report, in response to a mandate in the 

Senate Report, 112-173, on the NDAA for Fiscal Year 2013, addresses program cancellations 

and will be issued in early 2014. To meet our requirement under Section 812, this report (1) 

describes the results of DOD’s assessment, and (2) presents preliminary observations on 

termination liability estimates.

 1

Pub. L. No. 112-239 (2013). The NDAA does not define “termination liability”, nor did DOD when conducting its

assessment. For consistency with the Contract Funds Status Reports used by DOD, in this report we use the term 

“termination liability” to include costs incurred because of termination, as well as profit or fee owed. We do not include 

cost incurred for the work performed.

2

The Act defines a covered contract as a contract for the development or production of a major defense acquisition 

program for which potential termination liability could reasonably be expected to exceed $100,000,000.
Page 2 GAO-14-107R DOD Contract Termination

We conducted this performance audit from July 2013 to November 2013 in accordance with 

generally accepted government auditing standards. Those standards require that we plan and 

perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our 

findings and conclusions based on our audit objectives. We believe that the evidence obtained 

provides a reasonable basis for our findings and conclusions based on our audit objectives. 

Results in Brief

According to DOD, weapons programs generally receive estimates of termination liability from 

contractors, though there is no comprehensive guidance on how or when programs should 

require or consider termination liability estimates. DOD plans to include additional language to 

help ensure that program managers are aware of the need to consider termination liability 

before contract award and during the life of a contract in its next update of its acquisition 

management guidance.

3

Background

However, our preliminary observations show that while programs are 

receiving estimates of termination liability from the contractors, in some cases, DOD’s ability to 

predict actual termination costs with these estimates appears limited. We will continue to 

monitor this issue and will report our final results in early 2014.

DOD may enter into one or more contracts with a prime contractor for the development, 

production, or maintenance phases of a major defense acquisition program. In some cases, 

during the period of performance of a contract, changed circumstances can require termination 

of the contract before it is completed. The Federal Acquisition Regulation (FAR) grants the 

government the right to fully terminate or partially terminate a contract for the government’s 

convenience at any time during the performance of a contract and provides various termination 

for convenience clauses depending on the type and dollar amount of the contract.4 Terminating 

a contract for the convenience of the government is allowed because in some cases, 

termination of a contract is in the government’s best interest. Even if the contractor is performing 

acceptably, the government can end its contractual obligation if it no longer needs the weapons 

or supplies provided under the contract because of a reduction in military force or the end of a 

war. However, the government is generally obligated, within certain limitations, to compensate 

the contractor for certain costs. Examples include the costs of disposing of inventory and 

negotiating with subcontractors. The FAR specifies these limitations and the categories of costs 

to which a contractor may be entitled when the government terminates a contract for 

convenience.5

 3

Department of Defense Instruction 5000.02, Operation of the Defense Acquisition System (Dec. 8, 2008). 

To assist the government in budgeting for the potential incurrence of termination 

liability costs and in determining if the rate of funding for a contract is sufficient, DOD cost-type 

contracts may contain a requirement for the contractor to provide funding data, including 

potential termination liability estimates, by submitting Contract Funds Status Reports (CFSR) 

4

See, e.g., FAR §§ 52.249-2 and 52.249-6. 

5

Under a fixed-price contract, the contractor is entitled to compensation for the work done, the preparations made for 

the terminated portions of the contract, profit on work done and preparations made by the contractor for the 

terminated portion of the contract, and the costs of settlement of the work terminated. FAR §§ 49.201(a), 49.202(a), 

52.249-2(f)-(g). Under a fixed-price contract, the government’s liability is limited to the contract price plus the amount 

of settlement expenses. FAR §§ 49.207, 52.249-2(f). Under a cost-reimbursable contract, the contractor is entitled to 

compensation for the costs reimbursable under the contract for performance of the contract before the effective date 

of the termination, the costs of settlement of the work terminated, and a portion of the fee payable under the contract. 

FAR §§ 31.205-42, 49.305-1(a), 52.249-6(h).
Page 3 GAO-14-107R DOD Contract Termination

(DD Form 1586) at the end of each calendar quarter or contractor accounting period nearest the 

end of each quarter during the contract period of performance.6

DOD Found Termination Liability Estimates Are Being Considered but That Additional 

Guidance Is Needed 

 

DOD provided us with its assessment of efforts to prepare estimates of potential termination 

liability for covered contracts. DOD reported program managers are preparing estimates of 

termination liability, though we found it was unclear whether program managers were 

developing their own estimates or using CFSR estimates. DOD determined based on its review 

that potential termination liability is a factor in decision making when terminating covered 

contracts and at certain points during the life cycle of a program. For example, DOD reported 

that all six MDAPs DOD reviewed considered potential termination liability estimates during the 

life of the contract. One of the six program offices reported that the office considered termination 

liability estimates before awarding the contract. According to DOD’s assessment, in several 

instances program contracts required a CFSR from the contractor. Additionally, the DOD 

assessment found that cost estimators within DOD’s Cost Assessment and Program Evaluation 

(CAPE) organization consider termination liability estimates when they conduct independent 

cost estimates.7

DOD found there is no comprehensive guidance on how or when programs should consider 

termination liability. Limited guidance is currently available in the Financial Management 

Regulation, Volume 2 and on the CFSR form.

We were told by a CAPE official that potential termination liability is not the 

major focus of the independent cost estimates. According to DOD officials, CAPE’s review is to 

determine cost risks associated with technology and schedule and their impact on a program’s 

budget, and occurs only at a program’s milestone decision points before a program can proceed 

to the next acquisition phase. CAPE might not review costs in the interim between these 

phases, which can last several years, and would not necessarily be aware of changes in cost

estimates until the next milestone decision point. 

8

 6

The CFSRs supply funding data about defense contracts to program managers for: (a) updating and forecasting 

contract funds requirements, (b) planning and decision making on funding changes in contracts, (c) developing funds 

requirements and budget estimates in support of approved programs, (d) determining funds in excess of contract 

needs and available for deobligation, and (e) obtaining rough estimates of termination costs.

According to DOD officials, when they talked 

with program officials in their sample, none of the program officials expressed the need for 

additional guidance because they felt adequate training on contract termination is offered 

through the Defense Acquisition University. However, DOD officials told us they are drafting 

new guidance for the DOD 5000.02 instruction to help ensure program managers are aware of 

the need to consider termination liability before contract award and during the execution of a 

contract. A DOD official stated that the revised instruction would likely not be adopted before the 

start of 2014. DOD determined that no additional actions are needed to address the mandate.

7

An independent cost estimate is conducted independently of the program office or defense agency. It is a full lifecycle cost estimate including all costs of development, procurement, military construction, and operations and support 

for a system. An independent cost estimate is required to be approved before a major defense acquisition program 

can enter the development phase or production phase of the acquisition lifecycle. 10 U.S.C. § 2434; Department of 

Defense Instruction 5000.02, Operation of the Defense Acquisition System Encl. 4, Table 2-1 (Dec. 8, 2008). 

8

Volume 2 of DOD’s Financial Management Regulation requires that programs with certain types of contracts submit 

termination liability estimates with their budget estimates.
Page 4 GAO-14-107R DOD Contract Termination

DOD’s Ability to Predict Actual Termination Costs with Available Estimates Appears 

Limited 

Through our ongoing work looking at termination liability and program cancellations, we found 

weapons programs generally received estimates of termination costs from contractors in the

CFSR. However, this information did not necessarily enable DOD to predict the actual cost of 

terminating a contract. The cost data included in these reports are developed by contractors and 

are rough estimates of costs that would be necessary to liquidate all government obligations if 

the contract were terminated. These reports are provided to DOD on a quarterly basis. Because 

they are estimates and the various factors affecting termination liability change through the life 

of contract, they can fluctuate over time. Our past work found that DOD officials questioned the 

reliability of these estimates because they were provided by the contractors and were not given 

high priority for verification by the government.9

Agency Comments 

Some program officials we spoke with during 

our ongoing work were uncertain of how contractors arrived at these estimates, and were not 

aware of any additional information provided by contractors to support these estimates. Further, 

during our ongoing work we have learned that contractors may increase these estimates if 

termination of the contract seems probable. However, according to DOD officials, estimates of 

the termination costs can be useful for planning and budgeting decisions surrounding contract 

terminations. We will continue to monitor this issue and report our final results in our 

forthcoming report on program cancellations. In addition, our forthcoming report will include our 

findings from the questions we submitted to selected DOD programs about whether officials 

have been considering contract termination liability estimates before award and during the 

course of a contract.

We requested comments on a draft of this report from the Department of Defense, but none 

were provided. 

-----

We are sending copies of this report to the appropriate congressional committees. We are also 

sending a copy to the Secretary of Defense. This report will also be available at no charge on 

our website at http://www.gao.gov. Should you or your staff have questions, please contact me 

at (202) 512-4841 or chaplainc@gao.gov.

Contact points for our Offices of Congressional Relations and Public Affairs may be found on 

the last page of this report. Key contributors to this report were Katherine Trimble, Assistant 

Director; Ann Marie Udale, Peter Anderson, Maria Durant, Kristine Hassinger, Raffaele Roffo, 

and Matt Shaffer.

Cristina Chaplain 

Director, Acquisition and Sourcing Management 

 

9

GAO, Defense Contracting: Terminating Major Weapons Contracts for the Government’s Convenience, NSIAD-91-

255 (Washington, D.C.: Aug.30, 1991).
Page 5 GAO-14-107R DOD Contract Termination

List of Committees 

The Honorable Carl Levin 

Chairman 

The Honorable James Inhofe 

Ranking Member 

Committee on Armed Services 

United States Senate 

The Honorable Dick Durbin

Chairman 

The Honorable Thad Cochran

Ranking Member 

Subcommittee on Defense 

Committee on Appropriations 

United States Senate 

The Honorable Howard McKeon 

Chairman 

The Honorable Adam Smith 

Ranking Member 

Committee on Armed Services 

House of Representatives 

The Honorable Chairman

The Honorable Pete Visclosky 

Ranking Member 

Subcommittee on Defense 

Committee on Appropriations 

House of Representatives

(121120)
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