Contract Management: Extent of Federal Spending under Cost-Reimbursement Contracts Unclear and Key Controls Not Always Used
Published: 2009-09-30T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Federal agencies obligate billions of dollars annually using cost-reimbursement contracts. This type of contract involves high risk for the government because of the potential for cost escalation and because the government pays a contractor's costs of performance regardless of whether the work is completed. As such, cost-reimbursement contracts are suitable only when the cost of the work to be done cannot be estimated with sufficient accuracy to use fixed-price contracts. Agencies may use this contract type only if certain conditions are met. At your request, GAO assessed (1) the extent of agencies' obligations under these contracts, (2) the rationales for using this contract type, (3) determinations that contractors' accounting systems are adequate for determining costs applicable to the contracts, and (4) procedures for monitoring contractor cost controls. GAO analyzed federal procurement data and contract files and interviewed contracting and other government officials.
section_title: What GAO Found
paragraphs: The complete picture of the government's use of cost-reimbursement contracts is unclear. From fiscal years 2003 through 2008 federal obligations under cost-reimbursement contracts were reported to have increased $16 billion, to $136 billion, which represented a decrease in the total percentage of federal obligations over the 6-year period, from 34 percent to 26 percent. However, the overall downward trend is misleading. A significant increase has been reported for obligations using the "combination" contract type, a category that based on GAO's analysis of 2008 data, includes many contracts with cost-reimbursement obligations that are not recorded as such. According to OFPP, a decision was recently made to eliminate the use of "combination" as a Federal Procurement Data System-Next Generation contract type, effective for all new contract awards starting in fiscal year 2010. In addition, GAO found billions of dollars for which the contract type had been coded as "missing" in fiscal year 2008. Agencies' rationales for using cost-reimbursement contracts were difficult to determine because contracting officers frequently did not document--even in acquisition plans--why they chose to use this contract type. The current requirement for such documentation is minimal, but recent legislation (not yet implemented in the Federal Acquisition Regulation) requires that acquisition plans address the rationale. Of the 92 contracts and orders GAO reviewed, about 30 percent did not include any documentation. The supporting documentation GAO did find generally did not explain why a cost-reimbursement contract for the specific requirement was selected. GAO also found little evidence that agency officials are analyzing contracts' pricing history and requirements to determine if they can transition to a contract type with firmer pricing, even though experience may provide a basis for doing so. Of the 92 contracts and orders GAO reviewed, about half had any evidence that, at least within 4 years before contract award, contractors' accounting systems had been deemed adequate to determine costs applicable to the contract. Twenty contract files had no evidence that the contractors' accounting systems were determined adequate and 20 other contract files contained determinations that had been made either many years before award or after the contract was awarded. Inadequate accounting systems, or accounting systems that had not been deemed adequate for many years, may result in the government making improper payments to contractors. GAO found a range of procedures for monitoring contractor cost controls at the agencies in its review. Procedures at the civilian agencies generally call for program officials to review contractor invoices. At the Department of Defense, cost surveillance depends on contractor-reported earned value management data, supplemented with audits for the purpose of testing whether invoiced costs are allowable. GAO's prior work has raised concerns about the effectiveness of these audits.

section_title: Letter
paragraphs: Federal agencies obligate more than $100 billion annually using cost- reimbursement contracts. This type of contract is considered high risk for  the government because of the potential for cost escalation and because  the government pays a contractor’s costs of performance regardless of  whether the work is completed. As such, cost-reimbursement contracts  are suitable only when the cost of the work to be done cannot be  estimated with sufficient accuracy to use any type of fixed-price contract.
To mitigate risk and help ensure that the best interests of the government  are served when entering into a cost-reimbursement contract, agencies  may use this contract type only if the contractor’s accounting system is  adequate for determining costs applicable to the contract. This helps  prevent situations where contractors bill the government for unallowable  costs. Appropriate government surveillance is also required to provide  reasonable assurance that the contractor is using efficient methods and  effective cost controls. At your request, we reviewed the federal  government’s use of cost-reimbursement contracts and  identified agencies’ reported obligations under these contracts,    determined what agencies are buying using cost-reimbursement contracts,    assessed contracting officers’ rationales for using this contract type and  whether analysis is being conducted to determine whether a different  contract type is warranted based on experience with the requirement,    determined whether contractors’ accounting systems had been deemed  adequate for determining costs applicable to the contracts, and  identified agencies’ procedures for surveillance of contractor cost  controls.
To select the agencies included in our review, we analyzed cost- reimbursement contract actions and dollars obligated as reported in the  Federal Procurement Data System-Next Generation (FPDS- NG). Fiscal  year 2007 FPDS-NG data were the latest available at the time we selected  the agencies for review, but we subsequently obtained data on cost- reimbursement obligations for fiscal year 2008 and included those data in  our trend analysis. Based on the fiscal year 2007 data, we grouped  agencies into one of three categories:    agencies whose obligations under cost-reimbursement contracts were less    agencies whose obligations were from 20 to 50 percent, and    agencies whose obligations were 51 percent or higher.
We reviewed contract files for 10 randomly selected contracts or orders  (orders are used to procure goods or services from an established  contract) from each of 10 agencies that fell in the second and third  categories, with two exceptions. We reviewed only one contract at the  Corporation for National and Community Service and at the Department  of the Treasury’s Alcohol and Tobacco Tax and Trade Bureau, as those  contracts accounted for the totality of those agencies’ reported cost- reimbursement contracts in fiscal year 2007. In all, we reviewed 92  contracts or orders issued under cost-reimbursement contracts. We tested  the reliability of the FPDS-NG data by comparing basic reported  information (such as contract number, contract type, and awarding  activity) to information in the contract or order files. Table 1 shows the  agencies where we conducted the file reviews and the percentages of  reported fiscal year 2007 obligations using cost-reimbursement contracts  or orders.
We supplemented our file reviews by interviewing the cognizant  contracting officials and personnel responsible for surveillance of  contractor costs. We identified surveillance procedures at the agencies in  our review but, because of time constraints, did not assess compliance  with those procedures for the 92 contracts and orders. In addition, we  interviewed agency procurement policy representatives and heads of  contracting activities for 10 agencies from the first category cited above,  which had reported a very high use (95 percent or more) of fixed-price  contracts, to determine the reasons for their low use of cost- reimbursement contracts. We reviewed relevant sections of the Federal  Acquisition Regulation (FAR), implementing agency policies and  regulations, our Standards for Internal Control in the Federal   Government, and past GAO reports. In determining whether the  contractors’ accounting systems had been deemed adequate before  contract award, we used a period of 4 years, which is the outermost time  frame in Defense Contract Audit Agency (DCAA) policy, as being “current”  for auditing an accounting system that has a significant impact on  government contract costs. We sought any evidence in the contract file  that the contracting officer had made a determination of the adequacy of a  contractor’s accounting system and, where there was no evidence, we held  discussions with the contracting officer.
We conducted this performance audit from July 2008 to September 2009 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 the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives. Appendix I provides more detail on our  scope and methodology, as well as a listing of the 10 agencies with  reported high use of fixed-price contracts.
subsections: section_title: Background
paragraphs: Federal agencies can choose among three main contract types to procure  goods and services: fixed-price, time-and-materials, and cost- reimbursement. Each contract type comes with a different level of cost or  performance risk for the government, as shown in table 2.
Different types of cost-reimbursement contracts can be used, based on  whether incentives, award fees, or other arrangements can be used to  motivate contractor efforts and discourage contractor inefficiency and  waste. Some of these types, and their limitations, follow.
Cost-sharing contracts: The contractor receives no fee and is reimbursed  only for an agreed-upon portion of its allowable costs. A cost-sharing  contract may be used when the contractor agrees to absorb a portion of  the costs, in the expectation of substantial compensating benefits.    Cost-plus-incentive-fee contracts: An objective relationship can be  established between the fee earned and performance results, such as  actual costs or delivery dates. This contract type provides for an initially  negotiated fee to be adjusted later by a formula based on the relationship  of total allowable costs to total target costs.
Cost-plus-award-fee contracts: Objective incentive targets are not feasible  and judgmental standards, such as quality and technical ingenuity, can be  applied. A potential fee is intended to provide an incentive for excellence  in such areas as quality, timeliness, technical ingenuity, and cost effective  management; award of the fee is a unilateral decision made solely by the  government. We have reported on agencies’ use of cost-plus-award-fee  contracts, finding in some cases that award fees had been paid to  contractors regardless of acquisition outcomes.
Cost-plus-fixed-fee contracts: These contracts provide for payment to the  contractor of a negotiated fee that is fixed at contract inception. The fixed  fee does not vary with actual cost, but may be adjusted as a result of  changes in the work to be performed under the contract. This contract  type permits contracting for efforts that might otherwise present too great  a risk to contractors, but it provides the contractor only a minimum  incentive to control costs. Cost-plus-fixed-fee contracts are suitable, for  example, when contracting for research or preliminary exploration or  study, and the level of effort required is unknown.
Cost-reimbursement contracts are suitable only when uncertainties  involved in contract performance do not permit costs to be estimated with  sufficient accuracy to use a fixed-price contract. The two major reasons  for the inability to accurately estimate costs are (1) the lack of knowledge  of the work needed to meet the requirements of the contract, for example,  under research contracts, which necessarily involve substantial  uncertainties, and (2) the lack of cost experience in performing work, such  as the development of a weapon system because manufacturing  techniques and specifications are not stable enough to warrant contracting  on a fixed-price basis. We have reported that during weapon system  development, the Department of Defense (DOD) often asks prime  contractors to develop cutting-edge systems and awards cost- reimbursement contracts for the work. Because the government often  does not perform the up-front analysis needed to determine whether its  needs can be met by the contract requirements, significant cost increases  can occur under the contracts as the scope of requirements changes or  becomes better understood. As of fiscal year 2007, for example, DOD  anticipated reimbursing the prime contractors on the Joint Strike Fighter  and Future Combat Systems programs nearly $13 billion more than  initially expected.
Cost-reimbursement contracts involve significantly more government  oversight than do fixed-price contracts, which means the government  incurs additional administrative costs on top of what it is paying the  contractor. For example, the government must determine that the  contractor’s accounting system is adequate for determining costs related  to the contract and update this determination periodically. In addition,  contractor costs need to be monitored—known as cost surveillance—to  provide reasonable assurance that efficient methods and effective cost  controls are used.
Congress has taken action to increase oversight of these contracts, for  DOD specifically as well as governmentwide. The John Warner National  Defense Authorization Act for Fiscal Year 2007 called for the Secretary of  Defense to modify DOD’s regulations to require at Milestone B (approval  for major acquisition programs to enter the engineering and manufacturing  development phase) documentation of the basis for the contract type.  Before approving the use of a cost-type contract for development, the  Milestone Decision Authority must execute a written determination that  among other things, the program is so complex and technically challenging  that it would not be practicable to reduce program risk to a level that  would permit the use of a fixed-price type contract. Further, the  conference report accompanying the act stated that DOD should reduce  program risk to the point that the use of a fixed-price contract for a major  acquisition program may be appropriate.
In addition, the Duncan Hunter National Defense Authorization Act for  Fiscal Year 2009 called for revisions to the FAR, to include guidance on   (1) when and under what circumstances cost-reimbursement contracts are  appropriate, (2) the acquisition plan findings necessary to support  decisions to use cost-reimbursement contracts, and (3) the acquisition  workforce resources necessary to award and manage cost-reimbursement  contracts. The FAR revisions were required by July 11, 2009, but as of  September 28, 2009, had not been implemented. This act also states that  within 1 year after these revisions are promulgated, the inspector general  for each executive agency shall review the use of cost-reimbursement  contracts by the agency for compliance with these regulations and must  include the results of the review in the inspector general’s next semiannual  report.
Finally, in a March 2009 memorandum on government contracting issued  to the heads of departments and agencies, President Obama noted that  excessive reliance by the federal government on cost-reimbursement  contracts “creates a risk that taxpayer funds will be spent on contracts  that are wasteful, inefficient, subject to misuse, or otherwise not well  designed to serve the needs of the Federal Government or the interests of  the American taxpayer.” The President directed the Office of Management  and Budget to develop guidance to assist agencies in “reviewing, and  creating a process for ongoing review of, existing contracts in order to  identify contracts that are wasteful, inefficient, or not otherwise likely to  meet the agency’s needs, and to formulate appropriate corrective action in  a timely manner.” In this regard, on July 29, 2009, the Office of  Management and Budget sent a memorandum to the heads of departments  and agencies requiring agencies to reduce high-risk contracting  authorities, such as cost-reimbursement contracts. The memorandum  requires agencies to reduce by 10 percent the share of dollars obligated in  fiscal year 2010 under new contract actions that are awarded with high- risk contracting authorities.
section_title: Full Picture of Agencies’ Use of Cost- Reimbursement Contracts Is Unclear
paragraphs: The complete picture of the government’s use of cost-reimbursement  contracts is unclear. From fiscal years 2003 through 2008, federal  obligations under cost-reimbursement contracts were reported to have  increased by $16 billion, from $120 billion to $136 billion. When viewed as  a percentage of total reported federal obligations, this represented a  decrease over the 6-year period, from 34 percent to 26 percent. However,  this decrease is misleading for several reasons, including a significant  increase in agencies’ reported obligations under the “combination”  contract type, which includes cost-reimbursement obligations, and  contradictory guidance in the FPDS-NG user manual, which could result in  misreporting of contract type. Further, although contract type is a data  element field required in FPDS-NG for all awards, we found billions of  dollars reported as missing a contract type (i.e., no specific contract type  was indicated) or indicating “other” as the contract type. The contract type  field displays the type of contract that applies to the particular  procurement. It is incumbent on the contracting officers and agencies to  ensure the accuracy of all information submitted.
subsections: section_title: Significant Increase in “Combination” Contract Type Belies Reported Use of Cost-Reimbursement Contracts
paragraphs: Combination contracts, one of the contract type fields in FPDS-NG, are  those where two or more contract types are used, such as in different line  items in one contract action. Agencies have recently reported a significant  increase in obligations under this contract type, from less than 1 percent  ($1.3 billion) of total government obligations in fiscal year 2004 to almost 8  percent ($39 billion) in fiscal year 2008. DOD obligations accounted for  $34 billion, or 87 percent, of this amount.
Figure 1 depicts the reported trends in the percentage of total obligations  under cost-reimbursement contracts and under combination contracts.
We analyzed fiscal year 2008 FPDS-NG obligations coded as combination  contracts and found that half of the $39 billion was obligated under  contracts that had at least some cost-type actions, and about a quarter of  this amount ($9 billion) went to contracts that had 50 percent or more  cost-type obligations. These obligations were not recorded as cost- reimbursement in FPDS-NG.
Further illustrating the potential overlap between combination and cost- reimbursement contract types, we found that contracts coded as  combination are used to procure similar items as those coded as cost- reimbursement. Our examination of the 15 categories of items most often  procured under both cost-reimbursement and combination contract types  over the past several years showed substantial overlap. Table 3 depicts the  top 15 categories in both contract types and the 11 categories that are the  same, from fiscal year 2005 to July 13, 2009, the most current data  available at the time of our analysis.
Because many of the combination contracts include cost-type obligations,  those contracts coded as cost-reimbursement do not portray the full  picture of the government’s use of cost-reimbursement contracting. FPDS- NG does not delineate what contract types comprise those coded as  combination, for example, whether they are cost-plus-award-fee and cost- plus-incentive-fee contracts, or a mix of fixed-price and labor-hour line  items.
We also identified conflicting definitions in the FPDS-NG user manual,  which agency officials use as guidance when entering contract information  into the database, that further complicate efforts to identify obligations  under cost-reimbursement contracts. For contracts composed of more  than one contract type, instructions direct agencies to “identify the type  with greater contract value.” For example, if a contract has both cost- reimbursement and fixed-price portions but the fixed-price portion of the  contract makes up 55 percent of the expected contract value, the contract  would be coded as fixed-price. However, the very next page of the user  manual describes combination contracts as awards “where two or more  contract types apply.” It is not clear, then, whether contracts with more  than one contract type should be coded as the contract type representing  the preponderance or as combination contracts.
According to a response to a draft of this report by the Office of Federal  Procurement Policy (OFPP), a change was recently approved to FPDS-NG,  anticipated to be effective for all new contracts awarded in fiscal year  2010, that will eliminate “combination” as a contract type. Contracts  containing more than one contract type will be coded as the contract type  representing the preponderance of obligations. With the elimination of the  combination contract type option, the conflicting user manual definitions  we identified will be removed.
section_title: Missing Contract Types and Obligations Using “Other” Contract Type Contribute to Lack of Clarity about Extent of Cost-Reimbursement Obligations
paragraphs: Although FPDS-NG guidance states that contract type is a required field  for all contracts, we found that billions of dollars in obligations are either  missing a contract type (i.e., no contract type was reported) or the  contract type is indicated as “other.” In fiscal year 2008, over $10 billion in  obligations was reported as missing a contract type and $4.3 billion was  reported as “other.” In addition, some very large contracts that had been  previously labeled as cost-reimbursement were subsequently coded as  missing a contract type in fiscal year 2008. For example, six Navy  contracts with missing contract types had been coded in prior years as  predominately cost-reimbursement; in total these contracts accounted for  over $2 billion. Additionally, FPDS-NG guidance prohibited the use of the  “other” category as a contract type beginning in fiscal year 2009, but we  found contracts in fiscal year 2009, with obligations of $1.3 billion, that  were still using this category. OFPP, in its response to a draft of this  report, explained that contracts previously designated as “other” retain  that designation when modifications to those contracts are subsequently  made. We queried FPDS-NG and verified that the fiscal year 2009  obligations for the “other” contract type were all modifications to  contracts awarded earlier than fiscal year 2009. In its response, OFPP  noted that agencies have the ability to self-correct the contract type  selection on modifications and stated that it would discuss with agencies  the burden associated with making such changes on a voluntary basis  (such as for modifications to contracts that were recently awarded and  may not expire for a number of years).
section_title: Agencies Purchase a Range of Services under Contracts Coded as Cost- Reimbursement
paragraphs: For contracts coded strictly as cost-reimbursement in FPDS-NG, the  largest procurement categories in fiscal year 2008 were defense systems  research and development, professional services, and the operation of  government-owned buildings. The 10 largest procurement categories  reported as using cost-reimbursement contracts in fiscal year 2008 are  listed in table 4.
Contracts included in our sample make clearer the range of services  agencies are procuring under cost-reimbursement contracts. Table 5  provides examples of the goods and services procured with cost- reimbursement contracts at the 10 agencies in our review.
By contrast, the 10 agencies in our review that reported very high use—95  percent or more—of fixed-price contracts procure goods and services for  which the requirements are known and research and development is not  required, and that are available commercially and have substantial pricing  histories on which to base fixed prices. For example, officials from the  Department of Justice’s Bureau of Prisons told us they procure items for  prison operation and maintenance, as well as goods needed to regularly  operate these facilities, such as food and inmate clothing. The Department  of Agriculture’s Agricultural Marketing Service officials said that they  purchase janitorial services, and Defense Commissary Agency officials  said they purchase goods, such as groceries, which are sold in  commissaries throughout the world. Other examples of procurements by  those agencies that had a very high use of fixed-price contracts include  fuel, pharmaceutical products, ammunition, office supplies, clothing, and  information technology (IT) equipment, according to officials.
section_title: Rationale for Using Cost-Reimbursement Contracts Is Often Not Clear, and Analysis Is Not Conducted to Determine if Contract Type with Firmer Pricing Is Warranted
paragraphs: Contracting officials frequently did not document contract files to show  why they awarded cost-reimbursement contracts. The documentation we  did find, for the most part, used boilerplate language; was short, vague,  and repetitive; and did not show why a cost-reimbursement contract was  selected. In three cases, documentation in contract files stated that  funding unavailability was a reason cost-reimbursement contracts, rather  than fixed-price contracts, were awarded. We also found little evidence at  the agencies we reviewed that contracting officers are analyzing contract  pricing history or requirements to determine if experience under the  contract could provide a basis for firmer pricing.
subsections: section_title: Little Documentation Available Showing Why Contracting Officers Use Cost-Reimbursement Contracts
paragraphs: Although a formal determination and findings is no longer required to  justify a cost-reimbursement contract (as is the case for using time-and- materials contracts), contracting officers are generally required to include  in the contract file documentation to show why a particular contract type  was selected. The FAR does not contain details as to what this  documentation is to entail. Along these lines, a regulatory change is in  process to implement a recent congressional direction that acquisition  plans set forth the findings necessary to support a decision to use cost- reimbursement contracts. Standards for Internal Control in the Federal  Government also state that for an agency to manage its operations, it must  have relevant, reliable, and timely information relating to internal events.  From a management standpoint, that information should be recorded and  available to help ensure that this contract type is used only when suitable.  Setting forth a full and specific explanation showing why a cost- reimbursement contract was selected for award could, for example,  provide agency personnel and their managers with helpful information as  they consider awarding future contracts or exercising options on an  existing contract.
Of the 92 contract files we reviewed, we found that 28, or 30 percent,  contained no documentation showing why a cost-reimbursement contract  was selected for award, including in the acquisition plans. Contracting  officers frequently could not provide an explanation for its absence, were  unaware of the need for documentation, or stated that they inherited the  contract from contracting officers who had retired or otherwise left the  agency. In one case, the contracting officer told us that the decision to use  a cost-type contract was not reduced to a specific document in the file but  resulted from discussions. In another case, the contracting officer noted  that it was intuitive that the contract was not appropriate for a fixed-price  arrangement.
For those contracts that did contain documentation, it was often brief,  vague, and repetitive. For example, National Aeronautics and Space  Administration (NASA) contracting officers use a boilerplate template on  which they select the appropriate justification, without setting forth the  facts and explanation of why this contract type was selected. NASA’s  template includes the following choices for why a cost-reimbursement  contract should be awarded:    The level of complexity is moderate to high and performance uncertainties  cannot be sufficiently identified or their cost impacts reasonably  estimated.
Changes during performance are: likely _____, unlikely_____, or have an  average chance of occurring _____.
The Environmental Protection Agency also uses standard language, not  specific to the procurement at hand, to document its rationale for why it  awarded a cost-reimbursement contract. For example, two contract files  contained the statement, “these activities are non-routine, complex in  nature, and specific requirements have not been completely defined.” Two  other contract files had the following language: “due to the uncertainties  involved in the performance of this contract, costs cannot be estimated  with sufficient accuracy to use any type of fixed-price contract.”
Table 6 contains representative examples of rationales we found to be  brief and not clearly tied to the individual procurements.
The Navy Strategic Systems Program, in addition to the standard language  showing why it selected cost-reimbursement contracts, provided us with a  briefing explaining that a primary reason for using cost-reimbursement  contracts is the emphasis this office places on the safety, reliability,  quality, and readiness of the nuclear weapons it procures. Shifting too  much risk to the contractor, the Navy states, would increase the risk that  safety, reliability, quality, and readiness could be compromised because,  when problems are encountered, contractors are motivated not to lose  money and to look for ways to cut costs. Cutting costs can translate to  performance degradations that may not surface until years later. Navy  officials also told us that cost-reimbursement contracts for nuclear  weapons are cost-effective because the high technical risk of what is being  procured would expose contractors to great financial risk with a fixed- price contract, causing contractors to mitigate such risk with proposals  that would be prohibitively expensive.
One contract file in our review did include a more specific rationale for  using a cost-reimbursement contract type. A memorandum in a NASA  contract file justified the use of a cost-reimbursement contract to procure  traveling wave tubes, a component of electronic equipment. The  memorandum stated that “because of the high breakage rate which occurs  during fabrication of Traveling Wave Tubes, a fixed-price contract would  be too costly for the government. Consequently, a cost-type contract is the  chosen method of procurement.”
section_title: Funding Availability Sometimes Drove Decision to Use Cost- Reimbursement Contracts
paragraphs: In some cases, we found that it was not necessarily uncertainty about  requirements that drove the selection of a cost-reimbursement contract,  but rather uncertainties about funding availability. Some contracting  officers told us that cost-reimbursement contracts could be modified more  easily than fixed-price contracts as more funding became available (if, for  example, funding was made available on a periodic basis instead of at the  beginning of the fiscal year), whereas fixed-price contracts were required  to be fully funded up front. For example, a contracting officer at the  National Science Foundation (NSF) noted that as a result of the  ambiguities of the services provided and the funding available each year, a  fixed-price contract was not possible for the procurement. However, the  contracting officer said that even if there were no ambiguities regarding  the services to be awarded, if funding availability was incremental and  uncertain then the contract would be awarded on a cost-reimbursement  basis. At the Internal Revenue Service (IRS), one of the contract files we  reviewed contained documentation stating the following:  “The customer did not have sufficient funding available to structure the  task order and obligate the funding under a firm fixed price (FFP)  structure. As a result, a Cost Plus Fixed Fee … was awarded. The  customer estimated their requirement at $8.1 million; however, they were  only able to provide $2.1M at the time of award. After initial award, four  (4) additional increments of funds were provided to incrementally fund  this requirement in the first year. Given our continuous cycle of  Continuing Resolutions each Fiscal Year, our use of Cost Reimbursement  contract vehicles are the most practical awards.”
In our view, the perceived ease of adding funding under cost- reimbursement contracts as funding is made available is not a correct  assumption. Under a cost-reimbursement contract, an agency is required  to obligate the estimated costs (or ceiling) established in the base year  contract for the required services or products at the time of award. When  modifications are approved increasing the original funding ceiling in the  contract award, the increased costs are charged to the appropriation  current at the time of the modification. It is true that modifications of  fixed-priced contracts can be charged against the funding available at the  time of the original contract award, depending upon the type of contract  modification. However, agencies must obligate the ceiling amount under a  cost-reimbursement contract based upon a reasonable estimate of costs  for providing the service or product. Agencies cannot simply limit the  amount of a recorded obligation by stating that the contract is limited to  an amount of funding available for the contract or stating that the contract  will be incrementally funded if those amounts are different than the  estimated ceiling costs.
At the Air Force Aeronautical Systems Center, we found that the  availability of research and development funds—as opposed to  procurement—was a reason for awarding a cost-reimbursement contract.  The price negotiation memorandum for one contract we reviewed stated  that “The Government directed the contractor to bid the effort as firm  fixed price. (The contractor) submitted a firm fixed price in response ….  The Government later changed direction … in order to use FY07 3600  funds.” There was no additional indication in the contract file as to the  reason the decision was made to switch to a cost-reimbursement contract.  We were unable to discuss the reason for switching with the contracting  officer because the contracting officer had left the agency.
section_title: Agency Officials Are Not Conducting Analysis to Determine Potential to Transition to Contract Types with Firmer Pricing
paragraphs: The FAR does not specifically require a transition plan from a cost- reimbursement contract to one with firmer pricing. However, the FAR  states that in the course of an acquisition program, a series of contracts, or  a single long-term contract, changing circumstances may make a different  contract type appropriate in later periods than that used at the outset. In  particular, contracting officers should avoid the protracted use of a cost- reimbursement contract after experience provides a basis for firmer  pricing, for example, by transitioning part or all of the requirements to a  fixed-price contract. Information important to such an effort would  include a contracting officer’s analysis of the contract’s pricing history and  the results of program offices revisiting the government’s requirements to  determine whether they can be better defined. In this regard, on July 29,  2009, the Office of Management and Budget issued a memorandum  requiring agencies to reduce high-risk contracting instruments, such as  cost-reimbursement contracts. Using fiscal year 2008 as a baseline, the  memorandum states that agencies should aim to reduce by at least 10  percent the combined share of dollars obligated through new contracts in  fiscal year 2010 that (1) are awarded noncompetitively, receive only one  bid in response to a solicitation or a request for quote, or both; (2) are  cost-reimbursement contracts; or (3) are time-and-materials and labor- hour contracts. To meet this goal, the memorandum states that agencies  might plan for the migration of work from cost-type to fixed-price  contracts as requirements become better defined.
We did not assess whether an agency’s decision to use a cost- reimbursement contract was the most appropriate choice of contract type  during our review, but we generally found no evidence that agency  officials assessed, for example, the contract’s pricing history or  requirements under the contracts we reviewed to determine whether there  was a basis for firmer pricing, even when the contracts had been in place  for several years. For example, NSF awarded a $2.8 million cost- reimbursement contract in 2007 to collect and analyze data for a survey of  science and engineering research facilities. NSF has been conducting the  survey since 1986 and noted in its acquisition plan that methodological  studies have been performed during each cycle to improve the design and  processes for subsequent cycles. However, the documentation showing  why the agency selected a cost-reimbursement contract, rather than one  with firmer pricing, was vague, stating that the survey tasks include  “analysis work involving several uncertainties, and sufficient room during  the collection process for variegated opportunities to revise and improve  on survey methods, creating additional areas of uncertainty.” Although  contracting officers are to consider the cost-reimbursement contracts’  pricing history, there was no evidence in the contract file that this  occurred—or that the program office had revisited requirements—to  determine whether there was a basis to convert to a contract type with  firmer pricing. In another example, the Agency for Healthcare Research  and Quality (AHRQ) awarded a contract to collect data for its annual  Medical Expenditure Panel Survey. The contract, awarded in 2002 with  options extending through 2008, was worth over $128 million with the  options included. The same contractor had performed this survey since  1996, but the contract file contained no evidence regarding why a cost- reimbursement contract continued to be used, despite having at least 6  years of data regarding costs and requirements.
We found cases where leadership had encouraged movement away from  cost-reimbursement contracts, largely by focusing on the program offices’  role in establishing firmer requirements. An IRS contracting office, for  example, recently established a contract review board to review the use of  cost-reimbursement contracts supporting a multibillion-dollar IT  modernization program that has been in place for over 20 years. Cost- reimbursement contracts had initially been determined to be in the  government’s best interest because IRS was unable to define its  requirements sufficiently to allow for fixed-price contracts. According to  IRS officials, over time cost-reimbursement contracts and orders  continued to be awarded and issued for this program because it was  easier. In effect, maintaining the status quo became the way contracting  was done. Officials told us that the partnership between the contracting  and program office was weak; one contracting officer told us that a source  selection was conducted, the acquisition plan written, and proposal  evaluation made without any input from the contracting officer. In January  2008, new leadership at this IRS contracting office established a contract  review board to review and approve procurements proposed as cost- reimbursement contracts. The IRS Director, Office of Information  Technology Acquisition, told us that the review board represented a  significant paradigm shift from how business was conducted. In one case,  the board stopped a planned sole-source, cost-reimbursement order from  being awarded in favor of a competitive, firm-fixed-price task order. The  order was awarded for approximately $9.5 million—about half of the  government estimate and $15 million less than what the contractor  requested as a sole-source provider.
We also found two additional cases where agencies had contracted for IT  services on a firm, fixed-price basis. While we recognize that IT services  vary significantly in terms of complexity, in these cases contracting  officials had made a concerted effort to work with the program offices to  define requirements such that vendors could submit offers on a fixed-price  basis. Procurement officials at the District of Columbia’s Pretrial Services  Agency and the Department of Agriculture’s Farm Services Agency—two  agencies with high proportions of fixed-price contracts—noted that IT  services contracts were among their largest obligations under fixed-price  contracts. Both of the agencies were successful at implementing these  contracts as fixed-price contracts because their technical personnel (i.e.,  officials in their program offices) were required to separate and define  their IT contract requirements into specific, measurable deliverables. The  head of contracting activity at the Farm Services Agency told us that it was  “a long road” to get the program office on board with this approach, as the  office had preferred cost-reimbursement contracts for IT services in the  past, but that the effort paid off in terms of savings as well as a greater  likelihood that the government would get the deliverables it expected. This  official emphasized that a key to the agency’s success was including its  technical personnel in the contracting process.
section_title: Agencies Do Not Always Ensure That Contractors’ Accounting Systems Are Adequate for Determining Costs Applicable to Contracts
paragraphs: Cost-reimbursement contracts are to be used only when the contractor’s  accounting system is adequate for determining costs applicable to the  contract. This determination is critical because it helps assure the  government that the contractor has systems in place to accurately and  consistently record accumulated costs and bill for allowable costs. If  accounting systems are not deemed adequate, problems can arise when  costs are accumulated during contract performance. Contracting officers  have a number of methods available to them to make this determination.  One method is to rely upon assessments of accounting systems prepared  by DCAA for prior contracts. The FAR does not specify a time frame  within which an accounting system needs to be determined adequate to be  used as a basis to award a new cost-reimbursement contract. As such, for  the purposes of this review, we used a period of 4 years, which is the  outermost time frame in DCAA policy, as being “current” for auditing an  accounting system that has a significant impact on government contract  costs.
Another method by which contracting officers can determine if an  accounting system is adequate is to perform a pre-award survey of a  prospective contractor’s accounting system. According to the FAR,  determining that an accounting system is adequate as part of a pre-award  survey includes a determination of whether it is in accordance with  generally accepted accounting principles and whether it provides for    a proper segregation of direct costs from indirect costs,    an identification and accumulation of direct costs by contract,    a logical and consistent method for the allocation of indirect cost to  intermediate and final cost objectives,    an accumulation of costs under general ledger control,    a timekeeping system that identifies employees’ labor by intermediate or    a labor distribution system that charges direct and indirect labor to the  appropriate cost objectives, and    an interim (at least monthly) determination of costs charged to a contract  through routine posting of books of account.
The contracting officer is responsible for verifying that the contractor has  an adequate accounting system. For most of the contracts we reviewed,  this verification was based on a DCAA opinion stemming from its review  of the contractor’s accounting system and related internal control policies  and procedures, but the opinion can also be rendered by an independent  accounting firm or other designated entity. According to the DCAA  Contract Audit Manual, each relevant accounting or management system  that has a significant impact on government contract costs should be  audited on a cyclical basis, that is, every 2 to 4 years, depending on a  documented risk assessment of experience and current audit risk.
Regular accounting system reviews are necessary to help ensure that  changes to the contractor’s accounting practices are considered by the  government and evaluated for compliance with government contract cost  principles. Over the period of a contract, the contractor’s cost structure or  accounting procedures can change because of multiple factors, such as  changing the criteria for capitalizing or depreciating assets, applying  different indirect cost allocation bases, or merging of a contractor’s  various operating segments. By continuing to pay a contractor without  taking into account these changes, the government risks paying for  unallowable costs. The contracting officer takes into account DCAA’s  opinion, or that of the designated entity, but retains the ultimate authority  for determining whether the contractor’s accounting system is adequate.
As an example of what can occur when the determination of adequacy is  not made or the contractor’s accounting systems are not deemed  adequate, in August 2007, a contractor disclosed to the Air Force that it  had periodically overbilled on the Joint Strike Fighter Systems  Development and Demonstration cost-reimbursement contract since its  inception. The amount overbilled was about $267 million. In this case,  DCAA had rendered the opinion that the contractor’s accounting system  was “inadequate in part.” The contractor reimbursed the Air Force for the  amount overbilled and paid an additional $28 million in interest.
subsections: section_title: Timely Accounting System Approval in 52 Cases Reviewed; 13 Others Approved After Award
paragraphs: Of the 92 contract files we reviewed, only 52 (about 57 percent) had any  evidence that contractors’ accounting systems had been deemed adequate  in a current time frame (within 4 years or less) before contract award.  Other accounting systems had been deemed adequate either after award or  not at all. Where the contract files contained no evidence of an adequacy  determination, we interviewed the cognizant contracting officers to  confirm the lack of evidence. Table 7 depicts the results of our analysis of  contract files and discussions with contracting officers.
Thirteen contract files in our sample indicated that contractor accounting  systems were determined adequate after contract award; the contracts  were awarded before any determination that the accounting systems were  adequate for determining cost. For example, the Department of Energy  (DOE) awarded a contract in October 1996, but the accounting system was  not determined to be adequate until July 1998, more than 2 years after the  contract was awarded.
section_title: Approval for Seven Accounting Systems Occurred More Than 4 Years Prior to Award
paragraphs: Seven of the contract files we reviewed revealed that accounting systems  were not determined adequate before award within current time frames.  For example, NASA awarded a contract with an estimated value of more  than $205 million (with options) in April 2005. However, the contractor’s  accounting system was last determined to be adequate on a prior contract  in August 1998, more than 7 years before the award of the current  contract. In another example, at the Defense Microelectronics Activity,  DCAA found a contractor’s accounting system to be inadequate in part.  The contractor took corrective action, resolving some of the deficiencies  to DCAA’s satisfaction; the Defense Contract Management Agency  (DCMA) found that the remaining deficiencies were not material to  government contracts and concluded that the contractor’s accounting  system was adequate. A previous determination, based on a DCAA  opinion, that the contractor’s accounting system was adequate, was made  by DCMA in 2001—5 to 6 years before the orders we reviewed were  issued.
section_title: No Evidence of Accounting System Adequacy for 20 Contracts
paragraphs: We found no evidence, either pre- or post-award, of determinations that  the contractors’ accounting systems were deemed adequate for 20 of the  contracts we reviewed (with a total value of more than $1.4 billion, not  including option periods). This means that contracting officers obligated  funds without knowing whether the contractors had accounting systems  capable of billing the government properly. These 20 contracts were from  the following agencies:    NSF - 4 contracts    NASA - 2 contracts    Air Force Aeronautical Systems Center - 3 contracts    Corporation for National and Community Service - 1 contract    AHRQ - 10 contracts  Contracting officials confirmed the lack of evidence in the contract files.  However, most could not provide an explanation for why this was the  case, or were not aware of their responsibility for ensuring that contractor  accounting systems are determined adequate for cost-reimbursement  contracts. Some said that they inherited the contracts from contracting  officers who retired or otherwise left the agency. Further, a DCMA official  incorrectly told us that the contractor’s accounting system is presumed to  be adequate unless it is otherwise documented that the accounting system  is not adequate.
Four of these contract files contained opinions by DCAA that the  accounting systems were inadequate in part. According to DCAA internal  control criteria, an inadequate in part opinion meant that one or more  significant deficiencies existed that affected parts of the accounting  system. Such an opinion required the contractor to take corrective action  and could require DCAA to review contractor invoices. For example, one  of the Air Force Aeronautical Systems Center contracts we reviewed  showed that DCAA found the contractor’s accounting system to be  inadequate in part. According to the administrative contracting officer, the  inadequate in part opinion was significant enough to preclude the  contractor from direct billing the Defense Finance and Accounting System  for payment and required the contractor to submit invoices to DCAA for  review and approval before payment could be made to the contractor. On  December 19, 2008, DCAA issued audit guidance stating that it will no  longer report inadequate in part opinions. Audit reports that report any  significant deficiencies or material weaknesses will include an opinion  that the system is inadequate.
At AHRQ, none of the contract files we reviewed contained documentation  stating that the contractors’ accounting systems had been deemed  adequate for determining costs applicable to the contracts at any time.  Three of these contract files contained memos from the former AHRQ  senior staff accountant stating that although his review did not consider  the adequacy of the contractors’ financial capability or their accounting  systems, nothing came to his attention to preclude an award on this basis.  The contracting officers told us that they had relied on the National  Institutes of Health’s (NIH) negotiation of indirect cost rates for these  contracts. But according to the NIH Director of Financial Advisory  Services, this indirect rate negotiation does not satisfy the FAR  requirement that a contractor’s accounting system is deemed adequate for  determining costs applicable to its contracts.
section_title: Various Procedures for Cost Surveillance Require Effective Implementation to Avoid Improper Payments
paragraphs: For the agencies in our review, we found a range of cost surveillance  procedures. Cost surveillance procedures under cost-reimbursement  contracts are intended to help ensure that the contractor is performing  efficiently and effectively and that the government pays only for allowable,  allocable, and reasonable costs applicable to the contract. Lack of  adequate cost surveillance can lead to overpaying the contractor. The  civilian agency procedures call for program officials to review contractors’  invoices. DOD procedures do not include invoice review by program  offices, but rely on monthly reviews of contractors’ costs and a project  management tool called Earned Value Management (EVM), supplemented  by periodic DCAA audits. Whether cost surveillance is done by reviewing  invoices or by the methods used by DOD, the key is effective  implementation to help avoid improper payments or overbilling.
subsections: section_title: Cost Surveillance Procedures at Civilian Agencies
paragraphs: Procedures in the civilian agencies in our review generally call for  contracting officers’ representatives (COR) to examine contractor  invoices. CORs are appointed by the contracting officer to assist in the  technical monitoring or administration of a contract. Invoice reviews help  to ensure that the goods and services for which the government is being  billed were actually received, the amounts billed are allowable, and the  government is not incurring claimed costs that are inadequately  supported. Agency officials outlined the steps in the cost surveillance  process as follows.
The program office directs work to be done, consistent with the contract’s  statement of work.
How the work is done, together with the time and cost required to do the  work, is proposed by the contractor and, upon approval by the program  office, becomes a work request. Work requests describe the work to be  done, the labor categories needed, and the hours required by each labor  category to complete the work.
As invoices are submitted, the CORs are supposed to reconcile the  invoices to the work requests to ensure that the government only pays for  the completed work authorized by the work requests.
Some CORs told us that they also pay attention to the labor categories  charged to ensure that the contractor is billing for the level of expertise  actually used to do the work and the hours worked. Once an invoice is  reconciled, payment is made. Should a contractor experience technical  problems, which may cause cost overruns, the COR must determine if the  technical problems are legitimate before the government will approve  continued work and invoices for payment.
The efficacy of invoice review depends on an agency’s policies and  procedures and the diligence and expertise of the COR in implementing  them. Another factor is the time CORs have available to devote to  oversight duties. We have reported that CORs are often assigned these  oversight functions as an additional duty. In addition, we reported in 2007  that DOE was not adequately reviewing invoices for a multibillion-dollar  cost-reimbursement contract to design and construct the Hanford waste  treatment plant, risking hundreds of millions of dollars in improper  payments. Instead, DOE relied primarily on DCAA’s review and approval  of the contractor’s financial systems and on the contractor’s review and  approval of subcontractor charges. DOE’s heavy reliance on others, with  little oversight of its own, exposed the hundreds of millions of dollars it  spent annually on the project to an unnecessarily high risk of improper  payments. In September 2008, DOE amended its acquisition guide to hold  contracting officers responsible for ensuring that contract invoices are  properly reviewed and analyzed before any payment is made to  contractors.
section_title: DOD Reliance on Contractor-Provided Program Management Data May Be Inadequate if Required Audits Are Not Conducted to Supplement Cost Surveillance
paragraphs: At DOD, procedures for monitoring contractor costs depend in large part  on the EVM system—a tool that presents contractor-provided data to  measure the value of work accomplished in a given period compared to  the planned value of work scheduled and the actual cost of work  accomplished—supplemented with audits for the purpose of testing  whether invoiced costs are allowable. DOD policy dictates that CORs  shall not be delegated authority to approve invoices (as this is the role of  DCAA and administrative contracting officers), but they may review  contractor billings to determine whether the hours billed and labor mix  are commensurate with the work performed. CORs and program officials  responsible for surveillance for the DOD contracts in our sample told us  that they rely on contractor-provided monthly reports and EVM data to  perform cost surveillance. EVM data do not provide surveillance of  specific contract costs, as would be presented in an invoice, but are  intended to alert program managers to potential problems with cost or  schedule overruns sooner than a review of contract expenditures (such as  an invoice review) alone would. At the same time, however, the EVM  data’s level of detail at the contract and order level can be much less than  that of an invoice—where the specifics in terms of labor categories, travel,  and equipment would be reflected.
Therefore, analysis of EVM data alone does not satisfy FAR requirements  for cost surveillance under cost-reimbursement contracts. In addition to  the key control discussed above—determining that the contractor’s  accounting system is adequate—the EVM data must be supplemented with  audits for the purpose of testing whether invoiced costs are allowable.  DOD has two main sets of procedures in place to do this, one for when the  contractors are approved for direct billing and one for when they are not.  Direct billing allows approved contractors to send their invoices directly  to the Defense Finance and Accounting Service for payment, without  invoice review by either DCAA or the COR. DCAA is required to perform  annual review of paid invoices. In addition, for contractors approved for  direct billing, DCAA performs incurred cost audits and conducts “floor  checks” at contractor facilities to test the reliability of such things as  employee time records and job classifications. To be eligible to participate  in the direct billing program, contractors must meet certain criteria, such  as having an adequate accounting/billing system and related internal  controls, as determined by DCAA. If a contractor is not eligible to  participate in the direct billing program, the contractor must submit all  cost-reimbursement interim invoices to DCAA for approval for provisional  payment. DCAA then submits them to the Defense Finance and  Accounting Service for payment. Figure 2 depicts these various  procedures.
The effectiveness of DOD’s cost surveillance process depends, to a large  extent, on the adequacy of these DCAA procedures. Our recent work has  raised concerns in this regard. For example, rather than documenting the  population of invoices, preparing sampling plans, and testing a random  (statistical) sample, as should be done, auditors generally used a  nonrepresentative selection of invoices in deciding the number of invoices  they would review and the extent of testing they would perform to support  conclusions in their work. For example, we found that for one contractor  that generated $1.1 billion in annual billings to the government, the DCAA  auditor only reviewed 3 invoices totaling $88,000 out of 222 invoices  submitted for payment from March 2003 through February 2004, tested the  first invoice selected, and performed limited testing on the remaining 2  invoices. Despite this limited testing, DCAA prepared a memorandum for  the record, stating that “continued reliance can be placed on the  contractor’s procedures for the preparation of interim vouchers  (invoices)” and “the contractor has met the criteria for continued  participation in the direct billing program.” Also, we recently testified that  allegations that certain audits at three locations did not meet professional  standards were substantiated. Specifically, contractor officials and the  DOD contracting community improperly influenced the audit scope,  conclusions, and opinions in three cases, a serious independence issue. At  two DCAA locations, we found evidence that (1) working papers did not  support reported opinions, (2) DCAA supervisors dropped findings and  changed audit opinions without adequate evidence for their changes, and  (3) sufficient audit work was not performed to support audit opinions and  conclusions.
In our review, we found an additional example of what can happen when  adequate cost surveillance is not in place. NSF awarded a $1.1 billion, 10- year 5-month cost-reimbursement contract (with options) for logistic and  operational support for the U.S. Antarctic Program. As discussed in a  series of NSF Office of Inspector General audit reports, DCAA found that  the contractor was billing indirect costs as direct costs, billing over the  negotiated ceiling limitations, and not providing supporting  documentation for other costs. To compound these issues, NSF had not  determined that the contractor’s accounting system was adequate for  determining costs applicable to its contract. In November 2007, an  independent auditor reported that NSF had significant weaknesses in its  contract monitoring policies and procedures, meaning that the agency did  not know whether the costs it was paying the contractor were allowable  and reasonable. NSF officials acknowledged the weaknesses and have  begun to take corrective action.
As a final example of inadequate cost surveillance, in January 2009, the  DOE Inspector General reported weaknesses in a contractor’s internal  audit, which DOE relies on to help ensure that contractors’ costs charged  to DOE are allowable under the terms of the contract. For fiscal year  2007, the contractor had expended and claimed over $1.4 billion. The  Inspector General found that the contractor’s internal audit during fiscal  year 2007 was not satisfactory in several material respects. Specifically:    Procurements were not properly approved, but the contractor’s internal  audit management permitted the contractor to provide approvals 3 years  after the fact. Questioned costs associated with the procurements were  omitted from the contractor’s audit report.
The contractor’s internal audit manager encouraged the omission of  information that confirmed improper labor cost allocations.
After the completion of audit testing, the contractor’s internal audit  management directed the modification of the testing attribute related to  independent receipt of procured goods and services, an action that caused  some of the questioned costs to be excluded from reporting.
As a consequence, DOE managers at the Savannah River Site were not  provided with the information necessary to fully comprehend the  materiality of, or to address and resolve, internal control weaknesses. The  contractor did not agree with all of the Inspector General’s findings, but  did acknowledge weaknesses and indicated that it planned to address  them.
section_title: Conclusions
paragraphs: Cost-reimbursement contracts are appropriate when contracting for  requirements that involve substantial uncertainties, but they require  careful management to protect the government’s interests. At a macro  level, careful management is enabled by good information. Current  reporting in FPDS-NG, specifically regarding the combination contract  type and billions of dollars with missing contract types, does not provide  decision makers with adequate visibility into the government’s use of cost- reimbursement contracts. Further, while the FAR cautions against the  protracted use of cost-reimbursement contracts after experience provides  a basis for firmer pricing, it does not set forth procedures or provide  guidance for doing the analysis needed to make this determination. We  found little evidence that agency officials are analyzing whether such a  transition can be made. While recent congressional and executive branch  actions are intended to help ensure that cost-reimbursement contracts are  used only when appropriate, they have yet to take full effect.
section_title: Recommendations for Executive Action
paragraphs: We recommend that agency officials take the following four actions to  address the cost-reimbursement contract issues we found.
To help ensure that analysis is conducted to determine whether to  continue using cost-reimbursement contracts when experience may  provide a basis to transition to firmer pricing, we recommend that the  Administrator of OFPP take steps to amend the FAR. Specifically, we  recommend that the Administrator require procedures for contracting  officers (in conjunction with the requiring activity) to analyze, before the  award of a new contract or at other appropriate times during a contract’s  period of performance, the agency’s requirement and determine if its  experience with a procurement provides a basis for firmer contract  pricing. The results and findings of this analysis should be documented in  the contract file. If the analysis indicates that a basis for firmer pricing  does exist, the procedures should require consideration, modification, and  implementation, if feasible, of an acquisition plan to transition to a  contract type with firmer pricing.
To help clarify reporting requirements in FPDS-NG to provide a clearer  picture of the extent to which various contract types, including cost- reimbursement, are being used, we recommend that the Administrator of  OFPP   implement controls in FPDS-NG to preclude information from  being entered without a contract type being identified, that is,  eliminate the “missing” contract type option and  reconcile the conflicting instructions in the FPDS-NG user manual  for coding combination contracts versus coding based on the  preponderance of contract type.
We also recommend that the Secretary of Health and Human Services  direct the Director of AHRQ to provide guidance to the agency’s  contracting staff to ensure that they are aware of their responsibility to  ensure that contractors’ accounting systems have been deemed adequate  before awarding cost-reimbursement contracts.
section_title: Agency Comments and Our Evaluation
paragraphs: We requested comments on a draft of this report from OFPP, the  Departments of Defense, Energy, Health and Human Services, and  Treasury; NASA; the Environmental Protection Agency; NSF; and the  Corporation for National and Community Service. In comments provided  via e-mail, OFPP agreed with the recommendations directed to it. The  response stated that OFPP would work with the FAR Council to address  the issue of setting forth procedures for determining whether analysis may  indicate a basis for firmer contract pricing based on contract pricing  history and requirements. OFPP also stated that version 1.4 of FPDS-NG  (with a projected launch of February 2010) will make the selection of a  contract type mandatory, so that new contract awards will no longer be  coded as missing a contract type. Finally, OFPP stated that a decision was  recently made, while our report was at OFPP for comment, to make  changes to FPDS-NG to eliminate the “combination” contract type as an  option for new contracts starting in fiscal year 2010. Modifications made to  contracts awarded prior to fiscal year 2010 may still show “combination”  as the contract type, as contract type is inherited from the base contract  award; however, agencies have the ability to self-correct the contract type  selection at any time, and the retroactive contract type selection will flow  from the base contract to all modifications.
A final recommendation to OFPP, which was in our draft report, has been  removed based on new information. This recommendation had to with  obligations coded as “other” contract type in fiscal year 2009.  OFPP stated  that agencies are prevented from selecting “other” as a contract type for  new procurements awarded after September 30, 2008, but that this  contract type may still occur on modifications made after that date.  We  analyzed fiscal year 2009 FPDS-NG information and confirmed that the  obligations coded as “other” were modifications to existing contracts.   OFPP noted that, as with the “missing” contract type, agencies have the  ability to self-correct the “other” contract type on modifications to existing  contracts.  OFPP stated that it will discuss with agencies the burden  associated with making these changes on a voluntary basis, such as when  making modifications to contracts that were recently awarded and may  not expire for a number of years.
In written comments, reprinted in appendix II, NASA stated that the report  provides a balanced view of the issues related to the use of cost- reimbursement contracts. The Department of Health and Human Services  (HHS) also provided written comments, included in appendix III, agreeing  with our recommendation directed to it. HHS stated that, in response to  our findings, the Office of Acquisition Management and Policy issued a  departmentwide notice to remind contracting staff of the need to ensure  the adequacy of contractors’ accounting systems before award of a cost- reimbursement contract. HHS also stated that it would emphasize the  importance of documenting the basis for cost-reimbursement contracts in  acquisition plans and further encourage contracting officers to assess the  viability of transitioning from cost-reimbursement contracts to more  definite contract types. Finally, HHS provided additional information on  AHRQ’s contract for its annual Medical Expenditure Panel Survey.
The Departments of Defense, Energy, and Treasury provided technical  comments which we incorporated as appropriate. The Environmental  Protection Agency, NSF, and the Corporation for National and Community  Service had no comments on the report.
As agreed with your offices, unless you publicly announce its contents  earlier, we plan no further distribution of this report until 30 days from the  report date.  We will then send copies of this report to interested  congressional committees; the Secretaries of Defense, Energy, Health and  Human Services, and the Treasury; the Administrators of the  Environmental Protection Agency, NASA, and OFPP; the Director of NSF;  and the Chief Executive Officer of the Corporation for National and  Community Service. The report also will be available at no charge on  GAO’s Web site at http:///www.gao.gov.
If you or your staff have any questions about this report or need additional  information, please contact me at (202) 512-4841 or needhamjk1@gao.gov.  Contact points for our Offices of Congressional Relations and Public  Affairs may be found on the last page of this report. Staff  acknowledgments are provided in appendix IV.
section_title: Appendix I: Scope and Methodology
paragraphs: To determine the extent to which federal agencies are using cost- reimbursement contracts, we extracted and analyzed, from the Federal  Procurement Data System-Next Generation (FPDS-NG), cost- reimbursement coded contract actions and dollars obligated by agencies  for fiscal years 2003 to 2007. In some cases, agency data are reported to  FPDS-NG at component levels; in other cases, the entire agency reports as  a whole. We also extracted and analyzed from FPDS-NG contract actions  coded as “combination,” “other,” and “missing” for fiscal years 1999  through 2008.
To determine what agencies are buying using cost-reimbursement  contracts, we analyzed FPDS-NG data for fiscal year 2008. We also  analyzed the statements of work for the contracts and orders in our  sample.
To determine agencies’ rationales for using cost-reimbursement contracts,  whether contracting officers had deemed contractor accounting systems  adequate for determining costs applicable to the contracts, and  procedures for surveillance of contractor cost controls, we took the  following steps. Based on FPDS-NG data for fiscal year 2007, we grouped  the agencies and their components into three categories based on their  reported obligations under cost-reimbursement contracts. Category 1  comprises agencies that reported obligating less than 20 percent of their  total obligations in fiscal year 2007 under cost-reimbursement contracts.  Category 2 comprises agencies with reported cost-reimbursement  obligations of 20 to 50 percent. Category 3 comprises agencies with cost- reimbursement obligations of 51 percent and higher. We reviewed the files  of 10 randomly selected contracts or orders, with obligations of at least $1  million, from 5 of the category 2 and 6 of the category 3 agencies, with two  exceptions. We reviewed only one contract at the Corporation for National  and Community Service and at the Department of the Treasury’s Alcohol  and Tobacco Tax and Trade Bureau, as those contracts accounted for the  totality of those agencies’ reported cost-reimbursement contracts in fiscal  year 2007.
In all, we reviewed 92 contracts or orders at the agencies listed below.  Agencies were selected based on location and their reported use of cost- reimbursement procurements.
Corporation for National and Community Service, Washington, D.C. –    Department of the Air Force, Aeronautical System Center, Wright- Patterson Air Force Base, Dayton, Ohio – 33 percent    Department of the Navy, Navy Strategic Systems Program, Arlington,    Department of the Treasury, Internal Revenue Service, National  Procurement Office, Oxon Hill, Maryland – 36 percent    Environmental Protection Agency, Cincinnati Procurement Operations  Division, Cincinnati, Ohio – 45 percent    Department of Defense, Defense Microelectronics Activity, McClellan,    Department of Health and Human Services, Agency for Healthcare  Research and Quality, Rockville, Maryland – 87 percent    Department of Energy, multiple sites in several states – 90 percent    Department of the Treasury, Alcohol and Tobacco Tax and Trade  Bureau, Washington, D.C. – 100 percent    National Aeronautics and Space Administration, Glenn Research  Center, Cleveland, Ohio – 81 percent    National Science Foundation, Arlington, Virginia – 81 percent  Our review of the contract files focused on whether the files contained  documentation providing the rationales for awarding cost-reimbursement  contracts and evidence that the contractors’ accounting systems were  adequate for determining costs applicable to their contracts. We also  reviewed the sections of the Federal Acquisition Regulation (FAR) and  implementing agency policies and regulations that stipulate the  requirements that need to be met before a cost-reimbursement contract is  to be used. We interviewed a recognized expert from academia with  experience with this contract type. To supplement file reviews, we  interviewed agency contracting officers, contract specialists, or both to  determine how they documented their rationales for awarding cost- reimbursement contracts.
As a data reliability check, for the 11 agencies in our review we also  identified cost-reimbursement contracts coded in FPDS-NG as buying  commercial items. We did this because the FAR prohibits the use of cost- reimbursement contracts to acquire commercial items, as commercial  items can be procured with a contract type other than a cost contract on  the open market. FPDS-NG reported that 3 of the agencies had at least one  cost-reimbursement contract coded as buying a commercial item. For  these contracts, we obtained explanations for the coding from agency  officials. In all cases, agency officials explained, to our satisfaction, that  the coding was in error. For example, FPDS-NG showed that 12 cost- reimbursement contracts at the Air Force’s Aeronautical System Center  were used to procure commercial items. Center officials explained that the  coding was incorrect because of a glitch in the implementation of a new  computerized contract writing system, which has subsequently been  corrected. A review of the contracts showed that they should have been  coded as fixed-price or time-and-materials contracts, not cost- reimbursement contracts, as reported to FPDS-NG.
Further, we conducted interviews with agency procurement policy  representatives and heads of contracting activities for 10 agencies with  very high reported use (95 percent or more) of fixed-price contracts to  determine the reasons for their low use of cost-reimbursement contracts.  One of the agencies that we identified as having reported a high use of  fixed-price contracts in fiscal year 2007, the Department of Justice’s U.S.  Marshals Service, was dropped from this part of our review because we  found that many of its contracts had been miscoded. Although the U.S.  Marshals Service had reported 95 percent of its obligations as fixed price,  discussions with contracting officials revealed that many of their  obligations should have been coded as labor-hour contracts and not as  fixed-price contracts. U.S. Marshals Service officials told us that they have  taken steps to correct these coding errors in FPDS-NG.
The remaining nine agencies, together with the percentage of their fiscal  year 2007 obligations using fixed-price contracts, are presented below.
Court Services and Offender Supervision Agency, Pretrial Services  Agency, Washington, D.C. – 99.8 percent    Department of Agriculture, Agricultural Marketing Service, Washington,    Department of Agriculture, Farm Service Agency, Washington, D.C. – 98    Department of Agriculture, Agricultural Research Service, Washington,    Department of Defense, Defense Commissary Agency, Fort Lee, Virginia –  100 percent    Department of Defense, Defense Logistics Agency, Fort Belvoir, Virginia –    Department of the Interior, Office of Surface Mining Reclamation and  Enforcement, Washington, D.C. – 97 percent    Department of Justice, Federal Prison System, Washington, D.C. – 97    General Services Administration, Public Buildings Service, Washington,  Finally, to identify agencies’ procedures for surveillance of contractor  costs, we reviewed contract files and documents maintained by  surveillance officials for each contract and order in our review. We also  reviewed agency cost surveillance procedures, relevant parts of the  Defense Contract Audit Agency’s contract audit manual and our Cost  Estimating and Assessment Guide, which provides information on  practices for ensuring credible cost estimating, including earned value  management. In addition, we interviewed contracting officers and the  personnel responsible for the surveillance.
Where appropriate, we supplemented our analysis with reviews of prior  GAO reports, agency inspector general reports, and recent statutory and  regulatory actions pertaining to cost-reimbursement contracts.
We conducted this performance audit from July 2008 to September 2009 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 the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives.
section_title: Appendix II: Comments from the National Aeronautics and Space Administration
section_title: Appendix III: Comments from the Department of Health & Human Services
section_title: Appendix IV: GAO Contact and Staff Acknowledgments
subsections: section_title: Acknowledgments
paragraphs: In addition to the contact named above, Michele Mackin, Assistant  Director; Julie Hadley; Daniel Hauser; Julia Kennon; LeAnna Parkey;  Kenneth Patton; Matthew Shaffer; and Sylvia Schatz made key  contributions to this report.