When acquiring goods or services by contract, U.S. government policy is generally to pay only for completed work. The purpose of this policy is to reduce the government’s risk of financial exposure in the event a contractor fails to perform. In the case of payments at the time of conditional acceptance, this would generally mean withholding sufficient funds to cover the estimated cost and profit associated with completing the work. This policy of only paying for completed work is grounded in the prohibition against advance payments contained in title 31, section 3324 of the United States Code, which states that “a payment under a contract to provide a service or deliver an article for the United States Government may not be more than the value of the service already provided or the article already delivered.” This policy is also evident in the provisions governing progress payments, which state that agencies “shall ensure that any payment for work in progress . . . is commensurate with the work accomplished. . . .” The statutory exceptions to this policy apply conditions or restrictions to the transaction. For example, a written determination is required from the head of an agency, or his or her designee, that the use of advance payments is in the public interest. These policies are implemented in the Federal Acquisition Regulations System. This system consists of the Federal Acquisition Regulation (FAR), which is the primary authority, and agency acquisition regulations that implement and supplement the FAR. The Department of Defense’s (DOD) implementing regulation is the Defense Federal Acquisition Regulation Supplement (DFARS). In addition, each of the military services’ acquisition organizations has issued supplemental guidelines for use in implementing policies and procedures in the FAR and the DFARS. According to the FAR, contracting officers normally should reject supplies and services that do not conform to contract specifications. However, FAR section 46.407 (Nonconforming Supplies or Services) provides exceptions for those circumstances (such as for reasons of economy or urgency) in which accepting such supplies or services may be in the government’s best interest. This section addresses only situations when the government has decided to accept items with permanent nonconformances and not require a contractor to correct the deficiencies after delivery. In these situations, the FAR recommends that the contract be modified to reduce the price or provide other consideration to reflect that the items are less than were specified in the contract. The FAR and the DFARS do not provide guidance for withholding payment for work to be performed after delivery in situations where the government conditionally accepts nonconforming or incomplete work. Moreover, within the military acquisition community, no consistent way has been developed for determining whether payments should be withheld or how to determine the amount to withhold. The DOD Director of Defense Procurement told us that a contracting officer should withhold from payment the estimated cost and profit for work to be done by the contractor after delivery. However, Air Force and Army acquisition officials told us that while the cost and profit of the remaining work should be a consideration, the amount withheld, if any, should be left to the discretion of the contracting officer. Air Force supplemental guidance includes a standard contract clause allowing contracting officers to use their discretion in determining the amount to be withheld. The Army provides no supplemental guidance to the FAR for use in conditionally accepting items and establishing a withhold amount. At the Naval Sea Systems Command and the Naval Air System Command (NAVAIR) procurement and contracting officials agreed that amounts withheld should directly relate to the anticipated cost of work to be performed by a contractor after delivery. However, contract clauses that the two commands use give a contracting officer authority to withhold a lesser amount. From 1981 through 1992, the Air Force Materiel Command’s (AFMC) Aeronautical Systems Division supplements provided for a standard contract clause entitled “Correction of Supplies Accepted With Deficiencies,” which called for withholding 10 percent of the price when conditionally accepting items. The clause allowed a contracting officer to use a higher or lower percentage as conditions warranted. In July 1997, AFMC revised this clause and left the determination of the amount withheld to the contracting officer’s discretion. The revised clause provides a list of factors to consider when deciding on a withhold amount, including (1) the cost to correct the deficiencies; (2) any loss of value to the government due to reduced reliability, increased life-cycle costs, or reduced availability; and (3) any other factors that may affect government use or cost of ownership. In ship construction and conversion contracts, the Naval Sea Systems Command uses a standard payment clause that requires a contracting officer to withhold a percentage of the contract price when a ship is conditionally accepted. The clause provides for withholding, as a performance reserve, the greater of either 1.5 percent of the contract price or $100,000. This clause also provides that a contracting officer may withhold more than the 1.5 percent if he or she finds that the standard withhold amount is insufficient to cover the cost to correct deficiencies or complete unfinished work. The NAVAIR standard clause entitled “Acceptance Under Fixed-Price Contracts” allows a contracting officer, under certain conditions, to accept nonconforming items and to withhold an amount, as he or she determines appropriate. A policy that would require the withholding of at least the estimated cost and profit in this circumstance or require written justification for an exception would protect the government’s interests and be consistent with the treatment accorded payments for work that has not been completed in other instances. For example, FAR, subpart 32.4, which implements the advanced payment statutes, requires that approval of a contracting officer’s recommendation for an advance payment be based on a written determination by an approving official that such advance payment is in the public interest or facilitates the national defense. Our review of four selected acquisition programs indicated that each of the services conditionally accepted nonconforming items, with the expectation that the contractors would correct known deficiencies and complete unfinished work. When conditionally accepting nonconforming items, each of the services paid contractors the billing prices, assuming 100-percent completion, less some amount that was withheld for nonconforming or unfinished work. The services differed in how they determined the withhold amounts, but in each case, the amounts were less than the estimated costs to correct known deficiencies and complete unfinished work. As a result, the contractors were paid for work not yet done. To meet the need for additional long-range airlift, the Air Force contracted with the McDonnell Douglas Corporation, which later merged with the Boeing Company, to develop and produce 120 C-17 aircraft. As of October 1997, the contractor had delivered 34 production aircraft, all of which were conditionally accepted by the Air Force with a number of waivers and deviations that required corrective action by the contractor. We reviewed the adequacy of amounts withheld for eight aircraft conditionally accepted under two contracts for fiscal years 1990 and 1992, production lots III and IV, respectively. At the time of last aircraft delivery for each lot, the Air Force had withheld a net amount of about $47 million for problems with such things as computer software and assembly workmanship and for certain components on which qualification testing had not been completed. However, the amount withheld was significantly less than the estimated cost to correct known deficiencies and finish other incomplete work. Both contracts stipulated that the contracting officer should withhold a minimum of 10 percent of the contract price when conditionally accepting aircraft until the contractor completed the corrective actions. The lot IV contract, however, allowed the contracting officer to deviate from this requirement and withhold a lesser amount. C-17 program officials stated that they did not believe 10 percent was reasonable given the aircraft’s high price. Therefore, starting with lot III, instead of withholding 10 percent of an aircraft’s billing price, the program office and the contractor agreed to categorize waivers and deviations and establish standard withhold amounts for each category. In addition, they agreed to negotiate specific amounts for unique nonconformances. However, the program office did not modify the C-17 contracts to incorporate this withhold policy. Program officials told us that the withhold policy implemented in the C-17 program was not intended to cover the estimated cost and profit of the work remaining to be done by the contractor after conditional acceptance. They said that withholds were intended only to be an incentive to the contractor to correct deficiencies and finish other incomplete work. Table 1.1 compares our estimate of what should have been withheld after the delivery of the last aircraft in each lot with the amounts actually withheld. Our review indicated that the cost and profit to correct deficiencies and complete unfinished work for production lots III and IV exceeded the $47 million withheld by about $61 million, based on the contractor’s estimates of the cost of the aircraft at completion, or about $127 million, based on DCMC’s estimates of the cost of aircraft at completion. The final aircraft of lots III and IV were accepted in February and August 1994, respectively. At the time of our review, the contractor was correcting deficiencies and completing unfinished work. The Army established the Family of Medium Tactical Vehicles (FMTV) program to replace its aging fleet of 2.5-ton and 5-ton trucks and vans. The Army plans to purchase about 85,000 FMTV vehicles over a 30-year period. In October 1991, the program office awarded a $1.2-billion contract to Stewart and Stevenson Services, Inc., for the initial production of 10,843 trucks and vans over 5 years. In August 1996, the program office revised the contract to procure these vehicles over a 7-year period. As of June 1997, the contract price to produce 11,197 trucks and vans was $1.36 billion. The contractor produced 3,040 vehicles during the program’s low-rate initial production phase. Nearly all of these vehicles (2,936) required a retrofit after production to resolve problems. These problems had been identified prior to acceptance during early testing.