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United States Government Accountability Office GAO January 2008 Report to Congressional Committees DEFENSE CONTRACTING Contract Risk a Key Factor in Assessing Excessive Pass-Through Charges GAO-08-269 January 2008 DEFENSE CONTRACTING Highlights Highlights of GAO-08-269, a report to congressional committees Accountability Integrity Reliability Contract Risk a Key Factor in Assessing Excessive Pass-Through Charges Why GAO Did This Study One-third of the Department of Defense’s (DOD) fis
    United States Government Accountability Office GAO Report to Congressional Committees  DEFENSECONTRACTINGContract Risk a KeyFactor in AssessingExcessivePass-Through Charges   January 2008GAO-08-269  What GAO Found United States Government Accountability Office Why GAO Did This Study H ighlights Accountability Integrity Reliability   January 2008   DEFENSE CONTRACTING Contract Ri s k a Key Factor in A ss e ss in g Exce ss ivePa ss -Throu g h Char g e s   Highlights ofGAO-08-269, a report tocongressional committees One-third of the Department of Defense’s (DOD) fiscal year 2006spending on goods and serviceswas for subcontracts. Concernshave been raised among DODauditors and Congress about the potential for excessive pass-through charges by contractorsthat add little or no value whenwork is subcontracted. To betterunderstand this risk, Congressmandated that GAO assess theextent to which DOD may be vulnerable to these charges. Thisreport examines (1) DOD’sapproach to assessing the risk of excessive pass-through chargeswhen work is subcontracted, (2)the strategies selected privatesector companies use to minimizerisks of excessive pass-throughcharges when purchasing goodsand services, and (3) DOD’s interimrule to prevent excessive pass-through charges.GAO’s work is based on analysis of 32 fiscal year 2005 DOD contractactions at 10 DOD top contractinglocations and discussions withDOD acquisition policy, audit, andcontracting officials, includingDefense Contract Audit Agency(DCAA) and Defense ContractManagement Agency (DCMA) staff.GAO also interviewed nine selected private sector companies withdiverse contracting experience. What GAO Recommend s  GAO is recommending that DODguidance to implement its interimrule requires that assessments of  pass-through charges be risk-basedand involve DCAA and DCMA asappropriate. DOD concurred withthe recommendations.  Although no specific criteria exist for evaluating contractor value added, DODcontracting officials generally rely on tools in the Federal AcquisitionRegulation (FAR) to assess the risk of excessive pass-through charges whenwork is subcontracted. For the 32 selected contract actions GAO reviewed,DOD contracting officials generally applied these tools to their assessments.The degree of assessment depended on whether the contract was competedand whether the contract type required the government to pay a fixed price orcosts incurred by the contractor. When using full and open competition,contracting officials assessed contractor value added based on the technicalability to perform the contract, but did not separately evaluate cost sincemarket forces generally control contract costs, potentially minimizing the riskof excessive pass-through charges. However, when using noncompetitivecontracts, contracting officials were required to evaluate more detailed costinformation in assessing value added, as market forces did not determine thecontract cost. For example, for a $3 billion noncompetitive contract for an AirForce satellite program, contracting officials assessed detailed cost or pricingdata that included subcontractor costs, and received DCAA and DCMAsupport to negotiate lower overall contract costs. However, assessingcontractor value added is especially challenging in unique situations whererequirements are urgent in nature and routine contracting practices may beoverlooked. Related GAO work and DOD audits on contracts awarded forHurricane Katrina recovery efforts found multiple layers of subcontractors,questionable contractor value added, increased costs, and lax oversight.The selected private sector companies GAO interviewed rely heavily onacquisition planning, knowledge of supply chain, and managing contractualrelationships to minimize risk of excessive pass-through charges when purchasing goods and services. They seek to optimize competition tominimize overall contract costs, and several companies indicated that they prefer fixed-price competitive arrangements. In addition, some formcollaborative business relationships with contractors and subcontractors that provide greater insight into their supply chains and costs—a challenge DODcontinues to face. When using other than fixed-price contracts, they recognizethe financial risks and ensure proper oversight and accountability. As GAOhas reported in the past, DOD’s use of riskier contracts, such as time-and-materials contracts, has not always ensured good acquisition outcomes.DOD recently issued an interim rule requiring a contract clause in all eligiblecontracts, which allows it to recoup contractor payments that contractingofficers determine to be excessive. The rule also requires detailedinformation from contractors on their value added when subcontracting costsreach 70 percent or more of total contract cost. However, the rule alone willnot provide greater insight into DOD’s supply chain and costs—informationcompanies told us they use to mitigate excessive costs. Further, contractingofficials indicated the need for guidance to ensure effective implementationand consistent application of tools in the FAR as appropriate. To view the full product, including the scopeand methodology, click onGAO-08-269.For more information, contact Ann CalvaresiBarr at (202) 512-4841 orcalvaresibarra@gao.gov.    Contents Letter 1Results in Brief 3Background 5 Risks of Excessive Pass-Through Charges Are Assessed throughRoutine Evaluations of Contractor Value 7Selected Private Sector Companies Rely on Several Shared Approaches to Minimize The Risk of Excessive Pass-ThroughCharges 17 Contracting Officials Lack the Guidance and Insight Needed toEffectively Implement DOD’s Interim Rule 20Conclusions 22 Recommendations for Executive Action 22 Agency Comments 23  Appendix I Scope and Methodology 25  Appendix II Key Elements for Contracting Officers in Assessing Contractor Value Added 29  Appendix III Comments from the Department of Defense 32 Tables Table 1: Number of Selected Contracts by Competition and Risk 9Table 2: Selected Companies and Operations 27 Figures Figure 1: Total Subcontract Awards from DOD Contracts, FiscalYears 2002 through 2006 6Figure 2: Example of Costs with Subcontract Layers 7 Page i GAO-08-269 Pass-Through Charges     Abbreviations  ANC Alaska Native CorporationDCAA Defense Contract Audit AgencyDCMA Defense Contract Management AgencyDFARS Defense Federal Acquisition Regulation SupplementDOD Department of DefenseFAR Federal Acquisition RegulationSARA Services Acquisition Reform ActUSACE U.S. Army Corps of Engineers This is a work of the U.S. government and is not subject to copyright protection in theUnited States. It may be reproduced and distributed in its entirety without furtherpermission from GAO. However, because this work may contain copyrighted images orother material, permission from the copyright holder may be necessary if you wish toreproduce this material separately. Page ii GAO-08-269 Pass-Through Charges
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