National Nuclear Security Administration: Laboratories' Indirect Cost Management Has Improved, but Additional Opportunities Exist
Released: 2013-06-28T00:00:00


Highlights: section_title: Why GAO Did This Study
paragraphs: NNSA, a semiautonomous agency within DOE, oversees the nation’s nuclear security programs. M&O contractors manage NNSA’s facilities, including its national security laboratories––Lawrence Livermore, Los Alamos, and Sandia. Each year, M&O contractors spend billions of dollars to manage and operate these laboratories. Costs include both direct costs—which can be identified with a specific objective or program—and indirect costs, such as management, administrative, and facility costs. Federal Cost Accounting Standards give M&O contractors flexibility in how costs are classified as direct or indirect and allocated to programs.

GAO was asked to review M&O contractor indirect cost management. GAO examined (1) whether laboratory M&O contractors' practices differ for allocating indirect costs and, if so, how; (2) the extent to which NNSA ensures that laboratory M&O contractors’ allocated indirect costs are accurate; and (3) the extent to which NNSA ensures that laboratory M&O contractors’ indirect costs are reasonable. GAO reviewed NNSA and laboratory M&O contractor data and documents and spoke with DOE and NNSA officials and M&O contractors.

section_title: What GAO Found
paragraphs: The National Nuclear Security Administration’s (NNSA) management and operating (M&O) contractors differ in how they classify and allocate indirect costs at NNSA laboratories. Although different approaches are allowed by Cost Accounting Standards, these differences limit the ability to compare program costs across the laboratories. Recognizing the limitations of its current cost data, the Department of Energy (DOE) and NNSA are implementing the Institutional Cost Reporting initiative intended to create a standardized report of certain costs, including many indirect costs. However, DOE is uncertain how it will use the data gathered by this initiative, and these efforts may provide only limited improvements because the data will continue to only be reported at an aggregate level.

NNSA examines M&O contractors’ models for allocating indirect costs for compliance with Cost Accounting Standards’ requirements at least annually, which helps ensure accuracy. NNSA has identified instances when these models did not comply with these requirements, but NNSA has worked with M&O contractors to address these issues. NNSA generally relies on the M&O contractors’ internal audits, however, to assess whether M&O contractors’ day-to-day cost allocation practices conform to disclosed cost allocation models. NNSA reviews some summary data to independently assess day-to-day compliance with Cost Accounting Standards but does not conduct independent audits. DOE’s Office of Inspector General (OIG) has audit authority at NNSA laboratories. OIG officials stated that the frequency and scope for conducting audits to assess contractors’ compliance with Cost Accounting Standards should be based on the level of risk. However, NNSA and OIG officials and M&O contractors hold varying opinions regarding the level of risk that inaccurate indirect cost allocation practices at the laboratories pose. In the absence of formal, periodic risk assessments, NNSA may not have a well-documented basis for its decisions regarding the type, timing, and extent of future monitoring or oversight.

NNSA reviews M&O contractors’ cost data and other information to assess the reasonableness of their costs, including indirect costs. NNSA also uses other means to help ensure the reasonableness of these costs. For example, NNSA’s contracts require M&O contractors to regularly benchmark their costs to other contractors and industry. These requirements, however, do not specify the areas that should be examined, how frequently benchmarking should occur, and what process should be used for implementing any needed corrective actions. As a result, M&O contractor efforts to benchmark costs varied across laboratories.

section_title: What GAO Recommends
paragraphs: GAO recommends DOE clarify the uses of the data gathered through the Institutional Cost Reporting initiative, conduct periodic risk assessments, and incorporate more specific requirements for benchmarking in its laboratory M&O contracts. DOE generally agreed with GAO’s recommendations.

section_title: Letter
paragraphs: The National Nuclear Security Administration (NNSA)—a  semiautonomous agency within the Department of Energy (DOE)— manages the nation’s nuclear security programs. The primary missions  of these programs are to maintain the safety, security, and effectiveness  of the U.S. nuclear weapons stockpile; reduce the global threat posed by  nuclear proliferation and terrorism; and provide nuclear propulsion  systems for the U.S. Navy. NNSA undertakes these responsibilities  through eight sites. Three of these sites—Lawrence Livermore National  Laboratory, Los Alamos National Laboratory, and Sandia National  Laboratories—are national security laboratories. These three laboratories  are critical to carrying out NNSA’s mission to provide management and  security of the nation’s nuclear weapons programs. The laboratories also  support additional missions, including nuclear nonproliferation activities  and work for other federal agencies such as the Departments of Defense  and Homeland Security. In fiscal year 2012, NNSA’s annual appropriation  was $11 billion, $4.64 billion of which funded these three laboratories.

To manage and operate its laboratories, NNSA relies on management  and operating contractors, known as M&O contractors, and reimburses  them for the costs incurred in carrying out NNSA’s missions. These M&O  contractor costs include both direct costs—costs that can be directly  identified with specific cost objectives such as a program or project—and  indirect costs—costs of activities that cannot be specifically identified with  a specific cost objective but which indirectly support a program, such as  management, administrative, and facility costs. M&O contractors are  required to follow federal requirements governing NNSA indirect cost  management. These include Cost Accounting Standards, which contain  requirements for the measurement, assignment, and allocation of costs to  government contracts and provide criteria for the classification and  allocation of indirect costs. These standards also provide contractors with  some flexibility in how they classify and allocate indirect costs. In  addition, the Federal Acquisition Regulation requires that these costs be  reasonable, among other things. In recent years, according to NNSA  officials, indirect costs have accounted for about half of these three  laboratories’ budgets.

We have reported on NNSA’s indirect costs in the past. In 2005, we  reported that indirect costs at NNSA’s laboratories could not be readily  compared because of differences in how indirect costs are identified and  allocated to programs, and because of differences in the facilities’  missions, corporate structures, and accounting systems. In 2010, we  reported that NNSA does not collect reliable and timely information on  indirect costs at the NNSA sites, including the laboratories, which is  crucial for effective management of government operations and for  oversight. In 2012, we identified opportunities for the laboratories to  streamline their support functions, which include many indirect costs.  Further, NNSA’s and the DOE Office of Environmental Management’s  contract and project management for major projects—$750 million or  greater—remain on our list of programs at high risk of fraud, waste,  abuse, and mismanagement or are in most need of transformation. In  addition to our concerns, the Department of Defense (DOD), which  depends on NNSA to assess and maintain the reliability and safety of the  nuclear weapons stockpile and helps fund these efforts, has expressed  concerns about NNSA’s ability to accurately understand and assess its  major program costs. The National Defense Authorization Act for 2013,   tasked the Office of the  as well as the Nuclear Weapons Council,Secretary of Defense’s Cost Assessment and Program Evaluation  (CAPE) to work with NNSA to develop more accurate cost estimates for  its weapons programs.

You asked us to review M&O contractor indirect cost management at  NNSA’s national security laboratories. Our report examines: (1) whether  laboratory M&O contractors' practices differ for allocating indirect costs  and if so, how; (2) the extent to which NNSA ensures that laboratory M&O  contractors’ allocated indirect costs are accurate; and (3) the extent to  which NNSA ensures that laboratory M&O contractors’ indirect costs are  reasonable.

To determine whether laboratory M&O contractors’ practices differ for  allocating indirect costs, and if so, how, we reviewed federal Cost  Accounting Standards, which in part guide M&O contractor allocation  practices, and NNSA and M&O contractor documentation associated with  complying with these standards. We met with officials from NNSA’s Office  of Field Financial Management (OFFM) in Albuquerque, New Mexico. We  also visited Lawrence Livermore, Los Alamos, and Sandia national  laboratories and interviewed NNSA field office officials and M&O  contractors. We reviewed NNSA and contractor documents showing the  actions taken by NNSA and the M&O contractors to manage indirect  costs at the three laboratories, as well as data on these costs. We  reviewed indirect cost data used by M&O contractors to document  compliance with Cost Accounting Standards and manage indirect costs  and met with knowledgeable NNSA officials and M&O contractors to  assess the reliability of these data. We found them to be sufficiently  reliable for the purposes of this report. To gather additional perspectives  on how differences in cost allocation practices affect stakeholders, we  met with officials from DOD’s CAPE to discuss their review of the  laboratories’ costs and possible ways to improve the data collected that is  needed to support cost analysis informed decision making across the  NNSA laboratories and sites.

To examine the extent to which NNSA ensures that laboratory M&O  contractors’ reported indirect costs are accurate, we reviewed reports  prepared by each contractor’s internal audit function. We also interviewed  NNSA officials and M&O contractors to discuss steps taken to ensure  compliance with federal Cost Accounting Standards and interviewed  officials from the DOE Office of Inspector General (OIG) to determine  their role in assessing M&O contractors’ compliance.

To examine the extent to which NNSA ensures that laboratory M&O  contractors’ indirect costs are reasonable, we reviewed pertinent  documents and interviewed NNSA officials and M&O contractors about  steps taken to assess the reasonableness of indirect costs. We also  reviewed the M&O contracts in place in fiscal year 2012 and fiscal year  2012 performance evaluations of the laboratory M&O contractors to  identify the financial incentives, if any, provided to M&O contractors to  manage costs, including indirect costs. We reviewed studies completed  during the period from 2008 to 2012 to assess the reasonableness of  laboratories’ costs. Additional details on our objectives, scope, and  methodology can be found in appendix I.

We conducted this performance audit from April 2012 to June 2013 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: M&O contractors operate and maintain NNSA’s three national security  laboratories, as well as the infrastructure necessary to support the  nuclear weapons stockpile and the capabilities to conduct the scientific,  technical, engineering, and production activities that ensure the continued  safety and reliability of the stockpile. These laboratories perform various  forms of weapons research and development activities as follows:

Los Alamos National Laboratory in Los Alamos, New Mexico,  operated by Los Alamos National Security, LLC,nuclear components and providing unique capabilities such as  neutron scattering and radiography. Los Alamos also manufactures  plutonium components and weapons detonators.   is responsible for

Lawrence Livermore National Laboratory in Livermore, California,  operated by Lawrence Livermore National Security, LLC,responsible for nuclear components and providing unique capabilities  in high-energy density physics; high explosives research,  development, and assessment; and environmental containment of  high-hazard experiments.

Sandia National Laboratories in Albuquerque, New Mexico, and  Livermore, California, operated by Lockheed Martin Corporation, is  primarily responsible for nonnuclear components, including  environmental testing of nuclear weapons systems, nonnuclear  component engineering, and some nonnuclear component production.

NNSA and DOE officials are responsible for a variety of oversight  functions at the laboratories. For example, NNSA oversees and conducts  annual performance reviews of its M&O contractors at each laboratory.  OFFM, which includes the field Chief Financial Officer, is primarily  responsible for ensuring the integrity of the laboratories’ financial  management systems, including the proper allocation of direct and  indirect costs. In addition, NNSA maintains an on-site presence at each of  the laboratories through field offices that assist in the daily management  of the M&O contractor. The DOE OIG, which has audit authority at NNSA  laboratories, assists NNSA in carrying out its oversight responsibilities by  conducting independent audits as necessary.

In general, federal contractors such as NNSA’s M&O contractors are  subject to federal Cost Accounting Standards. These standards provide  direction for the consistent and equitable distribution of contractors’ costs  to help federal agencies more accurately determine the actual costs of its  contracts. Table 1 briefly describes Cost Accounting Standards. Appendix  II describes these standards in more detail.

In addition to Cost Accounting Standards, M&O contractors, DOE, and  NNSA must comply with other federal requirements, including the Federal  Acquisition Regulation and DOE financial management and accounting  orders. In particular, the Federal Acquisition Regulation applies to federal  agencies to help regulate the policies and procedures for acquisitions for  the government. A requirement of this regulation is that a contractor’s  costs must be reasonable.

We previously reported that indirect costs could not be readily compared  across laboratories and discussed steps DOE has taken to try to provide  more comparability of its costs. Specifically, in 2005, we reported that  differences in how indirect costs are identified and allocated to programs  and differences in the facilities’ missions, corporate structures, and  accounting systems affected the comparability of costs across  laboratories. In that report, we noted that while DOE required its M&O  contractors to separately report data on costs to support missions, such  as administrative support, these costs could not be readily compared.  These include costs that are classified as both direct and indirect. Further,  in 2012, in response to limitations in these data, we reported that DOE  was trying to improve its ability to oversee its M&O contractors’ costs  through the implementation of the Institutional Cost Reporting initiative.Specifically, this initiative is a multiyear effort that aims to collect certain  cost data and report them at an aggregate level across broad cost  categories such as maintenance and central administrative support.

section_title: M&O Contractors Differ in How They Allocate Indirect Costs, and Efforts to Standardize Cost Reporting May Provide Limited Improvements
paragraphs: M&O contractors differ in how they classify and allocate indirect costs,  which continues to make it difficult for NNSA, Congress, and others to  compare program costs across laboratories. Recognizing the limitations  of its cost data, DOE and NNSA are implementing the Institutional Cost  Reporting initiative, but this initiative may only provide limited  improvements over existing data.
subsections: section_title: Differences in How M&O Contractors Allocate Indirect Costs Limit the Comparability of Program Costs across Laboratories
paragraphs: M&O contractors’ differ in how they allocate indirect costs to specific  programs, as allowed by Cost Accounting Standards. To allocate costs to  programs, M&O contractors classify costs as either direct or indirect.  Direct costs, such as labor and materials, are assigned to the benefitting  program or programs. Indirect costs—those costs that cannot be  assigned to a particular program such as costs for administration and site  support—are accumulated, or grouped, into indirect costs pools. The  M&O contractor estimates the amount of indirect costs (accumulated into  indirect cost pools) that will need to be distributed to each program and  adjusts the costs to actual costs by the end of the fiscal year. The  contractor then distributes these costs based on a rate in accordance with  the cost allocation model. Typically, labor costs receive a higher  allocation of indirect costs than do costs such as direct material  expenditures. The final program cost is the sum of the total direct costs  plus the indirect costs distributed to the program (see fig. 1).

In implementing this allocation process, however, similar costs can be  allocated differently because M&O contractors’ cost allocation models,  which outline the M&O contractor’s structure for identifying and allocating  indirect costs, differ. Officials in NNSA’s OFFM said that because of the  flexibility the Cost Accounting Standards provide, NNSA does not have  the authority to require M&O contractors to classify and allocate costs in a  uniform manner. Specifically, M&O contractor cost allocation models  differ in how they (1) classify costs as either direct or indirect, (2)  accumulate these costs into indirect cost pools, and (3) distribute indirect  costs to specific programs. For example:

Classification. M&O contractors differ in how they classify costs as  direct or indirect. For example, M&O contractors at Los Alamos told  us they make significant use of service centers—departments which  perform specific technical or administrative services for programs  such as for telecommunications and computing and separately assign  these costs directly to the benefitting laboratory department  overheads or programs. In total, service center costs for fiscal year  2012 totaled around $180 million at Los Alamos. In contrast, M&O  contractors at Lawrence Livermore reported making limited use of  service centers—their costs totaling around $20 million for fiscal year  2012—and instead classified these costs as indirect. Lawrence  Livermore officials said that they conducted a business process  analysis, which found that it was more efficient and cost-effective for  their laboratory to allocate these costs through an indirect-cost pool  than to try to develop and administer service centers that would then  charge each program directly.

Accumulation. M&O contractors differ in how they accumulate indirect  costs into indirect-cost pools. For example, the M&O contractor at  Sandia used both program management and division support indirect- cost pools to accumulate certain indirect support costs that could not  be charged to specific projects. The M&O contractors at Los Alamos  and Lawrence Livermore recovered these costs through different  indirect-cost pools such as program office overhead and site support.  For fiscal year 2011, we found that M&O contractors accumulated  costs into differing numbers of indirect-cost pools, with one site using  as few as 4 pools and another using as many as 11.

Distribution. M&O contractors differ in how they distribute indirect  costs accumulated into indirect-cost pools to programs. For example,  in fiscal year 2013, the M&O contractor at Lawrence Livermore  distributed General and Administrative costs—costs incurred for the  administration of the lab such as executive management and human  resources—to total costs excluding materials and subcontract costs  incurred by programs, while the M&O contractor at Los Alamos  distributed these costs to total program costs including those for labor,  materials, and subcontract costs.

M&O contractors’ cost allocation models have also substantially changed  over time. For example, according to M&O contractor documentation for  Los Alamos, the M&O contractor substantially changed and simplified its  cost allocation model in fiscal year 2013 to improve compliance with Cost  Accounting Standards and increase the transparency of these costs.  M&O contractor documentation outlining the major changes indicated that  these changes increased administrative efficiency at the laboratory. While  the change in the cost allocation model did not change the total amount of  indirect costs allocated at the laboratory, the changes did affect the  amount of indirect costs allocated to certain program costs, such as the  cost of subcontractors employed at the laboratory and construction  projects, which now received a greater distribution of indirect costs. The  M&O contractor at Lawrence Livermore also substantially changed its  cost allocation model in recent years. For example, for fiscal years 2005  to 2013, the M&O contractor decreased the number of different rates  used to allocate indirect costs to its programs from 184 to 12. The M&O  contractor at Sandia has also substantially changed its cost allocation  model since fiscal year 2010. For example, the M&O contractor combined  certain indirect pools and changed the amount of indirect costs allocated  to some program costs, such as those for subcontractor labor.

Because of the differences in how M&O contractors allocate indirect costs  and changes in allocation practices over time, it remains difficult to  compare program costs either across laboratories or at an individual  laboratory over time. In particular, it is unclear whether the allocation  differences or other factors, such as more effective program  management, were the primary cause for the difference in program costs.  Specifically, differences in how costs are classified as either indirect or  direct, accumulated into indirect-cost pools, and distributed to specific  programs can impact the ratio of indirect to total program costs at the  laboratories. This ratio is, in part, used by Congress to compare M&O  contractor performance. However, as we have previously reported, this  ratio alone should not be used as a tool to compare performance as it  does not account for the myriad factors that can affect the ratio of indirect  to total program costs. Specifically, data on these costs do not account  for differences in M&O contractor allocation practices or differences in  laboratories’ mission, size, age, or condition, which affects costs. For  example, the maintenance costs for a 50-year-old manufacturing facility  will likely be higher than those of a modern research facility.

DOE officials noted that Cost Accounting Standards do not require all  contractors to use the same methodology to allocate indirect costs and  that project management and cost estimation can be conducted through a  variety of project management tools. However, GAO has previously noted  shortcomings with data collected, as well as its use by DOE and NNSA to  manage projects and estimate costs. For example, in 2010, we reported  that NNSA cannot accurately identify the total costs to operate and  maintain weapons facilities and infrastructure.  In 2011, we reported that  NNSA needs more comprehensive infrastructure and workforce data to  improve its enterprisewide decision making.  Further, in 2012, we  reported that NNSA lacked the analytical capability needed to review  proposals for program activities and verify cost estimates. Additionally,  according to a senior CAPE official responsible for working with NNSA to  develop more accurate cost estimates for its weapons programs, the cost  data collected by NNSA’s M&O contractors has shortcomings. According  to the official, M&O contractors organize their cost data to meet two  primary goals. First, contractors want to ensure that they are fully  reimbursed for their costs. Second, contractors want to ensure that they  fairly allocate indirect costs to programs and projects. However, the  CAPE official stated that these data are of limited use to support decision  making for programs, projects, and activities including weapons life  extension programs, facility construction projects, and facility operations.  The official stated that, during his team’s review, they found that the M&O  contractors’ cost data for the laboratories was rarely in a form that would  be useful for decision-making analysis. In addition, the official stated that  the quality of data varied widely across M&O contractors and substantial  effort by the CAPE team and the M&O contractor was required to  understand and explain trends in the data. The CAPE official added that  NNSA does not currently have the data needed to accurately identify the  total costs to operate and maintain its weapons facilities and structures.  The official stated that NNSA’s needs are changing rapidly as officials  deal with difficult choices in a budget-constrained environment. He added  that the need for better cost data collection to support decision making is  both immediate and imperative. The official stated that CAPE is actively  working with NNSA to guide and improve its ability to gather, analyze,  and present more useful M&O contractor cost data to decision makers. In  May 2013, NNSA announced the creation of the Office of Program  Review and Analysis, to provide independent analytical advice to help  improve NNSA’s ability to budget, plan, and oversee programs.

section_title: DOE and NNSA Are Taking Additional Steps to Standardize the Reporting of Certain Indirect Costs, but These Efforts May Provide Only Limited Improvements
paragraphs: DOE and NNSA are taking steps to standardize the reporting of certain  costs; however, these efforts may provide only limited improvements  because the data will continue to only be reported at an aggregate level.  As noted previously, in 2010, DOE began implementation of Institutional  Cost Reporting—a DOE-wide initiative to create a standardized report of  certain costs, including many indirect costs—to improve its ability to  oversee its sites’ costs. Specifically, Institutional Cost Reporting is a  system to collect and report costs at an aggregate level across 28 broad  cost categories. DOE officials and documentation noted several  anticipated improvements that are expected from implementing  Institutional Cost Reporting, including improved data reliability as  compared with previous method for collecting and reporting support  costs. In January 2012, we recommended that DOE take steps to ensure  that the data resulting from the Institutional Cost Reporting are complete  and comparable for monitoring sites’ support costs, and DOE concurred  with our recommendation. DOE established joint DOE and contractor  teams to perform peer reviews intended in part to standardize the data  collected through Institutional Cost Reporting. In May 2013, DOE officials  said that they had completed the reviews for several sites, including  Lawrence Livermore, Los Alamos, and Sandia. Officials stated that they  were uncertain when the remaining reviews would be completed.

According to DOE documents, the Institutional Cost Reporting initiative  established general goals to develop more timely, accurate, and  meaningful data on M&O contractor’s costs. However, DOE officials  responsible for helping implement the initiative stated that they are  uncertain how or if the data will actually be used. This is because this  initiative replaced an earlier system used by DOE to collect and report  support costs and, like this earlier system, the Institutional Cost Reporting  data will only provide data at an aggregate level across cost categories,  such as maintenance. In addition, DOE officials told us that since the  Institutional Cost Reporting data appear at an aggregate level, further  analyses will be needed to assess the causes for any differences in  Institutional Cost Reporting cost categories across the laboratories and  other sites. For example, if costs for an activity such as maintenance are  significantly higher at one laboratory than another, further research would  be needed to determine if the difference is due to efficiency or differences  in mission, condition of infrastructure, location, or other reasons. A senior  DOE official said that Institutional Cost Reporting is in its early stages and  that DOE does not currently know how the data will be used. Further,  DOE officials said they were uncertain about the extent to which  Institutional Cost Reporting data can be used to improve the transparency  and management of laboratory costs, especially indirect costs. To better  understand the Institutional Cost Reporting data and help identify  potential management uses, DOE officials said that they had initiated  several analyses to review specific cost items in the Institutional Cost  Reporting data. However, a DOE official helping oversee these efforts  noted that the data gathered through Institutional Cost Reporting may  ultimately not prove to be useful, as it may not provide meaningful data  that can be used to aid management and oversight. Officials with DOD’s  CAPE office have also expressed concerns over the usefulness of these  aggregated data to improve transparency, aid management, and identify  opportunities for cost savings. Moreover, in commenting on a draft of this  report, DOE noted that it has determined that the Institutional Cost  Reporting initiative data are aggregated at such a high level that they  cannot be used to compare detailed contractor costs.

OFFM officials also stated that their use of the Institutional Cost Reporting  data to assess costs and potentially identify cost savings is still largely in  the planning stages. Specifically, OFFM officials stated that, while the  Institutional Cost Reporting data is more useful and comparable than  other data, such as indirect cost rates, additional analyses are still  needed to determine if the cost differences identified in Institutional Cost  Reporting data are due to efficiency differences or other differences  among the laboratories. To date, OFFM officials have taken some steps  to use Institutional Cost Reporting data to compare costs across its  laboratories and help identify cost savings. For example, NNSA officials  said they used Institutional Cost Reporting data to help compare M&O  contractor costs. Following this comparison, OFFM is now planning an  effort to reduce the amount of state taxes paid by its M&O contractors.

section_title: NNSA Takes Some Steps to Assess the Accuracy of M&O Contractors’ Indirect Cost Allocations
paragraphs: NNSA has taken steps to examine the accuracy of M&O contractors’ cost  allocation models, but actions to independently assess day-to-day cost  allocation practices have been more limited. Specifically, NNSA’s OFFM  examines laboratory M&O contractors’ cost allocation models for  compliance with Cost Accounting Standards requirements, which helps  ensure accuracy. NNSA generally relies on M&O contractors’ internal  audits to assess whether day-to-day cost allocation practices conform to  disclosed M&O contractor models. NNSA’s efforts to independently  assess M&O contractors’ day-to-day cost allocation practices to ensure  compliance with Cost Accounting Standards are more limited.
subsections: section_title: NNSA Examines Laboratory M&O Contractors’ Cost Allocation Models for Compliance with Cost Accounting Standards
paragraphs: NNSA’s OFFM examines laboratory M&O contractors’ detailed cost  allocation models for compliance with Cost Accounting Standards each  time a contractor changes its model, which typically occurs upon initiation  of the contract and at least annually thereafter. Specifically, within 60  days before a contractor implements changes in a new cost allocation  model, the contractor must submit the proposed changes—in a document  called a disclosure statement—to OFFM for a compliance review. These  disclosure statements include a summary and justification of proposed  changes, a reference to the Cost Accounting Standards that apply to  each change, and information on the anticipated impact of the proposed  changes on a program area’s costs. OFFM reviews the disclosure  statement to determine whether the proposed change is adequately  described and complies with applicable Cost Accounting Standards. In  doing so, OFFM typically follows a detailed review plan or checklist  adapted as necessary for the review, including conducting on-site visits or  follow-up with the contractor to ensure the disclosed changes to the  model are in compliance with Cost Accounting Standards. Based on this  review, OFFM sends its recommendation for approval of the disclosure  statement to the contracting officer, who then makes the determination to  approve.

OFFM works with laboratory M&O contractors to try to bring cost  allocation models into compliance with Cost Accounting Standards and  has identified instances when a laboratory’s cost allocation model did not  comply with Cost Accounting Standards. Some of these instances  affected the accurate allocation of indirect costs. OFFM officials stated  that instances of noncompliance have been resolved or are in the process  of being resolved. Examples are as follows:     In March 2009, OFFM and NNSA site officials determined that the  M&O contractor’s indirect cost allocation model for Lawrence  Livermore did not fully comply with Cost Accounting Standards.  Specifically, activities such as science and technology strategic  planning and laboratory outreach were included in a strategic mission  support indirect-cost pool. These costs were viewed by Lawrence  Livermore as broadly institutional in the same manner as General and  Administrative costs. According to NNSA officials, the M&O contractor  allowed this practice to occur because it believed that these programs  did not equitably benefit from the activities covered by these indirect  costs. OFFM officials disagreed, and the M&O contractor changed its  cost allocation model in fiscal year 2013 to include these indirect costs  in the General and Administrative indirect-cost pool.

In October 2009, OFFM reviewed M&O contractor indirect cost  allocations at Lawrence Livermore being applied to the National  Ignition Facility—a research facility intended to demonstrate nuclear  fusion reactions using lasers—and determined that the M&O  contractor’s cost allocation model did not comply with certain aspects  of the Cost Accounting Standards. Specifically, the M&O contractor’s  model did not equitably distribute indirect costs during the  construction of the facility, as the Cost Accounting Standards require.  NNSA’s contracting officer concurred but permitted the M&O  contractor to continue using this model through October 2012 to  minimize disruption to the program. As a result, 18 other programs at  the site continued to assume a greater share of these indirect costs,  which totaled about $134 million for fiscal year 2013, according to our  analysis of M&O contractor documents. For example, according to  M&O contractor documents, the Departments of Defense and  Homeland Security, which conduct research at Lawrence Livermore,  paid more each year to cover indirect costs that would have otherwise  been collected from the National Ignition Facility project.

In July 2010 and January 2011, OFFM determined that the M&O  contractor’s indirect cost allocation model for Los Alamos did not fully  comply with Cost Accounting Standards because construction  projects and certain other types of labor were fully or partially exempt  from having to contribute the standard cost allocation amounts for  General and Administrative indirect costs at the laboratory. According  to OFFM officials, other programs at the site needed to contribute  more money to the General and Administrative cost pool to  compensate for this shortfall, resulting in the inequitable sharing of  these indirect costs across all programs. Los Alamos changed its  allocation model in fiscal year 2013 to eliminate these exemptions and  more equitably share these indirect costs across all programs.

section_title: NNSA Generally Relies on M&O Contractors’ Internal Audits to Assess Whether Day-to-day Cost Allocation Practices Conform to Disclosed M&O Contractor Models
paragraphs: Officials with NNSA’s OFFM told us that they generally rely on the M&O  contractors’ internal audit efforts to assess whether M&O contractors’  day-to-day cost allocation practices conform to their disclosed cost  allocation models. OFFM officials told us that they perform some limited  testing to verify that M&O contractors’ practices conform to their cost  allocation models but that they largely rely on the M&O contractors’   M&O contractors’  internal audit groups to perform this verification.internal audits have found that some contractor allocation practices do not  conform to their models. Internal audits at all three of the laboratories  identified some problems—particularly with how labor hours are charged  to projects, but NNSA officials stated that these problems are not  significant in relation to the costs incurred by M&O contractors. According  to OFFM officials, M&O contractors, and documents, the laboratories  have corrected or are in the process of correcting these problems, and  follow-up audits are also being conducted at some sites to verify that  problems are adequately addressed. Following are examples:

Los Alamos. In 2009, Los Alamos’ M&O contractor conducted an  internal audit to determine whether its laboratory’s day-to-day labor  allocation practices conformed to its disclosed cost allocation model.  The audit determined that labor hours reported by M&O contractor  employees did not always reflect the actual work performed, and labor  costs may not have been allocated equitably among all benefitting  programs and therefore was not consistent with their cost allocation  model. For example, one employee interviewed during the  contractor’s internal audit noted an instance where labor hours were  transferred from one program to another to prevent a cost overrun.  The M&O contractor identified and implemented corrective actions to  address the problem, including providing training and guidance to  laboratory employees about proper time and labor reporting practices.  In April 2011, the M&O contractor’s internal audit office conducted a  follow-up audit and found that three of four corrective actions  identified in the prior report were completed but that there was still  need for further improvement regarding the allocation of labor costs.  Specifically, the follow-up report concluded that the allocation of  indirect labor costs posed a high risk and significant concern.  According to the M&O contractor documentation, M&O contractor  managers later determined that the problem was not significant  enough to warrant further corrective action. However, the M&O  contractor’s internal audit management and OFFM officials told us  that they are continuing to work to resolve the issue.

Lawrence Livermore. Lawrence Livermore’s M&O contractor internal  auditors reported similar problems in September 2010, including some  instances where indirect labor hours were inaccurately allocated to  direct projects, inconsistent with its disclosed cost allocation model.  To correct these problems, M&O contractor managers agreed to  update policies, procedures, and guidance on proper cost allocation  practices at the laboratory, and develop training for employees. The  M&O contractor’s internal audit office plan for fiscal year 2013 states  that it expects to review the results of prior internal audits to determine  the need for additional audits in specific areas.

Sandia. Based on the problems found at the other two laboratories, an  NNSA Sandia Field Office official recently asked its M&O contractor’s  internal audit office at Sandia to verify Sandia’s labor hour allocations.  Sandia’s internal audit office reported in October 2012 that M&O  contractor employees were not always accurately allocating their time  in accordance with actual work performed. Corrective actions in  response to this audit are still being implemented. Specifically, the  M&O contractor agreed to improve guidance and training provided to  all employees about proper time charging practices and policies,  and to conduct periodic self-assessments to ensure compliance  with these practices and policies.

section_title: NNSA’s Efforts to Independently Assess M&O Contractors’ Day-to- day Cost Allocation Practices for Compliance With Cost Accounting Standards Are Limited
paragraphs: Although NNSA’s OFFM has responsibility for supporting contracting  officers in the day-to-day oversight of M&O contractors’ management of  indirect costs, its role does not include conducting independent audits to  assess compliance with Cost Accounting Standards, according to OFFM  officials. On a limited basis, however, OFFM reviews some summary  M&O contractor data to determine whether actual cost allocation  practices are consistent with disclosed practices and complies with  applicable federal requirements, and conducts expanded reviews, as  needed. Specifically, M&O contractors must annually submit a formal  statement documenting the total size of their indirect-cost pools and  allocations, as well as the indirect rates used during the previous fiscal  year. In addition to these steps, OFFM can request audit assistance from  the OIG—which has audit authority at NNSA laboratories.

OIG officials stated that the frequency and scope for conducting audits for  contractors’ compliance with Cost Accounting Standards should be based  on the level of risk. However, OFFM and OIG officials and M&O  contractors hold varying opinions regarding the level of risk of inaccurate  indirect cost allocation practices at the laboratories. For example, some  OFFM and OIG officials and M&O contractors told us that they believe the  risk is generally low compared with other federal agencies. Specifically,  because NNSA M&O contractor operations are federally funded, and the  operations are not mixed with private activities, the risk is low that federal  funds are being used to pay an inequitable and higher share of indirect  costs for private, nonfederal activities. In contrast, senior NNSA field  office official told us that he is concerned about the ongoing possibility  that indirect costs could be manipulated—that is, allocated to other  programs—to avoid exceeding program budgets and, therefore, believes  the risk is high. This concern was echoed by an M&O contractor’s internal  audit office, which reported in April 2011 that, based on its audit findings  the allocation of indirect costs posed a high risk. This contractor’s internal  audit office also confirmed that M&O contractor labor hours in at least one  instance were transferred to another program to prevent a cost overrun.  Despite the uncertainty of the risk of noncompliance, NNSA’s Chief  Financial Officer in OFFM does not conduct formal periodic risk  assessments. One of the federal standards for internal control—risk  assessment—states that management should assess the risks faced  entity-wide, and at the activity level, from both external and internal  sources. The standard also states that if risks have been identified,  management should decide what actions should be taken to mitigate  them. The identification and prioritization of these risks can then influence  decisions regarding the type, timing, and extent of future monitoring or  oversight. Risk identification methods may include, among other things,  forecasting and strategic planning, and consideration of findings from  audits and other assessments. Without a formal, periodic risk assessment  regarding the level of risk posed by noncompliance, NNSA may not have  a well-documented basis for its decisions regarding the type, timing, and  extent of future monitoring or oversight.

Recently, the OIG has taken some steps to improve its understanding of  the risks associated with M&O contractors’ noncompliance with Cost  Accounting Standards. First, the OIG contracted a private auditing firm to  perform a limited audit at Lawrence Livermore in 2012 to test compliance  with one Cost Accounting Standard that addresses the allocation of direct  and indirect costs.problems or potential issues or challenges were identified. Second, in  January 2013, OIG officials stated that they were developing additional  guidance to ensure that field staff document their consideration of these  risks in their annual assessments, as necessary.

section_title: NNSA Reviews M&O Contractor Information and Uses Other Means to Help Ensure the Reasonableness of Indirect Costs
paragraphs: NNSA reviews M&O contractor information to assess the reasonableness  of M&O contractor costs, including indirect costs, at the laboratories.  NNSA also uses other means to help ensure the reasonableness of  costs, such as requiring M&O contractors to compare costs with other  laboratories and industry, but these efforts vary across laboratories.
subsections: section_title: NNSA Reviews M&O Contractor Information to Assess Whether Indirect Costs Are Reasonable
paragraphs: NNSA reviews M&O contractor information and cost data to assess the  reasonableness of M&O contractor costs at the laboratories. In order for a  contractor’s costs to be reimbursed, they must be reasonable. The  Federal Acquisition Regulation provides that a cost is reasonable based  on a number of considerations and circumstances, including whether the  type of cost is generally recognized as ordinary and necessary for the  conduct of the contractor’s business or the contract performance.To  demonstrate compliance with the Federal Acquisition Regulation, M&O  contractors submit summary and some detailed information and data on  their costs to NNSA and the OIG for review and approval. For example,  according to DOE guidance, M&O contractors are required to annually  prepare and submit summary information identifying costs incurred during  the year. This information is then reviewed by NNSA’s field office Chief  Financial Officer, contracting officers located at the laboratories, and the  OIG, among others.  Further, NNSA contracting officers told us that they  review the M&O contractors’ own system of internal controls for ensuring  that incurred indirect costs comply with contract provisions, such as by  reviewing the M&O contractors’ internal audits assessing the  reasonableness of their costs. Contracting officers serve a principal role  in ensuring the reasonableness of M&O contractor costs, as required in  the Federal Acquisition Regulation. Decisions to approve M&O contractor  costs are documented in contracting officers’ approval memos, however,  the specific steps taken in these reviews to determine reasonableness  are not documented. In addition to the contracting officers’ review efforts,  OFFM officials stated that they review M&O contractors’ high-level  summary indirect cost information to help ensure the reasonableness of  M&O contractor costs. OFFM officials stated that they act in a supporting  role to the review efforts of the contracting officers in helping to ensure  the reasonableness of M&O contractors’ costs.

section_title: NNSA Uses Other Means to Help Ensure the Reasonableness of Costs, but These Efforts Vary Across Laboratories
paragraphs: NNSA also uses other means to encourage M&O contractors to manage  the laboratories in a cost-efficient and effective manner. In particular,  NNSA includes provisions in its contracts to encourage or require  laboratories to take steps to manage costs. For example, NNSA’s  contracts require M&O contractors to regularly benchmark costs to  standards for high performing external businesses and other contractors.  Laboratory M&O contractors take some steps to benchmark costs and  practices to industry and take corrective actions as needed, but these  efforts have varied from laboratory to laboratory. For example, the M&O  contractor at one laboratory stated that they undertook a benchmarking  study to compare the costs of servicing the laboratory’s fleet of vehicles  in-house as compared with using an outside vendor. The M&O contractor,  concluding that an outside provider would be more cost-effective,  contracted with an outside provider and estimated an annual savings of  approximately $775,000. In addition to M&O contractor-led efforts, NNSA  has also taken steps to benchmark costs at its laboratories and sites.  Specifically, NNSA hired external consulting groups to conduct  benchmarking studies in the areas of finance, information technology, and  human resources management across multiple NNSA sites, which  provided their reports to NNSA in March 2009.areas for improvement and, while M&O contractors noted that they  consider the information from these studies in decision-making  processes, they were unable to provide documentation showing what  steps were taken specifically in response to findings or recommendations  in these studies.

Although contracts for the three laboratories do require that  benchmarking be performed, the contract provisions do not specify the  areas that should be examined, how frequently benchmarking should  occur, and what process should be used for implementing any needed  corrective actions. In contrast, DOE provides more specific requirements  for benchmarking pension and post-retirement benefit costs.  Specifically, DOE guidance requires contractors to benchmark certain  employee benefits every 2 to 3 years and implement corrective action  plans if benchmarking efforts show that the value of certain employee  benefits are 5 percent or higher than industry averages.

In addition to benchmarking, OFFM is involved in other activities to help  identify cost savings, improve efficiency, and help ensure the  reasonableness of costs. We previously reported on efforts taken by DOE  and NNSA to reduce M&O contractors’ costs at its laboratories such as  through streamlining and centralizing certain support functions, such as  for human resources. In addition to those efforts, the OIG also conducts  audits to help reduce costs, including indirect costs. OFFM officials said  that they also participate in NNSA’s Business Management Advisory  Council, which includes NNSA’s Chief Operating Officer, chief operating  officers from each M&O contractor, field office representatives, and the  NNSA Senior Procurement Executive. The Business Management  Advisory Council meets quarterly to discuss proposals and initiatives to  improve efficiency and identify cost savings. For example, we previously  reported that, in 2011, the Business Management Advisory Council  considered consolidating human resource and other services at all of  NNSA’s sites to achieve cost savings.

To further encourage M&O contractors to manage the laboratories in an  effective and efficient manner, NNSA also includes performance-based  fees in its contracts. Specifically, field office contracting officials rate the  M&O contractors’ efforts to identify and implement cost-savings  measures, while also achieving mission goals, through annual  performance evaluation plans. These cost management efforts also  include efforts to identify and implement cost-savings measures.  However, according to NNSA officials, the amount of performance-based  fee tied to cost management efforts is relatively small—$1 million or less  at each laboratory annually—and may not provide a meaningful incentive  to the contractors. In contrast, the overall incentive fees for laboratory  M&O contractor work can be up to $60 million annually. NNSA officials  stated that, because financial incentive amounts are limited, mission work  could be negatively impacted if financial incentives were redirected to  improving cost management at the laboratories.

NNSA is exploring ways to improve the use of incentives in its contracts  to encourage M&O contractors to manage the laboratories in an efficient  and effective manner. Specifically, according to NNSA officials, NNSA  added requirements in the proposed combined contract for its Y-12 and  Pantex sites in fiscal year 2013, which would link future contract  extensions to cost-savings goals to improve cost management. For  example, these new provisions would have required the M&O contractors  to achieve at least 80 percent of the proposed cost-savings measures, as  outlined in their contractual language, in order to receive a contract  extension. However, we have questioned these anticipated cost savings  because of the limited details available about the actual work that will be  consolidated, and the adequacy of data used to estimate cost savings.

As of June 2013, the status of NNSA’s combined contract award for the  Y-12 and Pantex sites is uncertain. On April 29, 2013, we sustained  portions of bid protests regarding this combined contract. Specifically, we  concluded that NNSA failed to meaningfully assess the majority of each  offeror’s proposed cost savings, and based its source selection decision  on the unsupported assumption that all cost savings proposed by every  offeror would be achieved. The protest decision recommended that NNSA  reopen the procurement for this contract and request additional  information from the offerors about their proposed cost savings.  Following this decision, in May 2013, NNSA announced that it would  reopen competition for the combined contract. Because the contract has  not yet been implemented, it is too soon to evaluate the effectiveness of  these new contract provisions, but NNSA officials stated they anticipate  incorporating similar provisions into future contracts for the laboratories.

section_title: Conclusions
paragraphs: It is critical that NNSA and its M&O contractors ensure that the billions of  dollars spent each year at the laboratories are used effectively. Because  Cost Accounting Standards allow flexibility in how M&O contractors  classify and allocate direct and indirect costs to programs, however, it can  be difficult to assess cost data and meaningfully compare cost  management performance across laboratories. Recognizing these  challenges, DOE has been developing the Institutional Cost Reporting  initiative to separately collect data on certain costs, including many  indirect costs, in an effort to improve its ability to oversee M&O  contractors’ costs, including, indirect costs, at the NNSA laboratories. The  initiative is still under development, however, and the uses for the data  collected have not been determined. Without a clearer understanding of  how Institutional Cost Reporting data can be used to manage costs and  what data are needed, it is unclear if this initiative will provide meaningful  improvement over existing data.

NNSA has made progress in improving M&O contractors’ cost allocation  models to better comply with Cost Accounting Standards. However, key  officials hold differing views about the level of risk of inaccurate indirect  cost allocation practices at the laboratories. OIG officials stated that the  frequency and scope for conducting audits for contractors’ compliance  with Cost Accounting Standards should be based on the level of risk.  However, OFFM does not conduct periodic, formal risk assessments of  contractor compliance to determine the level of risk. Without such  assessments, NNSA does not have important information needed to  make decisions about the type, timing, and extent of future monitoring or  oversight.

In addition to efforts to assess the accuracy of indirect costs, NNSA and  M&O contractors also use benchmarking as a means to assess the  reasonableness of costs. Although DOE orders and M&O contracts define  specific benchmarking requirements for pension costs, contracts are less  specific in terms of what types of indirect costs should be benchmarked,  how frequently benchmarking should take place, and the process for  ensuring corrective actions are taken, as needed. Without more  consistent and comparable benchmarking, NNSA will likely lack useful  data about costs across the laboratories, as well as in the private sector,  that could inform cost management decisions at the laboratories and  identify areas for cost savings.

section_title: Recommendations for Executive Action
paragraphs: To help improve its ability to oversee M&O contractor costs, including  indirect costs, for its laboratories and make more effective use of DOE  and contractor resources, we recommend the Secretary of Energy take— or, as appropriate, direct the Administrator of NNSA to take—the following  three actions:

Clarify how data collected by the Institutional Cost Reporting initiative  will be used.

Direct OFFM to conduct formal, periodic risk assessments of M&O  contractors’ compliance with Cost Accounting Standards by using (1)  laboratory M&O contractor internal audit results, (2) OIG audit results,  and (3) other relevant information obtained through ongoing  monitoring and oversight to provide a well-documented basis for its  future monitoring and oversight, including determining the appropriate  level of OIG audit assistance needed.

Incorporate more specific benchmarking requirements into future  laboratory contracts—similar to the benchmarking requirements used  by DOE to assess and manage pension and post-retirement benefit  costs—including which costs should be benchmarked, how frequently  benchmarking should occur, and what process should be used to  ensure corrective actions are taken, as needed.

section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to DOE for its review and comment. In  written comments, NNSA’s Associate Administrator for Management and  Budget, responding on behalf of DOE and NNSA, wrote that DOE agreed  with our report’s three recommendations. DOE’s written comments on our  draft report are included in appendix III. DOE also provided technical  comments, which we incorporated into the report as appropriate.

In response to our first recommendation that DOE clarify how data  collected by the Institutional Cost Reporting initiative will be used, DOE  stated in its written comments that it will clarify the uses of the data, and  that its estimated completion for this action is September 30, 2013.  However, DOE stated that it has determined that the data are aggregated  at such a high level that they cannot be used to compare detailed  contractor costs. We remain concerned that, without better cost data,  DOE and NNSA may continue to be limited in their abilities to effectively  oversee M&O contractor costs. DOE agreed with our second  recommendation that it conduct formal, periodic risk assessments of M&O  compliance with Cost Accounting Standards. In its comments, DOE  stated that OFFM will conduct such assessments and that its estimated  completion date for this action is September 30, 2013. The agency also  agreed in principle to our third recommendation that it incorporate more  specific benchmarking requirements into future laboratory contracts,  similar to its benchmarking requirements used to assess and manage  pension and postretirement benefit costs, stating that it would evaluate  options to determine appropriate benchmarking requirements for inclusion  in future M&O contracts. DOE stated that the estimated completion for  this action is December 31, 2013.

DOE also provided a general comment referencing our draft report’s  discussion of the flexibility afforded NNSA’s eight integrated contractors  by Cost Accounting Standards and the cost data collected by NNSA. In  particular, DOE stated that the Cost Accounting Standards intentionally  afford flexibility for all government contractors and that our report leaves  the false impression that NNSA is somehow required to create  consistency, when current practices are intentionally designed for  flexibility. As stated in our report, we agree that Cost Accounting  Standards provide flexibility for contractors and provided additional  clarification in the report. DOE stated that the repeated statements about  "flexibility" and how the current data do not address CAPE-identified  requirements are misleading to the average reader who may not  distinguish between the appropriateness of accounting practices and the  separate issue of collecting data from accounting and other project  management systems. DOE noted that project management and cost  estimation are done through a variety of project management tools and  that, as presented, the report would give the impression that NNSA is  somehow not "accounting" for costs appropriately, and it is factually  incorrect to suggest that accounting practices that adhere to applicable  law are somehow askew. We recognize that there are various methods to  gather data, however, as our previous work and CAPE’s work have  noted, these data have shortcomings for supporting decision making for  programs, projects, and activities. NNSA also stated that it agreed that  efforts to produce information to better support decision making from  existing data could be improved. We continue to believe that improved  data could aid DOE and NNSA in their efforts to oversee and manage  sites’ costs.

We are sending copies of this report to the Secretary of Energy, the  NNSA Administrator, the appropriate congressional committees, and  other interested parties. In addition, the report is available at no charge on  the GAO website at http://www.gao.gov.

If you or your staff members have any questions about this report, please  contact me at (202) 512-3841 or trimbled@gao.gov.  Contact points for  our Offices of Congressional Relations and Public Affairs may be found  on the last page of this report. GAO staff who made major contributions to  this report are listed in appendix IV.

section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: This report examines (1) whether laboratory Management and Operating  (M&O) contractors' practices differ for allocating indirect costs and, if so,  how; (2) the extent to which National Nuclear Security Administration  (NNSA) ensures that laboratory M&O contractors’ allocated indirect costs  are accurate; and (3) the extent to which NNSA ensures that laboratory  M&O contractors’ indirect costs are reasonable.

To determine whether laboratory M&O contractors’ practices differ for  allocating indirect costs, and, if so, how, we reviewed federal Cost  Accounting Standards, which, in part, guide M&O contractor allocation  practices, and NNSA and M&O contractor documentation associated with  complying with these standards. We met with officials from NNSA’s Office  of Field Financial Management (OFFM) in Albuquerque, New Mexico. We  also visited Lawrence Livermore, Los Alamos, and Sandia National  Laboratories and interviewed M&O contractors and NNSA field office  officials. We reviewed NNSA and contractor documents showing the  actions taken by NNSA and the M&O contractors to manage indirect  costs at the three laboratories, as well as data on these costs. We  reviewed indirect cost data used by M&O contractors to document  compliance with Cost Accounting Standards and manage indirect costs  and met with knowledgeable NNSA officials and M&O contractors to  assess the reliability of these data. We found them to be sufficiently  reliable for the purposes of this report. To gather additional perspectives  on how differences in cost allocation practices affect stakeholders, we  met with the Office of the Secretary of Defense’s Cost Assessment and  Program Evaluation (CAPE) office to discuss their review of the  laboratories’ cost accounting systems to improve cost estimation for  weapons stockpile programs. To describe DOE and NNSA’s Institutional  Cost Reporting initiative, we spoke with DOE officials in its headquarters  and Germantown, Maryland, offices for financial management and  accounting and NNSA officials in OFFM. We also reviewed DOE and  NNSA internal guidance, as well as documents describing this initiative.

To examine the extent to which NNSA ensures that laboratory M&O  contractors’ reported indirect costs are accurate, we reviewed relevant  federal requirements, in particular, federal Cost Accounting Standards.  We also interviewed OFFM officials and M&O contractors to discuss  whether and how these standards apply to laboratory M&O contractors  and the steps taken to ensure that M&O contractor cost allocation models  comply with applicable standards. In addition, we obtained specific  information regarding OFFM’s identification of key instances where the  M&O contractors’ cost allocation models did not comply with these  standards, how they did not comply, and the general status of actions to  correct any significant problems. To determine the extent to which NNSA  ensures that laboratory M&O contractor’s day-to-day cost allocation  practices conform to their disclosed cost allocation models, we  interviewed OFFM, M&O contractor internal audit, and DOE Office of  Inspector General (OIG) officials. As appropriate, we reviewed relevant  past audits at each of the laboratories, the associated corrective actions  taken and planned, and general plans for future audits. To understand the  OIG’s historical involvement in conducting independent audits of Cost  Accounting Standards at NNSA laboratories, we reviewed relevant  correspondence between NNSA and the OIG, and met with OIG officials  to clarify their role in conducting past and future audits.

To examine the extent to which NNSA ensures that laboratory M&O  contractors’ indirect costs are reasonable, we reviewed pertinent  documents and interviewed NNSA officials and M&O contractors about  steps taken to assess the reasonableness of indirect costs. We reviewed  requirements relating ensuring the reasonableness of costs, including the  Federal Acquisition Regulation, DOE’s accounting handbook, and DOE  orders. We reviewed the M&O laboratory contracts in place in fiscal year  2012 to identify requirements for managing costs, including indirect costs.  We also identified any requirements in the contracts for benchmarking  efforts and financial incentives, if any, to encourage cost management.  We reviewed performance evaluations of the laboratory M&O contractors  to identify any information related to the reasonableness of costs or the  effectiveness of cost-savings initiatives. We also reviewed pertinent  NNSA and contractor documents related to the review and approval of  M&O contractor costs, including reasonableness. We reviewed pertinent  studies performed by NNSA, M&O contractors, or outside consulting firms  that were completed between 2008 and 2013 related to assessing or  addressing the reasonableness of laboratories’ costs. We reviewed  NNSA requirements linking M&O contract extensions to cost-savings  initiatives to help ensure the reasonableness of costs, including the  proposed combined contract for the Y-12 and Pantex sites. We met with  officials from OFFM in Albuquerque and also visited Lawrence Livermore,  Los Alamos, and Sandia National Laboratories to interview M&O  contractors and NNSA field office officials on their efforts to ensure cost  reasonableness at the laboratories, and to discuss any opportunities for  improvement in this area.

We conducted this performance audit from April 2012 to June 2013 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.

section_title: Appendix II: Federal Cost Accounting Standards
paragraphs: Description  The cost accounting practices used in accumulating and reporting  of actual cost must be consistent with the practices used in  estimating costs in pricing proposals. The purpose of the standard  is to enhance the likelihood that comparable transactions are  treated alike and to obtain improved reliability of estimates and  comparisons with performance.

The same type of cost must be consistently classified as direct or  indirect with respect to all work performed. The purpose of this  standard is to require that each type of cost is allocated only once  and on only one basis to any contract or other cost objective in  order to prevent overcharging of some contracts and to eliminate  double counting.

Establishes the criteria for allocation of home office expenses to  segments and minimizes the amount of such expenses classified  as residual.

Facilitates the consistent measurement of costs based on a  capitalization policy that adheres to the criteria of the standard.

The purpose of this standard is to facilitate the negotiation, audit,  and settlement of unallowable costs.

Provides criteria for the periods to be used as cost accounting  periods for contract estimating, accumulating, and reporting of cost.

Provides criteria for using standard costs for estimating,  accumulating, and reporting costs of direct material and direct  labor.   The standard also provides criteria regarding the  establishment of standards, accumulation of standard costs, and  disposition of variances from standard costs.

Provides criterion for assigning these compensated personal costs  to the cost accounting period in which the related entitlement is  earned.

Provides criteria for assigning costs of tangible assets to cost  accounting periods and for consistent allocation of those costs to  cost objectives.

Provides criteria for the allocation of the cost of general and  administrative expenses based on their beneficial or causal  relationships.

This standard requires the contractor to have written statements of  accounting policies and practices for accumulating the costs of  material and for allocating costs of material to cost objectives.

Description  Establishes the components of pension costs and the bases for  measuring such costs. It also provides criteria for determining the  amount of pension costs to be assigned to cost accounting periods.

Provides for adjustment of pension cost for actuarial gains and  losses, their assignment to cost accounting periods, and bases for  allocation of pension costs to business segments.

Provides for the explicit recognition of the cost of money for  facilities capital as an element of contract costs.

Provides criteria for the measurement and assignment of deferred  compensation costs to cost accounting periods.   The cost of  deferred compensation is to be assigned to the cost accounting  period in which the contractor incurs an obligation to compensate  the employee.

Provides criteria for the measurement of insurance costs, the  assignment of such costs to cost accounting periods, and their  allocation to cost objectives.

Establishes criteria for the measurement of the cost of money  attributable to capital assets under construction, fabrication, or  development as an element of the cost of those assets.

Provides for consistent determination of direct and indirect costs,  provides criteria for the accumulation of indirect costs, including  service center and overhead costs in indirect-cost pools, and  provides guidance relating to the selection of allocation measures  based on the beneficial or causal relationship between an indirect- cost pool and cost objectives.

Provides criteria for the accumulation of independent research and  development costs and bid and proposal costs.   It also provides  criteria for the allocation of such costs to cost objectives based on  the beneficial or causal relationship between such costs and cost  objectives.

section_title: Appendix IV: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact

section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Janet Frisch, Assistant Director;  Paul Kinney; Mehrzad Nadji; Alison O’Neill; Christopher Pacheco; Sophia  Payind;  Cheryl  Peterson;  Steven  Putansu;  Kiki  Theodoropoulos;  Nick  Weeks; and William Woods made key contributions to this report.


Question-summary annotations: questions: question: How do NNSA managing and operating contractors classify indirect costs?
answer: The National Nuclear Security Administration’s (NNSA) management and operating (M&O) contractors differ in how they classify and allocate indirect costs at NNSA laboratories.
child_questions: question: How does this compare to Cost Accounting Standards?
answer: Although different approaches are allowed by Cost Accounting Standards, these differences limit the ability to compare program costs across the laboratories.

question: How are DOE and NNSA mitigating the limitations of current cost data?
answer: Recognizing the limitations of its current cost data, the Department of Energy (DOE) and NNSA are implementing the Institutional Cost Reporting initiative intended to create a standardized report of certain costs, including many indirect costs.
child_questions: question: How will DOE use the information from this initiative?
answer: However, DOE is uncertain how it will use the data gathered by this initiative, and these efforts may provide only limited improvements because the data will continue to only be reported at an aggregate level.

questions: question: How does NNSA ensure Cost Accounting Standards requirements?
answer: NNSA examines M&O contractors’ models for allocating indirect costs for compliance with Cost Accounting Standards’ requirements at least annually, which helps ensure accuracy. NNSA has identified instances when these models did not comply with these requirements, but NNSA has worked with M&O contractors to address these issues.
child_questions: question: To what extent does NNSA rely on the internal audits of M&O contractors?
answer: NNSA generally relies on the M&O contractors’ internal audits, however, to assess whether M&O contractors’ day-to-day cost allocation practices conform to disclosed cost allocation models.
child_questions: question: How does NNSA verify these internal audits?
answer: NNSA reviews some summary data to independently assess day-to-day compliance with Cost Accounting Standards but does not conduct independent audits.

question: To what extent is the reliance on internal audits risk for NNSA?
answer: However, NNSA and OIG officials and M&O contractors hold varying opinions regarding the level of risk that inaccurate indirect cost allocation practices at the laboratories pose. In the absence of formal, periodic risk assessments, NNSA may not have a well-documented basis for its decisions regarding the type, timing, and extent of future monitoring or oversight.

questions: question: How does NNSA assess M&O contractors' data?
answer: NNSA reviews M&O contractors’ cost data and other information to assess the reasonableness of their costs, including indirect costs. NNSA also uses other means to help ensure the reasonableness of these costs.

question: How do NNSA contracts help ensure reasonable costs?
answer: For example, NNSA’s contracts require M&O contractors to regularly benchmark their costs to other contractors and industry.
child_questions: question: What weaknesses exist in the NNSA contracts?
answer: These requirements, however, do not specify the areas that should be examined, how frequently benchmarking should occur, and what process should be used for implementing any needed corrective actions.
child_questions: question: How does this affect M&O contractor costs?
answer: As a result, M&O contractor efforts to benchmark costs varied across laboratories.

questions: question: What is NNSA's role regarding nuclear security?
answer: NNSA, a semiautonomous agency within DOE, oversees the nation’s nuclear security programs.
child_questions: question: What role do M&O contractors have in NNSA?
answer: M&O contractors manage NNSA’s facilities, including its national security laboratories––Lawrence Livermore, Los Alamos, and Sandia.

question: What costs are associated with M&O contractors?
answer: Each year, M&O contractors spend billions of dollars to manage and operate these laboratories. Costs include both direct costs—which can be identified with a specific objective or program—and indirect costs, such as management, administrative, and facility costs.
child_questions: question: How do Federal Cost Accounting Standards affect M&O contractors?
answer: Federal Cost Accounting Standards give M&O contractors flexibility in how costs are classified as direct or indirect and allocated to programs.

questions: question: What was GAO asked to examine?
answer: GAO was asked to review M&O contractor indirect cost management.
child_questions: question: What did this report examine regarding NNSA?
answer: GAO examined (1) whether laboratory M&O contractors' practices differ for allocating indirect costs and, if so, how; (2) the extent to which NNSA ensures that laboratory M&O contractors’ allocated indirect costs are accurate; and (3) the extent to which NNSA ensures that laboratory M&O contractors’ indirect costs are reasonable.

question: How did GAO collect data for this report?
answer: GAO reviewed NNSA and laboratory M&O contractor data and documents and spoke with DOE and NNSA officials and M&O contractors.