Iraq Contract Costs: DOD Consideration of Defense Contract Audit Agency's Findings
Published: 2006-09-25T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The government has hired private contractors to provide billions of dollars worth of goods and services to support U.S. efforts in Iraq. Faced with the uncertainty as to the full extent of rebuilding Iraq, the government authorized contractors to begin work before key terms and conditions were defined. This approach allows the government to initiate needed work quickly, but can result in additional costs and risks being imposed on the government. Helping to oversee their work is the Defense Contract Audit Agency (DCAA), which examined many Iraq contracts and identified costs they consider to be questioned or unsupported. The Conference Report on the National Defense Authorization Act for Fiscal Year 2006 directed GAO to report on audit findings regarding contracts in Iraq and Afghanistan. As agreed with the congressional defense committees, GAO focused on Iraq contract audit findings and determined (1) the costs identified by DCAA as questioned or unsupported; and (2) what actions DOD has taken to address DCAA audit findings, including the extent funds were withheld from contractors. To identify DOD actions in response to the audit findings, GAO selected 18 audit reports representing about 50 percent of DCAA's questioned and unsupported costs on Iraq contracts. GAO requested comments from DOD on a draft of this report, but none were provided.
section_title: What GAO Found
paragraphs: Defense Contract Audit Agency audit reports issued between February 2003 and February 2006 identified $2.1 billion in questioned costs and $1.4 billion in unsupported costs on Iraq contracts. DCAA defines questioned costs as costs that are unacceptable for negotiating reasonable contract prices, and unsupported costs as costs for which the contractor has not provided sufficient documentation. This information is provided to DOD for its negotiations with contractors. Based on information provided by DCAA, DOD contracting officials have taken actions to address $1.4 billion in questioned costs. As a result, DOD contracting officials negotiated contract cost reductions of $386 million according to DCAA. Based on the information provided by DCAA, as of July 2006, the remaining $700 million in questioned costs is still in process. Because unsupported costs indicate a lack of contractor information that is needed to assess costs, DCAA cannot and does not render an opinion on those costs. Therefore, DCAA does not track the resolution of unsupported costs. For the 18 audit reports selected for this review, GAO found that DOD contracting officials took a variety of actions to address DCAA's audit findings, including not allowing some contractor costs. In the contract documentation GAO reviewed, DOD contracting officials generally considered DCAA's questioned and unsupported cost findings when negotiating with the contractor. GAO found DOD contracting officials were more likely to use DCAA's advice when negotiations were timely and occurred before contractors had incurred substantial costs. For example, in three audit reports related to a logistics support task order negotiated prior to the onset of work, DCAA questioned $204 million. According to DCAA's calculations, $120 million of these questioned costs was removed from the contractor's proposal as a result of its audit findings. In contrast, DOD officials were less likely to remove questioned costs from a contract proposal when the contractor had already incurred these costs. For example, in five audit reports comprising about $600 million of questioned costs reviewed, GAO found that the DOD contracting officials determined that the contractor should be paid for all but $38 million of the questioned costs, but reduced the base used to calculate the contractor's fee by $205 million. By reducing the base, the DOD contracting official reduced the contractor's fee by approximately $6 million. In addition to identifying questioned and unsupported costs, DCAA has the option of withholding funds from the contractor and chose to withhold a total of $236 million for eight cases included in this review.

section_title: Letter
paragraphs: The United States is spending billions of dollars to achieve U.S. political,  The United States is spending billions of dollars to achieve U.S. political,  security, and economic goals in Iraq. Between fiscal years 2003 and 2006,  security, and economic goals in Iraq. Between fiscal years 2003 and 2006,  the U.S. government has allocated about $311 billion to support U.S.  the U.S. government has allocated about $311 billion to support U.S.  stabilization and reconstruction efforts in Iraq. The United States has  stabilization and reconstruction efforts in Iraq. The United States has  relied heavily on private-sector contractors to provide the goods and  relied heavily on private-sector contractors to provide the goods and  services needed to support both the military and reconstruction efforts in  services needed to support both the military and reconstruction efforts in  Iraq. Faced with the uncertainty as to the full extent of rebuilding Iraq, the  Iraq. Faced with the uncertainty as to the full extent of rebuilding Iraq, the  government authorized contractors to begin work before key terms and  government authorized contractors to begin work before key terms and  conditions were defined. This approach allows the government to initiate  conditions were defined. This approach allows the government to initiate  needed work quickly, but can result in additional costs and risks being  needed work quickly, but can result in additional costs and risks being  imposed on the government. Given the dollar amounts involved, it is  imposed on the government. Given the dollar amounts involved, it is  essential that these acquisitions be handled in an efficient, effective, and  essential that these acquisitions be handled in an efficient, effective, and  accountable manner to mitigate the government’s risk.  accountable manner to mitigate the government’s risk.
The Defense Contract Audit Agency (DCAA) provides services that can  The Defense Contract Audit Agency (DCAA) provides services that can  help DOD ensure accountability for its acquisitions. DCAA performs audits  help DOD ensure accountability for its acquisitions. DCAA performs audits  and provides financial advisory services in connection with negotiation,  and provides financial advisory services in connection with negotiation,  administration, and settlement of contracts and subcontracts. For  administration, and settlement of contracts and subcontracts. For  example, DCAA has audited many Iraq contract proposals and contracts  example, DCAA has audited many Iraq contract proposals and contracts  and has identified costs it considers to be questioned or unsupported.  and has identified costs it considers to be questioned or unsupported.  DCAA defines questioned costs as those costs considered to be not  DCAA defines questioned costs as those costs considered to be not  acceptable for negotiating a reasonable contract price, and unsupported  acceptable for negotiating a reasonable contract price, and unsupported  costs as costs for which the contractor has not furnished sufficient  costs as costs for which the contractor has not furnished sufficient  documentation to support the cost proposed or claimed.  documentation to support the cost proposed or claimed.
National Defense Authorization Act of 2006, H.R. Conf. Rep. No. 109-360, p. 767(Dec. 18,  2005). findings, including the extent to which funds were withheld from  contractors.
To determine the costs DCAA questioned or identified as unsupported, we  analyzed information provided to us by DCAA on Iraq-related audit reports  issued between February 2003 and February 2006. To identify actions  taken by DOD to address audit findings and funds withheld, we selected   18 audit reports comprised of (1) the 10 reports with the highest dollar  amounts of questioned and unsupported costs, and (2) 8 other audit  reports with questioned and unsupported costs above $5 million. The  questioned and unsupported costs for the 18 selected reports totaled   $1.8 billion, or approximately 50 percent of all questioned and  unsupported costs identified through DCAA’s data on Iraq contracts. The  selected audit reports represent work performed by four contractors.  For  each audit report, we obtained key documentation from DCAA and DOD,  and interviewed DCAA auditors and DOD contracting officials. Appendix I  provides details on our scope and methodology. We conducted our work  from March 2006 through September 2006 in accordance with generally  accepted government auditing standards.
subsections: section_title: Background
paragraphs: The United States, along with its coalition partners and various  international organizations and donors, has embarked on a significant  effort to rebuild Iraq. The United States is spending billions of dollars to  reconstruct Iraq while combating an insurgency that has targeted military  and contractor personnel and the Iraqi people. The United States has  relied heavily on private-sector contractors to provide the goods and  services needed to support both the military and reconstruction efforts in  Iraq.
DCAA is responsible for providing contract audits for DOD, along with  general accounting and financial advice to DOD acquisition officials  negotiating government contracts. DCAA performs many types of audits  for DOD, including audits of contractor proposals, audits of estimating and  accounting systems, and incurred cost audits. Generally, the results of a  DCAA audit are intended to assist contracting officials in negotiating  reasonable contract prices. Normally, DCAA audits contractors’ proposals  and provides contracting officials advice on the reasonableness of  contractor costs prior to negotiations. DCAA also conducts audits of cost- type contracts after they are negotiated to ensure costs incurred on these  contracts are acceptable. Relying on cost information provided by the  contractor and assessing whether the costs comply with government  regulations, DCAA may identify certain costs as questioned or  unsupported. DCAA defines questioned costs as costs considered to be not  acceptable for negotiating a reasonable contract price, and unsupported  costs as costs that lack sufficient supporting documentation. DCAA  reports its findings to contracting officers for consideration in negotiating  reasonable contract prices.
DCAA audit reports represent one way DCAA can assist contracting  officials as they negotiate government contracts. Also, contracting officials  may invite DCAA to participate in contract negotiations to explain audit  findings and recommendations, and may factor DCAA audit findings into  evaluations of contract proposals. The Federal Acquisition Regulation  (FAR) acknowledges that DCAA’s role is advisory, and assigns the  contracting officer responsibility for ensuring that the contractor’s  proposed price is fair and reasonable. While DCAA audit  recommendations are nonbinding, DCAA’s Contract Audit Manual states  that contracting officials deviating from DCAA advice during negotiations  should explain the reasons why they disagreed with DCAA.
DOD Directive 5105.36 also enables DCAA to withhold payments by   (1) suspending payment for specific incurred costs lacking documentation  or (2) disapproving costs that do not conform with applicable regulations.  DCAA can issue a Form 1 to a contractor notifying it that funds will be  withheld, which initiates review of the challenged costs by the contracting  officer.
section_title: DCAA Audit Reports Identified Billions of Dollars of Questioned and Unsupported Costs on Iraq Contracts
paragraphs: Between February 2003 and February 2006, DCAA issued hundreds of  audit reports that collectively identified $3.5 billion in questioned and  unsupported costs on Iraq-related contracts, primarily through audits of  contractor proposals. In some cases, DCAA was asked to audit multiple  iterations of contractor proposals as these proposals were revised over a  period of time. Based on information provided by DCAA, contracting  officials have responded to audit findings that questioned $1.4 billion.   As a result, contracting officials negotiated contract cost reductions of   $386 million according to DCAA. DCAA does not render an opinion about  costs it determines to be unsupported; therefore they do not track the  resolution of unsupported costs.
subsections: section_title: DCAA Identified Billions of Dollars in Questioned and Unsupported Costs
paragraphs: Between February 2003 and February 2006, DCAA tracked 349 audit  reports that identified about $3.5 billion in questioned and unsupported  costs on Iraq contracts. Of this total, DCAA classified $2.1 billion as  questioned, and $1.4 billion as unsupported. DCAA identified these  questioned and unsupported costs in audits related to 99 different  contractors. Most of the questioned and unsupported costs were identified  through audits of contractor proposals. Specifically, in DCAA’s database,  more than three-quarters of the audits with questioned and unsupported  costs were classified as “forward pricing activity,” which primarily  involves auditing contractor proposals or parts of proposals.
In some cases, DCAA reviewed multiple contractor proposals for the same  work. DOD officials told us that contractors submitted multiple proposals  because requirements changed or the proposal was considered inadequate  for negotiations. For example, over a 6-month period, DCAA issued four  audit reports on three different proposals for a task order related to an oil  mission.  Each audit superseded the prior one, and DCAA updates its  information to reflect the most recent report.
section_title: DCAA Tracks How Questioned Costs Are Addressed but Does Not Track Similar Information for Unsupported Costs
paragraphs: While DCAA tracks and records how questioned costs are addressed by  the contracting official in negotiation, it does not track similar information  about unsupported costs. Based on the data provided to us by DCAA, as of  July 3, 2006, contracting officials had responded to 169 of DCAA’s   349 Iraq audit reports. DCAA considered the findings to be addressed  because the contracting official had documented the result of negotiations  with the contractor.
Based on information provided by DCAA, for the $1.4 billion in questioned  costs addressed by contracting officials, contracting officials sustained  $386 million of the total questioned costs. DCAA defines sustained costs as  the costs reduced through negotiations directly attributable to findings  reported by the DCAA auditor for proposal audits. Based on the  information provided by DCAA, as of July 2006, the remaining $700 million  in questioned costs is still in process. DCAA’s information does not reflect  what actions, if any, the contracting officials have taken to respond to  these audit report findings.
According to a DCAA official, DCAA does not track how unsupported  costs are addressed. DCAA guidance implementing the FAR requires the  contracting official to report on the disposition of questioned amounts, but  not specifically on whether contractors provided sufficient documentation  to eliminate unsupported costs. Because unsupported costs indicate a  lack of contractor information that is needed to assess costs, DCAA  cannot and does not render an opinion on those costs. Therefore, DCAA  does not track the resolution of unsupported costs.
section_title: DOD Contracting Officials Have Taken a Range of Actions to Address Audit Findings
paragraphs: For the 18 audit reports selected for this review, we found that DOD took  a variety of actions in response to audit findings, including not allowing  some contractor costs. Based on contract documentation we reviewed, the  DOD contracting officials generally considered DCAA’s questioned and  unsupported cost findings when negotiating with the contractor. We found  that DOD contracting officials were more likely to use DCAA’s advice  when negotiations were timely and occurred before contractors had  incurred substantial costs. In contrast, DOD officials were less likely to  remove questioned costs from a contract proposal when the contractor  had already incurred these costs. In addition to identifying questioned and  unsupported costs, DCAA can also withhold funds from the contractor,  which it chose to do in eight of the cases included in our review. Other  actions taken by the DOD contracting officials included inviting DCAA to  attend meetings or negotiations with the contractor and conducting  additional analyses to respond to audit findings.
subsections: section_title: DOD Generally Considered DCAA Audit Findings When Negotiating with the Contractor
paragraphs: Our review of the government’s documentation of contract negotiations  for the selected audit reports showed that DOD generally considered  DCAA audit findings. The majority, or 13 of the 15 memorandums,  identified how the contracting officials addressed DCAA audit findings.  Most memorandums discussed questioned and unsupported costs  identified by DCAA in areas such as labor, equipment, material, and  subcontracts, but some lacked specific detail on how DCAA audit findings  were addressed. However, in two cases we were unable to determine from  the negotiation documentation how DCAA audit findings were used.
section_title: DOD Contracting Officials Less Likely to Remove Questioned Costs Already Incurred by the Contractor
paragraphs: To address the more than $1 billion in questioned costs related to the  audits selected, we found that the DOD contracting officials were less  likely to remove questioned costs from a contractor proposal when the  contractor had already incurred these costs. For example, in 5 audit  reports comprising about $600 million of questioned costs reviewed, we  found that the DOD contracting officials determined that the contractor  should be paid for nearly all of the questioned costs (all but $38 million),  but reduced the base used to calculate the contractor’s fee (by   $205 million). By reducing the base, the DOD contracting official reduced  the contractor’s fee by approximately $6 million.
Generally, when entering into a contract, the government and contractor  reach agreement on the key aspects of the contract, including the scope  and price of the work, before the work is authorized to start. However, the  FAR enables the government to authorize the contractor to begin work  before doing so in certain cases, such as when the government demands  the work start immediately and it is not possible to negotiate a fully  defined contract in sufficient time to meet the requirement. Our past work  has shown that the use of undefinitized contract actions can pose risks to  the government, such as potentially significant additional costs.  Acquisition regulations generally require that the contracting official  define the scope and costs of such contracts within 180 days of the  contract’s start date. According to contract officials, urgent conditions in  Iraq led the government to initiate such contract actions without first  specifying their scope of work and agreeing to the contract price.
In many cases we reviewed, contractors completed some work and  incurred substantial costs well before the government negotiated the  contract price. Of the 18 audits covered in our review, 11 audit reports  corresponded to contract actions where more than 180 days had elapsed  from the beginning of the period of performance to final negotiations. For  nine of these audits, the period of performance DOD initially authorized  for each contract action concluded before final negotiations took place.
For example, DCAA questioned $84 million in its audit of a task order  proposal for an oil mission. In this case, the contractor did not submit a  proposal until a year after the work was authorized, and DOD and the  contractor did not negotiate the final terms of the task order until more  than a year after the contractor had completed work (see fig. 1). The DOD  contracting officer paid the contractor for all questioned costs but reduced  the base used to calculate contractor profit by $45 million. As a result, the  contractor was paid about $3 million less in fees. In the final negotiation  documentation, the DOD contracting official stated that payment of  incurred costs is required for cost-type contracts, absent unusual  circumstances. This same rationale was used in negotiations on several  other task orders.
In contrast, in the few audit reports we reviewed where the government  negotiated prior to starting work, we found that the portion of questioned  costs removed from the proposal was substantial. For example, in 3 audit  reports related to a logistics support task order, DCAA questioned   $204 million. Since the government and the contractor negotiated the  terms of this task order prior to the onset of work, the contractor had not  incurred any costs at the time of negotiation (see fig. 2 for timeline).  According to DCAA’s calculations, $120 million of these questioned costs  was removed from the contractor’s proposal as a result of its audit  findings.
section_title: DCAA Withheld Funds Related to Some Audit Reports We Reviewed
paragraphs: In addition to identifying questioned and unsupported costs, DCAA can  withhold funds from contractors in certain situations. The cognizant  administrative contracting officer may subsequently determine that the  withheld costs should be approved for payment to the contractor. We  found DCAA withheld $236 million from contractors related to 8 of the  audits included in our review. Subsequently, as a result of either additional  documentation provided by the contractor or the DOD administrative  contracting officer determination, $148 million of the withheld funds was  released to the contractor and the government did not pay $36 million to  the contractor. The remaining $51 million has not been settled yet—a DOD  contracting official is reviewing the available information to make a  decision about whether or not these costs will be reimbursed.
In the audit reports reviewed, the vast majority of funds withheld by DCAA  ($171 million of the $236 million) related to dining facilities services  provided at U.S. troop camps in Iraq. The contractor was directed by the  Army to build, equip, and operate the dining facilities located at U.S. troop  base camps in Iraq and to provide four meals a day to the camp  populations. The population at each camp was specified in the Army’s  description of the work to be performed by the contractor. In addition,  contractor and government representatives counted the number of troops  served at each mealtime. However, the Army’s description of the work did  not specify whether the contractor should bill the government for the  camp population identified in the work description or the actual head  count for each meal. Generally, the government was billed based on the  estimated base camp population, but DCAA stated that the billings should  be based on the actual head count, which was lower than the estimated  base camp population included in the work description. As a result, DCAA  withheld funds by reducing payment for dining facilities costs on  contractor billings by 19.35 percent. Ultimately, the DOD and the  contractor negotiated a settlement where it was agreed that $36 million  would not be paid to the contractor.
In another example, DCAA withheld a payment to the contractor for its  subcontractor’s costs of $12 million related to electrical repair services.  DCAA determined the cost to be unreasonable based on a comparison of  price quotes from other subcontractors for similar electrical repair  services. As a result of the action taken by DCAA to withhold payment, an  Army Corps of Engineers contracting official reviewed contractor data.  The contracting official determined the subcontractor’s price was  reasonable given the short contract time frames. A memo outlining the  Army Corps of Engineers’ rationale for paying the contractor for the  subcontractor costs states, “Corps of Engineers representatives in  Baghdad directed all of the contractors there to do whatever was  necessary, regardless of cost, to meet schedule commitments.” The   $12 million withheld was released to the contractor. DCAA officials  expressed concerns that the DOD contracting official had not sought their  assistance when settling this issue with the contractor.
section_title: DOD Took a Variety of Other Actions to Address DCAA Audit Findings
paragraphs: We found that DOD contracting officials took a variety of other actions to  address DCAA audit findings. In many of the cases we reviewed, DCAA  was invited to participate in meetings or negotiations with the contractor.  For example,    To address the questioned costs identified in the task orders for the oil  mission, the DOD contracting official convened a meeting to include  the contractor representatives, DCAA officials, and Army Corps of  Engineers officials. As a result of discussions in this meeting, a DCAA  official told us that DCAA stopped questioning some costs such as the  percentage paid to contractor employees for working in a dangerous  area and price adjustments the contractor paid to its subcontractors for  fuel from Turkey. In addition, the DOD contracting official asked DCAA  to provide alternative negotiation positions, and in response DCAA  developed memorandums outlining several options for each task order.  Ultimately the DOD contracting official used a negotiation position  presented in each memorandum to establish the government’s  negotiation position with the contractor. When asked if he was  satisfied with the resolution of the questioned costs, a DCAA official  involved in the process told us he thought the DOD contracting official  did the best job he could.
In another example, DCAA attended negotiations between the  contractor and the government for an electricity contract. DCAA’s role  at this meeting was to answer questions and to reiterate its opinion.  Subsequent to negotiations, DCAA participated in additional meetings  with the contractor and the Army Corps of Engineers to ensure that its  concerns with the contractor purchasing system were addressed.  DCAA officials told us that problems with the contractor purchasing  system were related to the unsupported costs identified in the audit.  DCAA officials involved in this process told us that they were generally  satisfied with the actions taken by DOD and the contractor to resolve  their audit findings.
In some cases, DOD officials conducted additional analyses in response to  DCAA’s audit findings. For example, for the audit reports we reviewed  related to the oil mission, DCAA questioned the cost of fuel and  transportation based on a comparison between the price paid by the  contractor and the price paid by the Defense Energy Support Center  (DESC) when it took over the mission from the contractor in April 2004.   In response, DOD collected additional information to update the fuel and  transportation cost comparison. For example, although DESC negotiated  prices based on trucks shipping fuel to Iraq three times per month, in  practice the trucks were only able to make two trips per month, a fact that  increased the cost of the mission to DESC. Overall, the additional analyses  provided a rationale for the DOD contracting official to pay the contractor  for some of DCAA’s questioned costs.
We requested comments from DOD on a draft of this report, but none were  provided.
We are sending copies of this report to the Secretary of Defense,  appropriate congressional committees, and other interested parties. We  will make copies of this report available on request. In addition, this report  will be available at no charge on GAO’s Web site at http://www.gao.gov.
If you have any questions concerning this report, please contact me at  (202) 512-4841 or by e-mail at huttonj@gao.gov. Contact points for our  Office of Congressional Relations and Public Affairs may be found on the  last page of this report. Other major contributors to this report were   Penny Berrier Augustine, Tim Bazzle, Greg Campbell, David E. Cooper,  Tim DiNapoli, Julia Kennon, John Krump, Eric Lesonsky, Janet McKelvey,  Guisseli Reyes-Turnell, Raffaele Roffo, and Jeffrey Rose.
section_title: Appendix I: Scope and Methodology
paragraphs: To determine the costs identified by the Defense Contract Audit Agency  (DCAA) as questioned or unsupported, we analyzed data from DCAA’s  management information system on all DCAA Iraq-related audit reports  with questioned or unsupported costs issued between February 2003 and  February 2006. To develop an understanding and assess the reliability of  the information included in the database, we held discussions with and  obtained documentation from DCAA officials located in Fort Belvoir and  we conducted electronic testing for obvious inconsistencies and  completeness. During our review of the database we identified records for  20 audits, 1 percent of the database, which listed 2 different totals for  questioned and/or unsupported costs. For these 20 audits, based on our  conversation with a DCAA official, we selected the amount that reflected  the most current total for questioned and/or unsupported costs. We  determined the data used in our review to be sufficiently reliable for our  purposes.
To determine the actions taken by the Department of Defense (DOD) in  response to DCAA audit findings, including the extent to which funds were  withheld from contractors, we selected 18 audit reports comprised of   (1) the 10 reports with the highest dollar amounts of questioned and  unsupported costs and (2) a selection of 8 of the remaining audit reports  with questioned and unsupported cost dollars above $5 million. We  excluded audit reports issued after November 1, 2005 from the selection to  ensure that DOD contracting officials had adequate time to resolve the  audit findings. The questioned and unsupported costs for the 18 audits  total approximately $1.8 billion, or about 50 percent of all questioned and  unsupported costs identified through DCAA’s database on Iraq contracts.  These reports include (1) 11 audits of 8 task order proposals to provide  logistics support for U.S. troops, (2) 3 audits of task order proposals to  provide fuel and fuel transportation, (3) 3 audits of task order proposals  for electricity services, and (4) 1 audit of a proposal for contract  management and administrative support functions. The 18 selected audit  reports represent work performed by 4 contractors. For the selected  audits, we held discussions with DCAA officials located in Fort Belvoir;  Arlington, Texas; Lexington, Massachusetts; Seattle, Washington; Kent,  Washington; and Iraq. We collected key documentation related to each  audit report, such as DCAA’s calculation of the resolution of questioned  costs and dollars withheld (Form 1). For each audit, we also held  discussions with DOD contracting officials located in Rock Island, Illinois;  Dallas, Texas; Winchester, Virginia; and Iraq. We interviewed these  officials to determine the actions taken by DOD to address DCAA’s audit  findings and obtained key documentation such as price negotiation  memorandums.
We conducted our review from March 2006 through September 2006 in  accordance with generally accepted government auditing standards.