On June 10, 1975, the U.S. government executed a Memorandum of Understanding with the governments of Belgium, Denmark, the Netherlands, and Norway to produce F-16 aircraft under a program known as the F-16 Multinational Fighter Program. Of the 998 aircraft produced under this program, the U.S. Air Force purchased 650 and the European participating governments purchased the remaining 348. Under the ongoing MLU program, the Europeans are upgrading their F-16 aircraft by equipping them with new cockpits and avionics systems. On behalf of the four European participating governments, the U.S. Air Force awarded prime contracts to Lockheed Martin Tactical Aircraft Systemsand Northrop Grumman Corporation valued at $622.7 million and $106.5 million, respectively, to provide the aircraft upgrades. The U.S. government participated in the development phase of the MLU program, but it withdrew from the production phase in November 1992. The European countries’ Supreme Audit Institutions (SAIs) have raised a number of issues regarding the pricing of the MLU contracts. The U.S. and European participating governments agreed that they would “endeavor to establish the same price for the same articles when they were procured under the same conditions from the same source.” Due to the proprietary nature of the information affecting the negotiation of the contracts, SAIs are precluded from having access to this information. On December 15, 1994, a meeting, involving representatives from the U.S. and the European participating governments, was held during which agreement was reached to provide assurance that the MLU contract prices were fair and reasonable. Among the issues discussed were the rates and factors used to price the MLU contracts. According to the minutes of the meeting, the European representatives were assured that the “. . . rates and factors that are used for MLU contracts are the same for all other LFWC [Lockheed Fort Worth Company] F-16 contracts with the U.S. Government.” Since these rates and factors are proprietary, the Netherlands representative asked if the United States could provide certification that the same rates are used on all U.S. government contracts. The Defense Plant Representative Office Commander agreed to provide the certification and did so on March 24, 1995. Lockheed Martin and Northrop Grumman proposed and Air Force negotiators used rates and factors to price the two MLU prime contracts that were different from those used to price contemporaneous U.S. government contracts. Also, Air Force negotiators used two incorrect rates in pricing the Northrop Grumman prime contract. These two conditions increased the prime contract prices by a total of $9.4 million. The rates and factors used to price the Lockheed Martin MLU contract were not the same as those used to price U.S. government contracts. Instead, on December 23, 1994, Lockheed Martin proposed a “special” set of rates to price the MLU contract rather than using the lower FPRA rates in effect at that time. The Air Force used the special rates in negotiating the MLU contract prices. This action increased the contract price by $8 million. During the December 1994 working group meeting involving U.S. and European representatives, the Defense Plant Representative Office Commander stated he would certify that the rates used to price the MLU contract would be the same as those used to price all U.S. government contracts. Subsequently, in a March 24, 1995, written certification, the Commander stated “. . . that the applicable FPRA rates and factors used in the MLU program are the same as all other programs negotiated between the LFWC and the U.S. Government.” However, contrary to the Commander’s certification, the Air Force negotiated two other contracts with Lockheed Martin on the same day the MLU contract was negotiated using lower FPRA rates and factors. Neither Lockheed Martin nor the Air Force withdrew from the FPRA that was in effect at the time the MLU contract price was agreed to. The Defense Federal Acquisition Regulation Supplement stipulates that FPRA rates must be used to price contracts unless waived by the head of the contracting activity. No such waiver was requested or obtained for the special rates used to price the MLU contract. Furthermore, there was no evidence in the contract negotiation records or files that the special rates were audited by DCAA or approved for use by the Defense Plant Representative Office. Lockheed Martin proposed and Air Force negotiators used the lower FPRA rates to establish the negotiation objective for the contract price. Before contract price agreement was reached, however, Lockheed Martin provided Air Force negotiators the special set of rates and factors that they accepted and used to price the contract. Lockheed Martin officials told us a special set of rates and factors was required to negotiate the MLU contract because the existing FPRA was only valid through calendar year 1997. They explained that the MLU contract performance period covered calendar years 1993 through 2001 and that rates and factors for the outyears were required. They believe that the special rates benefited the MLU customers because a new FPRA, negotiated shortly after the MLU contract, included higher rates than those used for the MLU contract. In responding to a draft of this report, the Air Force agreed a special set of rates and factors was used to price the MLU contract, but it believed the use of those rates and factors was in the best interest of the European participating governments. The Air Force also stated that the Defense Plant Representative Office Commander signed the certification in good faith, based on his knowledge at that time, and with full intention of being consistent with the pricing agreement between the U.S. and the European participating governments. The Air Force further stated that the Defense Plant Representative Office was negotiating a new FPRA while MLU contract negotiations were going on and had already offered Lockheed Martin higher rates and factors than were in the existing FPRA. The Air Force pointed out that Lockheed Martin would never have accepted the lower existing FPRA rates and factors, which covered the period 1993 through 1997. We agree that the certification was signed in good faith. We also agree that the existing FPRA extended only through 1997 and that rates and factors were needed to cover the MLU contract performance period. However, when changing conditions cause rates in an FPRA to be no longer valid, defense procurement regulations provide approved methods for dealing with the situation—either withdraw from the rate agreement or obtain a waiver from the head of the contracting activity. Air Force negotiators did neither. We found that the Defense Plant Representative Office had issued recommended rates and factors covering 1998 and 1999. Thus, Air Force negotiators—using the existing FPRA and recommended rates—had rates and factors covering 1993 through 1999. According to negotiation records, this period accounted for 99 percent of the MLU contract value. Furthermore, the $8-million increase to the MLU contract is not due to higher rates and factors for the years beyond the FPRA period. Rather, the increase is due to increased rates and factors for 1993 through 1997—the same period covered by the existing FPRA. In addition, the MLU contract awarded to Northrop Grumman for radar systems encountered the same situation as the Lockheed Martin contract—that is, it extended beyond the period covered by the existing FPRA. However, in contrast to the Lockheed Martin situation, the Air Force used existing FPRA rates and factors to price the radar contract. The contract performance period extended into the year 2002, while the existing FPRA went through only 1996. Northrop Grumman proposed and the Air Force used the existing FPRA rates and factors and projected these rates and factors over the remaining contract performance period. Northrop Grumman proposed and the Air Force accepted a G&A overhead rate established for pricing foreign military sales contracts rather than a lower domestic rate established for pricing U.S. government contracts. Use of the G&A rate for foreign military sales contracts increased the MLU contract price by $1.3 million. Northrop Grumman officials told us they used the G&A rate for foreign military sales contracts because of the additional costs in doing business with foreign customers. They also stated they were unaware of any requirement to use the same rates applied to U.S. government contracts. They further stated that such a requirement was not made known to the corporation in the Air Force’s request for proposal or subsequent contract award. In commenting on a draft of this report, the Air Force pointed out that use of the foreign military sales G&A rate was proper on the Northrop Grumman MLU contract. The Air Force advised us that the contractor could not use and the Air Force could not accept the domestic G&A rate for pricing the contract because it would be a misallocation of costs. The Air Force also pointed out that use of the foreign military sales G&A rate did not violate the intent or the spirit of the agreement between the U.S. and the European participating governments. It should be noted that while the Air Force contends that it would have been improper to use the domestic G&A rate for pricing the Northrop Grumman contract, the Air Force used a domestic G&A rate to price the Lockheed Martin MLU contract. The Air Force did not explain this inconsistency. In addition to using the higher G&A rate for foreign military sales contracts, Air Force negotiators used two incorrect rates in pricing the MLU contract, which caused its price to be increased by $163,600. The Air Force concurred that use of the incorrect rates was an oversight. In total, the MLU contract price was increased by $1.4 million as a result of using the higher G&A rate for foreign military sales contracts and two incorrect rates. DCAA conducted preaward audits of both prime contract proposals and questioned various costs.