Iraq Contract Costs: DOD Consideration of Defense Contract Audit 
Agency's Findings (25-SEP-06, GAO-06-1132).			 
                                                                 
The government has hired private contractors to provide billions 
of dollars worth of goods and services to support U.S. efforts in
Iraq. Faced with the uncertainty as to the full extent of	 
rebuilding Iraq, the government authorized contractors to begin  
work before key terms and conditions were defined. This approach 
allows the government to initiate needed work quickly, but can	 
result in additional costs and risks being imposed on the	 
government. Helping to oversee their work is the Defense Contract
Audit Agency (DCAA), which examined many Iraq contracts and	 
identified costs they consider to be questioned or unsupported.  
The Conference Report on the National Defense Authorization Act  
for Fiscal Year 2006 directed GAO to report on audit findings	 
regarding contracts in Iraq and Afghanistan. As agreed with the  
congressional defense committees, GAO focused on Iraq contract	 
audit findings and determined (1) the costs identified by DCAA as
questioned or unsupported; and (2) what actions DOD has taken to 
address DCAA audit findings, including the extent funds were	 
withheld from contractors. To identify DOD actions in response to
the audit findings, GAO selected 18 audit reports representing	 
about 50 percent of DCAA's questioned and unsupported costs on	 
Iraq contracts. GAO requested comments from DOD on a draft of	 
this report, but none were provided.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-1132					        
    ACCNO:   A61385						        
  TITLE:     Iraq Contract Costs: DOD Consideration of Defense	      
Contract Audit Agency's Findings				 
     DATE:   09/25/2006 
  SUBJECT:   Audit reports					 
	     Contract administration				 
	     Contract costs					 
	     Cost analysis					 
	     Defense audits					 
	     Defense cost control				 
	     Defense procurement				 
	     Federal regulations				 
	     Financial analysis 				 
	     Questionable payments				 
	     Risk assessment					 

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GAO-06-1132

     

     * Results In Brief
     * Background
     * DCAA Audit Reports Identified Billions of Dollars of Questio
          * DCAA Identified Billions of Dollars in Questioned and Unsupp
          * DCAA Tracks How Questioned Costs Are Addressed but Does Not
     * DOD Contracting Officials Have Taken a Range of Actions to A
          * DOD Generally Considered DCAA Audit Findings When Negotiatin
          * DOD Contracting Officials Less Likely to Remove Questioned C
          * DCAA Withheld Funds Related to Some Audit Reports We Reviewe
          * DOD Took a Variety of Other Actions to Address DCAA Audit Fi
     * GAO's Mission
     * Obtaining Copies of GAO Reports and Testimony
          * Order by Mail or Phone
     * To Report Fraud, Waste, and Abuse in Federal Programs
     * Congressional Relations
     * Public Affairs

Report to Congressional Committees

United States Government Accountability Office

GAO

September 2006

IRAQ CONTRACT COSTS

DOD Consideration of Defense Contract Audit Agency's Findings

GAO-06-1132

Contents

Letter 1

Results In Brief 2
Background 4
DCAA Audit Reports Identified Billions of Dollars of Questioned and
Unsupported Costs on Iraq Contracts 5
DOD Contracting Officials Have Taken a Range of Actions to Address Audit
Findings 6
Appendix I Scope and Methodology 15

Figures

Figure 1: Timeline of Key Contracting Events for Restore Iraqi Oil
Contract, Task Order 5 9
Figure 2: Timeline of Key Contracting Events for Logistics Civil
Augmentation Program III Contract, Task Order 89 10

Abbreviations:

DCAA Defense Contract Audit Agency DESC Defense Energy Support Center DOD
Department of Defense FAR Federal Acquisition Regulation

This is a work of the U.S. government and is not subject to copyright
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separately.

United States Government Accountability Office

Washington, DC 20548

September 25, 2006 September 25, 2006

Congressional Committees Congressional Committees

The United States is spending billions of dollars to achieve U.S.
political, security, and economic goals in Iraq. Between fiscal years 2003
and 2006, the U.S. government has allocated about $311 billion to support
U.S. stabilization and reconstruction efforts in Iraq. The United States
has relied heavily on private-sector contractors to provide the goods and
services needed to support both the military and reconstruction efforts in
Iraq. Faced with the uncertainty as to the full extent of rebuilding Iraq,
the government authorized contractors to begin work before key terms and
conditions were defined. This approach allows the government to initiate
needed work quickly, but can result in additional costs and risks being
imposed on the government. Given the dollar amounts involved, it is
essential that these acquisitions be handled in an efficient, effective,
and accountable manner to mitigate the government's risk. The United
States is spending billions of dollars to achieve U.S. political,
security, and economic goals in Iraq. Between fiscal years 2003 and 2006,
the U.S. government has allocated about $311 billion to support U.S.
stabilization and reconstruction efforts in Iraq. The United States has
relied heavily on private-sector contractors to provide the goods and
services needed to support both the military and reconstruction efforts in
Iraq. Faced with the uncertainty as to the full extent of rebuilding Iraq,
the government authorized contractors to begin work before key terms and
conditions were defined. This approach allows the government to initiate
needed work quickly, but can result in additional costs and risks being
imposed on the government. Given the dollar amounts involved, it is
essential that these acquisitions be handled in an efficient, effective,
and accountable manner to mitigate the government's risk.

The Defense Contract Audit Agency (DCAA) provides services that can help
DOD ensure accountability for its acquisitions. DCAA performs audits and
provides financial advisory services in connection with negotiation,
administration, and settlement of contracts and subcontracts. For example,
DCAA has audited many Iraq contract proposals and contracts and has
identified costs it considers to be questioned or unsupported. DCAA
defines questioned costs as those costs considered to be not acceptable
for negotiating a reasonable contract price, and unsupported costs as
costs for which the contractor has not furnished sufficient documentation
to support the cost proposed or claimed. The Defense Contract Audit Agency
(DCAA) provides services that can help DOD ensure accountability for its
acquisitions. DCAA performs audits and provides financial advisory
services in connection with negotiation, administration, and settlement of
contracts and subcontracts. For example, DCAA has audited many Iraq
contract proposals and contracts and has identified costs it considers to
be questioned or unsupported. DCAA defines questioned costs as those costs
considered to be not acceptable for negotiating a reasonable contract
price, and unsupported costs as costs for which the contractor has not
furnished sufficient documentation to support the cost proposed or
claimed.

The Conference Report on the National Defense Authorization Act for Fiscal
Year 20061 directed GAO to report on audit findings regarding contracts in
Iraq and Afghanistan. As agreed with the congressional defense committees,
we focused on Iraq contract audit findings and determined (1) the costs
identified by DCAA as questioned or unsupported; and (2) what actions DOD
has taken to address DCAA audit The Conference Report on the National
Defense Authorization Act for Fiscal Year 20061 directed GAO to report on
audit findings regarding contracts in Iraq and Afghanistan. As agreed with
the congressional defense committees, we focused on Iraq contract audit
findings and determined (1) the costs identified by DCAA as questioned or
unsupported; and (2) what actions DOD has taken to address DCAA audit
findings, including the extent to which funds were withheld from
contractors.

1 National Defense Authorization Act of 2006, H.R. Conf. Rep. No. 109-360,
p. 767(Dec. 18, 2005).

To determine the costs DCAA questioned or identified as unsupported, we
analyzed information provided to us by DCAA on Iraq-related audit reports
issued between February 2003 and February 2006. To identify actions taken
by DOD to address audit findings and funds withheld, we selected 18 audit
reports comprised of (1) the 10 reports with the highest dollar amounts of
questioned and unsupported costs, and (2) 8 other audit reports with
questioned and unsupported costs above $5 million. The questioned and
unsupported costs for the 18 selected reports totaled $1.8 billion, or
approximately 50 percent of all questioned and unsupported costs
identified through DCAA's data on Iraq contracts. The selected audit
reports represent work performed by four contractors. For each audit
report, we obtained key documentation from DCAA and DOD, and interviewed
DCAA auditors and DOD contracting officials. Appendix I provides details
on our scope and methodology. We conducted our work from March 2006
through September 2006 in accordance with generally accepted government
auditing standards.

                                Results In Brief

Between February 2003 and February 2006, DCAA issued hundreds of audit
reports that collectively identified $2.1 billion in questioned costs and
$1.4 billion in unsupported costs on Iraq contracts, primarily through
audits of contractor proposals. Based on information provided to us by
DCAA, contracting officials had addressed $1.4 billion of DCAA's
questioned costs. Of that amount, contracting officials reduced contract
costs by about $386 million, according to information provided by DCAA.2
Based on the information provided by DCAA, as of July 2006, the remaining
$700 million in questioned costs is still in process. Because unsupported
costs indicate a lack of contractor information that is needed to assess
costs, DCAA cannot and does not render an opinion on those costs.
Therefore, DCAA does not track the resolution of unsupported costs.

2 DCAA provided information that identified $453 million in reduced
contract costs. Based on our review of 18 audit reports, we found DCAA's
information on reduced contract costs included $67 million that was paid
to the contractor but removed from the base used to calculate the
contractor's fees. DCAA officials acknowledged these costs should not be
included and that the $453 million does not represent a total reduction in
contract costs.

For the 18 audit reports selected for this review, we found that DOD
contracting officials took a variety of actions in response to DCAA's
audit findings, including not allowing some contractor costs. Based on
contract documentation we reviewed, the DOD contracting officials
generally considered DCAA's questioned and unsupported cost findings when
negotiating with the contractor. We found that DOD contracting officials
were more likely to use DCAA's advice when negotiations were timely and
occurred before contractors had incurred substantial costs. For example,
in 3 audit reports related to a logistics support task order negotiated
prior to the onset of work, DCAA questioned $204 million. According to
DCAA's calculations, $120 million of these questioned costs was removed
from the contractor's proposal as a result of its audit findings. In
contrast, DOD officials were less likely to remove questioned costs from a
contract proposal when the contractor had already incurred these costs. Of
the 18 audits covered in our review, 11 audit reports corresponded to
contract actions where more than 180 days had elapsed from the beginning
of the period of performance to final negotiations. For example, in 5
audit reports comprising about $600 million of questioned costs reviewed,
we found that the DOD contracting officials determined that the contractor
should be paid for all but $38 million of the questioned costs, but
reduced the base used to calculate the contractor's fee by $205 million.
By reducing the base, the DOD contracting official reduced the
contractor's fee by approximately $6 million. In addition to identifying
questioned and unsupported costs, DCAA can withhold funds from contractor
payments,3 and chose to withhold a total of $236 million for 8 cases
included in our review. Of the $236 million, the government decided to pay
the contractors $148 million, not to pay $36 million, and $51 million has
not been settled yet.4

We requested comments from DOD on a draft of this report, but none were
provided.

3 Pursuant to the authority of DOD Directive 5105.36, DCAA can issue a
Form 1. A Form 1 constitutes notice of costs suspended and/or disapproved
incident to the audit of contractor costs incurred under a contract.
Suspended costs are costs that have been determined to be inadequately
supported or otherwise questionable, and not appropriate for reimbursement
under contract terms at this time. Such costs may be determined
reimbursable after the contractor provides the auditor additional
documentation or explanation. Disapproved costs have been determined to be
unallowable, that is, not reimbursable under the contract terms.

4 Monies withheld do not add to $236 million due to rounding.

                                   Background

The United States, along with its coalition partners and various
international organizations and donors, has embarked on a significant
effort to rebuild Iraq. The United States is spending billions of dollars
to reconstruct Iraq while combating an insurgency that has targeted
military and contractor personnel and the Iraqi people. The United States
has relied heavily on private-sector contractors to provide the goods and
services needed to support both the military and reconstruction efforts in
Iraq.

DCAA is responsible for providing contract audits for DOD, along with
general accounting and financial advice to DOD acquisition officials
negotiating government contracts. DCAA performs many types of audits for
DOD, including audits of contractor proposals, audits of estimating and
accounting systems, and incurred cost audits. Generally, the results of a
DCAA audit are intended to assist contracting officials in negotiating
reasonable contract prices. Normally, DCAA audits contractors' proposals
and provides contracting officials advice on the reasonableness of
contractor costs prior to negotiations. DCAA also conducts audits of
cost-type contracts after they are negotiated to ensure costs incurred on
these contracts are acceptable. Relying on cost information provided by
the contractor and assessing whether the costs comply with government
regulations, DCAA may identify certain costs as questioned or unsupported.
DCAA defines questioned costs as costs considered to be not acceptable for
negotiating a reasonable contract price, and unsupported costs as costs
that lack sufficient supporting documentation. DCAA reports its findings
to contracting officers for consideration in negotiating reasonable
contract prices.

DCAA audit reports represent one way DCAA can assist contracting officials
as they negotiate government contracts. Also, contracting officials may
invite DCAA to participate in contract negotiations to explain audit
findings and recommendations, and may factor DCAA audit findings into
evaluations of contract proposals. The Federal Acquisition Regulation
(FAR) acknowledges that DCAA's role is advisory, and assigns the
contracting officer responsibility for ensuring that the contractor's
proposed price is fair and reasonable.5 While DCAA audit recommendations
are nonbinding, DCAA's Contract Audit Manual states that contracting
officials deviating from DCAA advice during negotiations should explain
the reasons why they disagreed with DCAA.

5 Federal Acquisition Regulation (FAR) 1.602-2(c), Responsibilities,
15.402(a) Pricing Policy (January 2006).

DOD Directive 5105.36 also enables DCAA to withhold payments by (1)
suspending payment for specific incurred costs lacking documentation or
(2) disapproving costs that do not conform with applicable regulations.
DCAA can issue a Form 1 to a contractor notifying it that funds will be
withheld, which initiates review of the challenged costs by the
contracting officer.

DCAA Audit Reports Identified Billions of Dollars of Questioned and Unsupported
                            Costs on Iraq Contracts

Between February 2003 and February 2006, DCAA issued hundreds of audit
reports that collectively identified $3.5 billion in questioned and
unsupported costs on Iraq-related contracts, primarily through audits of
contractor proposals. In some cases, DCAA was asked to audit multiple
iterations of contractor proposals as these proposals were revised over a
period of time. Based on information provided by DCAA, contracting
officials have responded to audit findings that questioned $1.4 billion.
As a result, contracting officials negotiated contract cost reductions of
$386 million according to DCAA. DCAA does not render an opinion about
costs it determines to be unsupported; therefore they do not track the
resolution of unsupported costs.

DCAA Identified Billions of Dollars in Questioned and Unsupported Costs

Between February 2003 and February 2006, DCAA tracked 349 audit reports
that identified about $3.5 billion in questioned and unsupported costs on
Iraq contracts. Of this total, DCAA classified $2.1 billion as questioned,
and $1.4 billion as unsupported. DCAA identified these questioned and
unsupported costs in audits related to 99 different contractors. Most of
the questioned and unsupported costs were identified through audits of
contractor proposals. Specifically, in DCAA's database, more than
three-quarters of the audits with questioned and unsupported costs were
classified as "forward pricing activity," which primarily involves
auditing contractor proposals or parts of proposals.

In some cases, DCAA reviewed multiple contractor proposals for the same
work. DOD officials told us that contractors submitted multiple proposals
because requirements changed or the proposal was considered inadequate for
negotiations. For example, over a 6-month period, DCAA issued four audit
reports on three different proposals for a task order related to an oil
mission. Each audit superseded the prior one, and DCAA updates its
information to reflect the most recent report.

DCAA Tracks How Questioned Costs Are Addressed but Does Not Track Similar
Information for Unsupported Costs

While DCAA tracks and records how questioned costs are addressed by the
contracting official in negotiation, it does not track similar information
about unsupported costs. Based on the data provided to us by DCAA, as of
July 3, 2006, contracting officials had responded to 169 of DCAA's 349
Iraq audit reports. DCAA considered the findings to be addressed because
the contracting official had documented the result of negotiations with
the contractor.

Based on information provided by DCAA, for the $1.4 billion in questioned
costs addressed by contracting officials, contracting officials sustained
$386 million of the total questioned costs. DCAA defines sustained costs
as the costs reduced through negotiations directly attributable to
findings reported by the DCAA auditor for proposal audits. Based on the
information provided by DCAA, as of July 2006, the remaining $700 million
in questioned costs is still in process. DCAA's information does not
reflect what actions, if any, the contracting officials have taken to
respond to these audit report findings.

According to a DCAA official, DCAA does not track how unsupported costs
are addressed. DCAA guidance implementing the FAR requires the contracting
official to report on the disposition of questioned amounts, but not
specifically on whether contractors provided sufficient documentation to
eliminate unsupported costs.6 Because unsupported costs indicate a lack of
contractor information that is needed to assess costs, DCAA cannot and
does not render an opinion on those costs. Therefore, DCAA does not track
the resolution of unsupported costs.

    DOD Contracting Officials Have Taken a Range of Actions to Address Audit
                                    Findings

For the 18 audit reports selected for this review, we found that DOD took
a variety of actions in response to audit findings, including not allowing
some contractor costs. Based on contract documentation we reviewed, the
DOD contracting officials generally considered DCAA's questioned and
unsupported cost findings when negotiating with the contractor. We found
that DOD contracting officials were more likely to use DCAA's advice when
negotiations were timely and occurred before contractors had incurred
substantial costs. In contrast, DOD officials were less likely to remove
questioned costs from a contract proposal when the contractor had already
incurred these costs. In addition to identifying questioned and
unsupported costs, DCAA can also withhold funds from the contractor, which
it chose to do in eight of the cases included in our review. Other actions
taken by the DOD contracting officials included inviting DCAA to attend
meetings or negotiations with the contractor and conducting additional
analyses to respond to audit findings.

6 The FAR states when the contracting officer elects not to adopt
significant audit or other specialist recommendations, the contracting
officer should provide a rationale which supports the negotiation result
in the price negotiation documentation. Federal Acquisition Regulation
(FAR) 15.405(a), Price Negotiation (January 2006).

DOD Generally Considered DCAA Audit Findings When Negotiating with the
Contractor

Our review of the government's documentation of contract negotiations for
the selected audit reports showed that DOD generally considered DCAA audit
findings.7 The majority, or 13 of the 15 memorandums, identified how the
contracting officials addressed DCAA audit findings.8 Most memorandums
discussed questioned and unsupported costs identified by DCAA in areas
such as labor, equipment, material, and subcontracts, but some lacked
specific detail on how DCAA audit findings were addressed. However, in two
cases we were unable to determine from the negotiation documentation how
DCAA audit findings were used.

DOD Contracting Officials Less Likely to Remove Questioned Costs Already
Incurred by the Contractor

To address the more than $1 billion in questioned costs related to the
audits selected, we found that the DOD contracting officials were less
likely to remove questioned costs from a contractor proposal when the
contractor had already incurred these costs. For example, in 5 audit
reports comprising about $600 million of questioned costs reviewed, we
found that the DOD contracting officials determined that the contractor
should be paid for nearly all of the questioned costs (all but $38
million), but reduced the base used to calculate the contractor's fee (by
$205 million). By reducing the base, the DOD contracting official reduced
the contractor's fee by approximately $6 million.

Generally, when entering into a contract, the government and contractor
reach agreement on the key aspects of the contract, including the scope
and price of the work, before the work is authorized to start. However,
the FAR enables the government to authorize the contractor to begin work
before doing so in certain cases, such as when the government demands the
work start immediately and it is not possible to negotiate a fully defined
contract in sufficient time to meet the requirement.9 Our past work has
shown that the use of undefinitized contract actions can pose risks to the
government, such as potentially significant additional costs.10
Acquisition regulations generally require that the contracting official
define the scope and costs of such contracts within 180 days of the
contract's start date. According to contract officials, urgent conditions
in Iraq led the government to initiate such contract actions without first
specifying their scope of work and agreeing to the contract price.

7 Documentation of contract negotiations includes price negotiation
memorandums, business clearance memorandums, and definitization
memorandums. For purposes of this report, we will refer to these documents
collectively as "memorandums."

8 There were 15 memorandums related to the selected audit reports included
in our review. Two of the memorandums addressed multiple audit reports.

In many cases we reviewed, contractors completed some work and incurred
substantial costs well before the government negotiated the contract
price. Of the 18 audits covered in our review, 11 audit reports
corresponded to contract actions where more than 180 days had elapsed from
the beginning of the period of performance to final negotiations. For nine
of these audits, the period of performance DOD initially authorized for
each contract action concluded before final negotiations took place.

For example, DCAA questioned $84 million in its audit of a task order
proposal for an oil mission. In this case, the contractor did not submit a
proposal until a year after the work was authorized, and DOD and the
contractor did not negotiate the final terms of the task order until more
than a year after the contractor had completed work (see fig. 1). The DOD
contracting officer paid the contractor for all questioned costs but
reduced the base used to calculate contractor profit by $45 million. As a
result, the contractor was paid about $3 million less in fees. In the
final negotiation documentation, the DOD contracting official stated that
payment of incurred costs is required for cost-type contracts, absent
unusual circumstances.11 This same rationale was used in negotiations on
several other task orders.

9 FAR 16.603 Letter Contracts (January 2006).

10 GAO, Rebuilding Iraq: Fiscal Year 2003 Contract Award Procedures and
Management Challenges, GAO-04-605 (Washington, D.C.: June 1, 2004).

11 The DOD contracting official indicates that because DCAA chose not to
suspend or disallow the funds, DCAA and DOD agree that these unusual
circumstances did not exist. However, DCAA officials do not agree with
this characterization.

Figure 1: Timeline of Key Contracting Events for Restore Iraqi Oil
Contract, Task Order 5

In contrast, in the few audit reports we reviewed where the government
negotiated prior to starting work, we found that the portion of questioned
costs removed from the proposal was substantial. For example, in 3 audit
reports related to a logistics support task order, DCAA questioned $204
million. Since the government and the contractor negotiated the terms of
this task order prior to the onset of work, the contractor had not
incurred any costs at the time of negotiation (see fig. 2 for timeline).
According to DCAA's calculations, $120 million of these questioned costs
was removed from the contractor's proposal as a result of its audit
findings.

Figure 2: Timeline of Key Contracting Events for Logistics Civil
Augmentation Program III Contract, Task Order 89

DCAA Withheld Funds Related to Some Audit Reports We Reviewed

In addition to identifying questioned and unsupported costs, DCAA can
withhold funds from contractors in certain situations.12 The cognizant
administrative contracting officer may subsequently determine that the
withheld costs should be approved for payment to the contractor. We found
DCAA withheld $236 million from contractors related to 8 of the audits
included in our review. Subsequently, as a result of either additional
documentation provided by the contractor or the DOD administrative
contracting officer determination, $148 million of the withheld funds was
released to the contractor and the government did not pay $36 million to
the contractor. The remaining $51 million has not been settled yet-a DOD
contracting official is reviewing the available information to make a
decision about whether or not these costs will be reimbursed.13

In the audit reports reviewed, the vast majority of funds withheld by DCAA
($171 million of the $236 million) related to dining facilities services
provided at U.S. troop camps in Iraq.14 The contractor was directed by the
Army to build, equip, and operate the dining facilities located at U.S.
troop base camps in Iraq and to provide four meals a day to the camp
populations. The population at each camp was specified in the Army's
description of the work to be performed by the contractor. In addition,
contractor and government representatives counted the number of troops
served at each mealtime. However, the Army's description of the work did
not specify whether the contractor should bill the government for the camp
population identified in the work description or the actual head count for
each meal. Generally, the government was billed based on the estimated
base camp population, but DCAA stated that the billings should be based on
the actual head count, which was lower than the estimated base camp
population included in the work description. As a result, DCAA withheld
funds by reducing payment for dining facilities costs on contractor
billings by 19.35 percent. Ultimately, the DOD and the contractor
negotiated a settlement where it was agreed that $36 million would not be
paid to the contractor.15

12 DCAA withholds funds from the contractor by issuing a Form 1. In
general, DCAA has two options for withholding funds. DCAA can suspend
reimbursement for costs that lack adequate support until the required data
are received and a determination can be made about whether the cost is
allowable. Or DCAA can disapprove costs that are not considered allowable.

13 Monies withheld do not add to $236 million due to rounding.

14 DCAA withheld a total of $212 million related to the dining facilities
issue. However, only $171 million of this total relates to the audit
reports included in our selection.

In another example, DCAA withheld a payment to the contractor for its
subcontractor's costs of $12 million related to electrical repair
services. DCAA determined the cost to be unreasonable based on a
comparison of price quotes from other subcontractors for similar
electrical repair services. As a result of the action taken by DCAA to
withhold payment, an Army Corps of Engineers contracting official reviewed
contractor data. The contracting official determined the subcontractor's
price was reasonable given the short contract time frames. A memo
outlining the Army Corps of Engineers' rationale for paying the contractor
for the subcontractor costs states, "Corps of Engineers representatives in
Baghdad directed all of the contractors there to do whatever was
necessary, regardless of cost, to meet schedule commitments." The $12
million withheld was released to the contractor. DCAA officials expressed
concerns that the DOD contracting official had not sought their assistance
when settling this issue with the contractor.

DOD Took a Variety of Other Actions to Address DCAA Audit Findings

We found that DOD contracting officials took a variety of other actions to
address DCAA audit findings. In many of the cases we reviewed, DCAA was
invited to participate in meetings or negotiations with the contractor.
For example,

15 The total settlement amount was for $55 million, but only $36 million
relates to the audit reports we reviewed.

           o  To address the questioned costs identified in the task orders
           for the oil mission, the DOD contracting official convened a
           meeting to include the contractor representatives, DCAA officials,
           and Army Corps of Engineers officials. As a result of discussions
           in this meeting, a DCAA official told us that DCAA stopped
           questioning some costs such as the percentage paid to contractor
           employees for working in a dangerous area and price adjustments
           the contractor paid to its subcontractors for fuel from Turkey. In
           addition, the DOD contracting official asked DCAA to provide
           alternative negotiation positions, and in response DCAA developed
           memorandums outlining several options for each task order.
           Ultimately the DOD contracting official used a negotiation
           position presented in each memorandum to establish the
           government's negotiation position with the contractor. When asked
           if he was satisfied with the resolution of the questioned costs, a
           DCAA official involved in the process told us he thought the DOD
           contracting official did the best job he could.

           o  In another example, DCAA attended negotiations between the
           contractor and the government for an electricity contract. DCAA's
           role at this meeting was to answer questions and to reiterate its
           opinion. Subsequent to negotiations, DCAA participated in
           additional meetings with the contractor and the Army Corps of
           Engineers to ensure that its concerns with the contractor
           purchasing system were addressed. DCAA officials told us that
           problems with the contractor purchasing system were related to the
           unsupported costs identified in the audit. DCAA officials involved
           in this process told us that they were generally satisfied with
           the actions taken by DOD and the contractor to resolve their audit
           findings.

In some cases, DOD officials conducted additional analyses in response to
DCAA's audit findings. For example, for the audit reports we reviewed
related to the oil mission, DCAA questioned the cost of fuel and
transportation based on a comparison between the price paid by the
contractor and the price paid by the Defense Energy Support Center (DESC)
when it took over the mission from the contractor in April 2004. In
response, DOD collected additional information to update the fuel and
transportation cost comparison. For example, although DESC negotiated
prices based on trucks shipping fuel to Iraq three times per month, in
practice the trucks were only able to make two trips per month, a fact
that increased the cost of the mission to DESC. Overall, the additional
analyses provided a rationale for the DOD contracting official to pay the
contractor for some of DCAA's questioned costs.

We requested comments from DOD on a draft of this report, but none were
provided.

We are sending copies of this report to the Secretary of Defense,
appropriate congressional committees, and other interested parties. We
will make copies of this report available on request. In addition, this
report will be available at no charge on GAO's Web site at
http://www.gao.gov .

If you have any questions concerning this report, please contact me at
(202) 512-4841 or by e-mail at [email protected] . Contact points for our
Office of Congressional Relations and Public Affairs may be found on the
last page of this report. Other major contributors to this report were
Penny Berrier Augustine, Tim Bazzle, Greg Campbell, David E. Cooper, Tim
DiNapoli, Julia Kennon, John Krump, Eric Lesonsky, Janet McKelvey,
Guisseli Reyes-Turnell, Raffaele Roffo, and Jeffrey Rose.

John P. Hutton Acting Director Acquisition and Sourcing Management

List of Congressional Committees:

The Honorable John Warner Chairman The Honorable Carl Levin Ranking
Minority Member Committee on Armed Services United States Senate

The Honorable Ted Stevens Chairman The Honorable Daniel K. Inouye Ranking
Minority Member Subcommittee on Defense Committee on Appropriations United
States Senate

The Honorable Duncan L. Hunter Chairman The Honorable Ike Skelton Ranking
Minority Member Committee on Armed Services House of Representatives

The Honorable C. W. Bill Young Chairman The Honorable John P. Murtha
Ranking Minority Member Subcommittee on Defense Committee on
Appropriations House of Representatives

Appendix I: Scope and Methodology

To determine the costs identified by the Defense Contract Audit Agency
(DCAA) as questioned or unsupported, we analyzed data from DCAA's
management information system on all DCAA Iraq-related audit reports with
questioned or unsupported costs issued between February 2003 and February
2006. To develop an understanding and assess the reliability of the
information included in the database, we held discussions with and
obtained documentation from DCAA officials located in Fort Belvoir and we
conducted electronic testing for obvious inconsistencies and completeness.
During our review of the database we identified records for 20 audits, 1
percent of the database, which listed 2 different totals for questioned
and/or unsupported costs. For these 20 audits, based on our conversation
with a DCAA official, we selected the amount that reflected the most
current total for questioned and/or unsupported costs. We determined the
data used in our review to be sufficiently reliable for our purposes.

To determine the actions taken by the Department of Defense (DOD) in
response to DCAA audit findings, including the extent to which funds were
withheld from contractors, we selected 18 audit reports comprised of (1)
the 10 reports with the highest dollar amounts of questioned and
unsupported costs and (2) a selection of 8 of the remaining audit reports
with questioned and unsupported cost dollars above $5 million.1 We
excluded audit reports issued after November 1, 2005 from the selection to
ensure that DOD contracting officials had adequate time to resolve the
audit findings. The questioned and unsupported costs for the 18 audits
total approximately $1.8 billion, or about 50 percent of all questioned
and unsupported costs identified through DCAA's database on Iraq
contracts. These reports include (1) 11 audits of 8 task order proposals
to provide logistics support for U.S. troops, (2) 3 audits of task order
proposals to provide fuel and fuel transportation, (3) 3 audits of task
order proposals for electricity services, and (4) 1 audit of a proposal
for contract management and administrative support functions. The 18
selected audit reports represent work performed by 4 contractors. For the
selected audits, we held discussions with DCAA officials located in Fort
Belvoir; Arlington, Texas; Lexington, Massachusetts; Seattle, Washington;
Kent, Washington; and Iraq. We collected key documentation related to each
audit report, such as DCAA's calculation of the resolution of questioned
costs and dollars withheld (Form 1). For each audit, we also held
discussions with DOD contracting officials located in Rock Island,
Illinois; Dallas, Texas; Winchester, Virginia; and Iraq. We interviewed
these officials to determine the actions taken by DOD to address DCAA's
audit findings and obtained key documentation such as price negotiation
memorandums.

1We initially selected 10 audit reports using our second criterion. During
the course of our review, we learned that two of these audit reports were
superseded by subsequent audits, and therefore actions taken were not
documented. As a result, we removed these two audit reports from our
review.

We conducted our review from March 2006 through September 2006 in
accordance with generally accepted government auditing standards.

(120529)

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www.gao.gov/cgi-bin/getrpt? GAO-06-1132 .

To view the full product, including the scope
and methodology, click on the link above.

For more information, contact John Hutton at (202) 512-4841 or
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Highlights of GAO-06-1132 , a report to Congressional Committees

September 2006

IRAQ CONTRACT COSTS

DOD Consideration of Defense Contract Audit Agency's Findings

The government has hired private contractors to provide billions of
dollars worth of goods and services to support U.S. efforts in Iraq. Faced
with the uncertainty as to the full extent of rebuilding Iraq, the
government authorized contractors to begin work before key terms and
conditions were defined. This approach allows the government to initiate
needed work quickly, but can result in additional costs and risks being
imposed on the government. Helping to oversee their work is the Defense
Contract Audit Agency (DCAA), which examined many Iraq contracts and
identified costs they consider to be questioned or unsupported.

The Conference Report on the National Defense Authorization Act for Fiscal
Year 2006 directed GAO to report on audit findings regarding contracts in
Iraq and Afghanistan. As agreed with the congressional defense committees,
GAO focused on Iraq contract audit findings and determined (1) the costs
identified by DCAA as questioned or unsupported; and (2) what actions DOD
has taken to address DCAA audit findings, including the extent funds were
withheld from contractors. To identify DOD actions in response to the
audit findings, GAO selected 18 audit reports representing about 50
percent of DCAA's questioned and unsupported costs on Iraq contracts.

GAO requested comments from DOD on a draft of this report, but none were
provided.

Defense Contract Audit Agency audit reports issued between February 2003
and February 2006 identified $2.1 billion in questioned costs and $1.4
billion in unsupported costs on Iraq contracts. DCAA defines questioned
costs as costs that are unacceptable for negotiating reasonable contract
prices, and unsupported costs as costs for which the contractor has not
provided sufficient documentation. This information is provided to DOD for
its negotiations with contractors. Based on information provided by DCAA,
DOD contracting officials have taken actions to address $1.4 billion in
questioned costs. As a result, DOD contracting officials negotiated
contract cost reductions of $386 million according to DCAA. Based on the
information provided by DCAA, as of July 2006, the remaining $700 million
in questioned costs is still in process. Because unsupported costs
indicate a lack of contractor information that is needed to assess costs,
DCAA cannot and does not render an opinion on those costs. Therefore, DCAA
does not track the resolution of unsupported costs.

For the 18 audit reports selected for this review, GAO found that DOD
contracting officials took a variety of actions to address DCAA's audit
findings, including not allowing some contractor costs. In the contract
documentation GAO reviewed, DOD contracting officials generally considered
DCAA's questioned and unsupported cost findings when negotiating with the
contractor. GAO found DOD contracting officials were more likely to use
DCAA's advice when negotiations were timely and occurred before
contractors had incurred substantial costs. For example, in three audit
reports related to a logistics support task order negotiated prior to the
onset of work, DCAA questioned $204 million. According to DCAA's
calculations, $120 million of these questioned costs was removed from the
contractor's proposal as a result of its audit findings. In contrast, DOD
officials were less likely to remove questioned costs from a contract
proposal when the contractor had already incurred these costs. For
example, in five audit reports comprising about $600 million of questioned
costs reviewed, GAO found that the DOD contracting officials determined
that the contractor should be paid for all but $38 million of the
questioned costs, but reduced the base used to calculate the contractor's
fee by $205 million. By reducing the base, the DOD contracting official
reduced the contractor's fee by approximately $6 million. In addition to
identifying questioned and unsupported costs, DCAA has the option of
withholding funds from the contractor and chose to withhold a total of
$236 million for eight cases included in this review.
*** End of document. ***