Federally Funded R&D Centers: Use of Contract Fee by the Aerospace
Corporation (Letter Report, 09/28/95, GAO/NSIAD-95-174).

Pursuant to a congressional request, GAO reviewed how the Aerospace
Corporation used a $15.5 million contract fee provided by the Air Force
in fiscal year 1993 to operate a federally funded research and
development center (FFRDC), focusing on the regulatory requirements
governing the determination and use of this fee.

GAO found that: (1) Aerospace Corporation spent 74 percent of the
contract fee on research and the remainder on equipment purchases,
property improvements, and unreimbursed expenses; (2) although the Air
Force stated the fee's intended use as a basis for award, Aerospace had
discretion over how to spend the fee once awarded; and (3) the manner in
which a contractor spends its corporate funds in a given year can affect
how much of a fee is needed the following year. In addition, GAO found
that the Department of Defense recommended that: (1) defense FFRDC fee
amounts should be based on the contracting officer's determination of
fee need and not on the application of weighted guidelines; (2) all
allowable and allocable costs should be moved to the cost reimbursement
portion of the contract; and (3) guidance should be developed on what
costs are to be considered ordinary and necessary to the operation of an
FFRDC.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  NSIAD-95-174
     TITLE:  Federally Funded R&D Centers: Use of Contract Fee by the 
             Aerospace Corporation
      DATE:  09/28/95
   SUBJECT:  Research and development facilities
             Aerospace research
             Aerospace contracts
             Research and development contracts
             Air Force procurement
             Contract monitoring
             Department of Defense contractors
             Space exploration
             Funds management
             Administrative costs
IDENTIFIER:  GPS
             NAVSTAR Global Positioning System
             
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Cover
================================================================ COVER


Report to Congressional Requesters

September 1995

FEDERALLY FUNDED R&D CENTERS - USE
OF CONTRACT FEE BY THE AEROSPACE
CORPORATION

GAO/NSIAD-95-174

Federally Funded R&D Centers

(705086)


Abbreviations
=============================================================== ABBREV

  FFRDC -
  FAR -
  GAO -
  DOD -
  SMC -
  DFARS -

Letter
=============================================================== LETTER


B-259377

September 28, 1995

The Honorable Bill Zeliff
Chairman
The Honorable Karen L.  Thurman
Ranking Minority Member
Subcommittee on National Security,
 International Affairs, and Criminal Justice
Committee on Government Reform and Oversight
House of Representatives

As requested by the former Chairman and Ranking Minority Member, we
reviewed how The Aerospace Corporation used a $15.5 million contract
fee provided by the Air Force in fiscal year 1993 to operate a
federally funded research and development center (FFRDC).  We also
reviewed the regulatory requirements governing the determination and
use of this fee.  This is our second report on Aerospace.  Our first
report addressed executive compensation, as requested.\1


--------------------
\1 Federally Funded R&D Centers:  Executive Compensation at The
Aerospace Corporation (GAO/NSIAD-95-75, Feb.  7, 1995). 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

Aerospace spent $11.5 million, or 74 percent, of its $15.5 million
fee for research.  It spent the remaining $4 million for capital
equipment purchases, real and leasehold property improvements, and
unreimbursed expenses. 

Even though the Air Force and Aerospace discuss Aerospace's specific
fee needs and intended use as a basis for fee award, the contract
contains the total fee amount.  Once the Air Force awards the fee,
Aerospace exercises some discretion over how to spend it and other
sources of corporate funds, such as interest income and fee from
other contracts.  The manner in which Aerospace spends its corporate
funds in a given year can affect how much Air Force fee is needed in
the following year. 

In May 1995, the Department of Defense (DOD) issued a report to the
Congress on fee management at defense FFRDCs.  The report focused on
ways to limit the use of fee.  It recommended, among other things,
that (1) defense FFRDC fee amounts be based on the contracting
officer's determination of fee need and not on the application of
weighted guidelines,\2 (2) all allowable and allocable costs be moved
from fee to the cost reimbursement portion of the contract, and (3)
guidance be developed regarding what costs are to be considered
ordinary and necessary to the operation of an FFRDC.  DOD has
indicated that it is working to improve the fee management process
based on these recommendations, as well as the most recent GAO and
DOD Inspector General work on this issue. 


--------------------
\2 These guidelines focus on performance risk, contract type, and
facilities capital employed. 


   BACKGROUND
------------------------------------------------------------ Letter :2

FFRDCs are private sector organizations funded primarily by federal
agencies to meet a special long-term research and development need
that cannot be met as effectively by existing in-house or contractor
resources.  One federal agency serves as the primary sponsor of the
FFRDC and signs an agreement specifying the purpose, terms, and other
provisions for the FFRDC's existence.  Agreement terms cannot exceed
5 years but can be extended after a review by the sponsor of the
continued use and need for the FFRDC.  Federal regulations state that
an FFRDC is required to conduct its business in a manner befitting
its special relationship with the government, operate in the public
interest with objectivity and independence, be free from
organizational conflicts of interest, and have full disclosure of its
affairs to the sponsoring agency. 

The Aerospace Corporation is a private, nonprofit mutual benefit
corporation created in 1960.  Aerospace's primary purpose is to
provide scientific and engineering support for the U.S.  military
space program.  Aerospace operates an FFRDC in support of U.S. 
national security space programs pursuant to the Federal Acquisition
Regulation (FAR), and its primary sponsor is the Air Force. 
Aerospace is governed by a 16-member Board of Trustees in accordance
with its articles of incorporation and bylaws. 

The Air Force Space and Missile Systems Center (SMC), a part of the
Air Force Materiel Command, has day-to-day management responsibility
over the FFRDC.  Through fiscal year 1994, SMC negotiated annual
cost-plus- fixed-fee contracts with Aerospace.  In fiscal year 1995,
it began operating under a cost-plus-award-fee contract where the
amount of fee is based on Aerospace's performance.  Table 1 shows the
contract costs and fees awarded to Aerospace between fiscal years
1989 and 1994. 



                                Table 1
                
                 Air Force Contract Costs and Fees With
                    Aerospace Between 1989 and 1994

                         (Dollars in millions)

Fiscal year                                     Contract costs     Fee
--------------------------------------------  ----------------  ------
1989                                                    $371.4   $19.0
1990                                                     389.8    20.5
1991                                                     375.6    19.9
1992                                                     373.5    16.8
1993                                                     401.7    15.5
1994                                                     355.4    15.6
----------------------------------------------------------------------
Although SMC is the primary customer, Aerospace also performs work
for other U.S.  government agencies, international organizations, and
foreign governments.  In fiscal year 1993, for example, Aerospace's
reported revenues totaled $422.2 million, of which 97.4 percent came
from the Air Force and other DOD agencies; 2.2 percent from other
federal agencies, such as the National Aeronautics and Space
Administration; and 0.4 percent from nonfederal government sources,
such as universities and foreign governments. 


   REGULATORY REQUIREMENTS ON
   FFRDC FEE
------------------------------------------------------------ Letter :3

The Office of Federal Procurement Policy Letter 84-1, dated April
1984, established governmentwide policies for the establishment, use,
review, and termination of the sponsorship of FFRDCs.  It provides
that the conditions affecting the negotiation of fee should be
identified in the contract, sponsoring agreement with the FFRDC, or
the sponsoring agency's policies and procedures, as appropriate. 

The FAR also requires that the sponsoring agreement or the sponsoring
agency's policies and procedures identify the considerations that
will affect the negotiation of fee when fee is determined to be
appropriate.  The Defense Acquisition Regulation Supplement (DFARS)
provides more specific guidance for determining whether a fee is
appropriate and how the fee is to be determined.  Since FFRDCs may
incur expenses that are unreimbursable under federal regulations, the
DFARS allows for a fee to cover unreimbursed expenses if they are
deemed ordinary and necessary to the FFRDC.  An SMC contracting
office instruction provides the fee determination procedures to be
used on the Aerospace contract.  It states that the fee is to be
based on a need that must be justified and that the fee must be used
for the purposes awarded. 


   AEROSPACE'S USE OF FEE
------------------------------------------------------------ Letter :4

In fiscal year 1993, Aerospace reported that it used about $11.5
million of the $15.5 million Air Force contract fee to sponsor
research.  It used the remainder of the fee, along with other
corporate resources, for capital equipment purchases, real and
leasehold property improvements, and other unreimbursed expenditures. 

According to Aerospace officials, the fee from Air Force contracts is
combined with funds from other sources in Aerospace's accounting
records.  Therefore, it is not possible to link each specific use of
Aerospace's funds to the specific funding source.  However, Aerospace
and SMC have a general understanding that sponsored research is to be
paid from the Air Force contract fee.  Also, the accounting standards
and principles governing Aerospace do not require it to match funding
use with funding source.  Table 2 shows Aerospace's actual sources
and applications of funds in fiscal year 1993. 



                                Table 2
                
                  Sources and Applications of Funds at
                     Aerospace for Fiscal Year 1993

Sources of funds                                                Amount
--------------------------------------------------------------  ------
Air Force contract fee                                           $15.5
Equipment depreciation                                            13.5
Leasehold amortization                                             1.0
Interest income                                                    0.9
Working capital change                                             0.4
Other contract fees                                                0.2
======================================================================
Total                                                            $31.5
Applications of funds
Research                                                         $11.5
Capital equipment                                                 14.3
Real and leasehold property improvements                           3.8
Unreimbursed expenses                                              1.9
======================================================================
Total                                                            $31.5
----------------------------------------------------------------------

      RESEARCH
---------------------------------------------------------- Letter :4.1

Aerospace used the Air Force fee primarily to sponsor research with
broader and longer term goals than the more immediate, direct goals
of individual Air Force program offices.  In fiscal year 1993,
Aerospace spent about $11.5 million, or 74 percent, of the Air Force
fee for sponsored research. 

According to Aerospace officials, these funds were used for research
in such areas as electronic device technology, surveillance, and
information sciences.  They added that sponsored research has
resulted in cost savings for the Air Force space program.  For
example, Aerospace attributed to such research a 50-percent increase
in the life expectancy of satellite sensors in the Defense
Meteorological Satellite Program.  It credited such research with
developing remedial procedures to extend the life of satellite
batteries, which have historically contributed to limiting the life
of the satellite.  Aerospace also cited many other research benefits,
such as combining missions on a single spacecraft system and using
commercial parts and techniques. 

One long-standing FFRDC issue has been whether to fund sponsored
research as a cost-reimbursable item or out of fee.  A 1962 report to
the President on government contracting for research and development,
known as the Bell report, supported the continuation of fee payments
for research because most nonprofit organizations must conduct some
independent, self-initiated research if they are to attract and
retain staff.\3 On the other hand, an August 1965 congressional
report on Aerospace noted that some research would normally be a
reimbursable expense and therefore all of the research could be
provided under reimbursement.\4 Similarly, in December 1994, the DOD
Inspector General concluded that FFRDC-sponsored research should be
reimbursed as contract costs to the extent that is allowable and
reasonable.\5 Most recently, in May 1995, a DOD study, completed at
the direction of the Congress, focused on ways to limit the use of
fee.  It recommended that all allowable and allocable costs,
including research, be considered as reimbursable costs rather than
paid from fee.\6

Although Aerospace believes that either funding approach is correct,
it believes that research is best funded using fee rather than being
reimbursed as a cost item.  It said that making research a
cost-reimbursable item would decrease the responsibility of Aerospace
management and the Board of Trustees over independent research and
increase administrative burden.  Also, Aerospace expressed concern
that Air Force program managers may not want to fund certain research
because these managers may have more immediate goals than those for
Aerospace's research program.  Air Force officials said they
acknowledged Aerospace's expertise and plan to use it to the maximum
extent possible regardless of the funding mechanism. 

Reimbursing research as a cost item would not necessarily reduce
total Air Force contract costs, according to DOD.  However, it would
subject all research to the FAR cost principles applicable to
cost-reimbursable items. 

Regardless of how Aerospace's research program is funded, Air Force
and Aerospace officials acknowledged that the program's effectiveness
in meeting Air Force needs could be improved.  Air Force officials
said that the benefits from research could be increased by
strengthening Air Force and Aerospace coordination on project
selection.  According to Aerospace, the effectiveness of the program
will be improved as a result of recent steps taken to improve the
research selection process.  These include (1) a formal collection of
prioritized Air Force Technology Need Statements, (2) Air Force
participation on Aerospace's Technical Program Committee, and (3) a
formal briefing by Aerospace to the Air Force demonstrating the
relationship between selected research projects and the Air Force's
prioritized technology needs. 


--------------------
\3 Government Contracting for Research and Development, Bureau of the
Budget, April 1962. 

\4 The Aerospace Corporation:  A Study of Fiscal and Management
Policy and Control, Report of the Subcommittee for Special
Investigations, Committee on Armed Services, House of
Representatives, August 12, 1965. 

\5 Contracting Practices for the Use and Operations of DOD-Sponsored
Federally Funded Research and Development Centers, Audit Report No. 
95-048, DOD Inspector General, December 2, 1994. 

\6 Comprehensive Review of the Department of Defense's Fee-Granting
Process for Federally Funded Research and Development Centers,
Department of Defense, May 1, 1995. 


      CAPITAL EQUIPMENT AND REAL
      AND LEASEHOLD PROPERTY
      IMPROVEMENTS
---------------------------------------------------------- Letter :4.2

In fiscal year 1993, Aerospace spent $18.1 million of its working
capital funds for capital equipment ($14.3 million) and for real and
leased property improvements ($3.8 million).  Aerospace officials
said these expenditures were funded from reimbursements for
depreciation and amortization ($14.5 million) and the Air Force
contract fee ($3.6 million).  The FAR allows as reimbursable costs
depreciation of capital equipment and amortization of real property
and leasehold improvements. 

SMC defines capital equipment as an asset that has an estimated
useful life of over 2 years and a cost of $1,500 or more.  It
includes those items that Aerospace generally uses to support Air
Force contracts but are not purchased in direct support of an
individual project, such as computer hardware and bundled software
and laboratory diagnostic and test tools.  Capital equipment used in
direct support of an individual Air Force project is charged as other
direct costs in the year acquired rather than depreciated.  DOD's May
1995 report to the Congress recommended requiring FFRDCs to submit an
annual 5-year capital acquisition plan.  According to Aerospace, such
a plan may be impracticable due to rapid changes in personnel,
technology, and equipment. 

Real and leasehold property improvements include building
rehabilitation projects, building equipment replacement, security and
safety requirements, new operational requirements, and seismic
upgrades to meet earthquake protection standards.  On the Aerospace
contract, leasehold amortization has been a reimbursable cost,
whereas building depreciation has been funded primarily through the
Air Force contract fee and other corporate funds. 


      UNREIMBURSED EXPENSES
---------------------------------------------------------- Letter :4.3

In fiscal year 1993, Aerospace spent $1.9 million from fee and other
corporate funds on unreimbursed costs, that it considered ordinary
and necessary to the FFRDC.  Some of these expenses were for
contributions, travel in excess of per diem, spouse and guest meals,
personal use of company-furnished automobiles, and advertising. 
Table 3 summarizes Aerospace's unreimbursed expenditures in fiscal
year 1993. 



                                Table 3
                
                 Aerospace's Unreimbursed Expenses for
                            Fiscal Year 1993

Unreimbursed expense                                            Amount
--------------------------------------------------------------  ------
New business                                                    $521,5
                                                                    00
Contributions                                                   562,00
                                                                     0
Miscellaneous                                                   308,00
                                                                     0
Travel in excess of per diem                                    76,000
Interest expense                                                22,000
Sundry                                                          422,00
                                                                     0
======================================================================
Total                                                           $1,911
                                                                  ,500
----------------------------------------------------------------------

         NEW BUSINESS
-------------------------------------------------------- Letter :4.3.1

According to Aerospace officials, new business expenses are incurred
to broaden Aerospace's involvement in non-DOD business to provide
employment and operational stability for Aerospace during periods of
declining DOD budgets.  The officials said more non-DOD business was
needed because it has been impossible for Aerospace to maintain
employment stability in an environment of budget ceilings and reduced
DOD funding.  Further, they said that broadening the corporation's
non-DOD business base helps slow attrition and retain the skills and
capabilities needed to support the Air Force's space mission. 
Aerospace noted that employment has declined by 27 percent since
1990.  Aerospace believes that inadequate staffing levels could
increase the risk of an expensive program failure, which could lead
to a serious degradation of national security readiness.  Aerospace
also said a broader business base also reduces the overhead costs
allocated to Air Force contracts.  According to Aerospace, the
precedent for new business development was set in the late 1960s.  At
the time, DOD encouraged FFRDCs to make their services available to
other government agencies so that they would transfer their technical
expertise to the civilian sector. 

SMC officials recognize the benefits of new business development
expenses in retaining Aerospace's core capabilities and reducing
overhead costs.  As a result, the officials said they negotiated
reasonable and cost-effective limits on new business expenses in the
contracts with Aerospace.  For example, they agreed to provide
$400,000 for cost-reimbursable, new business expenses in fiscal year
1993.  The officials said they made clear to Aerospace that any new
business expenses in excess of the contract limit were not
reimbursable and could not be charged to the Air Force contract fee. 
However, such restrictions were not expressly incorporated into
Aerospace's contract. 

In addition to the $400,000, Aerospace spent $551,500 on new business
expenses.  Aerospace officials said that $521,500 came from corporate
funds other than the Air Force contract fee and $30,000 was charged
directly to other contracts.  Table 4 shows the new business expenses
incurred by Aerospace during fiscal years 1990 through 1994. 



                                Table 4
                
                   Aerospace New Business Expense for
                     Fiscal Years 1990 Through 1994

                                                Additional
                                   Cost-            amount
                            reimbursable   paid from other
Fiscal year                       limits      fund sources       Total
----------------------  ----------------  ----------------  ==========
1990                             $46,800            $7,800     $54,600
1991                              85,000                 0      59,800
1992                             106,000           211,100     317,100
1993                             400,000           551,500     951,500
1994                           1,200,000           244,900   1,444,900
======================================================================
Total                         $1,837,800        $1,015,300  $2,827,900
----------------------------------------------------------------------
For fiscal year 1995, Aerospace proposed $2.5 million in
cost-reimbursable new business expenses and $400,000 for bid and
proposal expenses.  Aerospace officials said that allocating about 1
percent of its contracts' value for new business was not unreasonable
given the continued reduction in budget ceilings; the government's
commitment in the sponsoring agreement to a special, long-term
relationship; and the avoidance of costs associated with potential
reductions in force.  SMC officials said they negotiated into the
contract a cost-reimbursable amount of $1.2 million for both new
business expenses and bid and proposal expenses, which they believed
was an appropriate amount for the anticipated benefits to the Air
Force.  Air Force Headquarters officials indicate that they intend to
tightly control all non-FFRDC/non-DOD business activities of
Aerospace. 


         CONTRIBUTIONS
-------------------------------------------------------- Letter :4.3.2

Aerospace officials said contributions help in hiring quality
employees, advancing affirmative action goals, and maintaining
favorable relationships within the community.  Major cash
contributions were broadly categorized as either "community affairs
participation" or "gift matching program," and Aerospace spent
$307,000 and $255,000 for these categories, respectively, in fiscal
year 1993.  Under the FAR, contributions generally are not
reimbursable costs.  Accordingly, Aerospace's contributions were not
reimbursed as cost items but were funded from its corporate funds,
which included the Air Force fee.  Aerospace officials said
contributions were ordinary and necessary business expenditures that
were fully disclosed to the Air Force. 

As a result of restrictions on charitable contributions contained in
the fiscal year 1995 National Defense Authorization Act, Aerospace
and SMC agreed that Aerospace would not make any further charitable
contributions from funds obtained from DOD.  This agreement was
incorporated in the fiscal year 1995 contract. 


         MISCELLANEOUS
-------------------------------------------------------- Letter :4.3.3

Miscellaneous expenditures from corporate funds totaled $308,000 for
fiscal year 1993 and included $58,700 for the personal use of company
cars, $143,100 for conference meals and trustee expenses, and
$106,200 for other expenses. 

Aerospace corporate officers were provided company cars.  The FAR
states that the costs of automobiles owned or leased by the
contractor are allowable if they are reasonable and the cars are used
for company business.  Costs relating to the personal use of vehicles
by employees (including transportation to and from work) are
unallowable.  According to Aerospace, the $58,700 charged to
corporate funds for the personal use of company cars was primarily
for transportation to and from work and was reported as taxable
employee income. 

Unreimbursed conference meals and trustee expenses of $143,100 in
fiscal year 1993 included unallowable costs, such as meals for
spouses and guests, that were incurred at trustee and other meetings. 
For example, Aerospace included unreimbursed costs of over $4,000 for
36 spouses and guests at the Collier Award banquet for the Air
Force/industry team that developed the Global Positioning System, of
which Aerospace was a key member.  Aerospace said these unreimbursed
expenses of $143,100 were ordinary and necessary.  Similar
expenditures also were incurred in fiscal year 1994, including bar
charges of $1,764 for 63 people, at a dinner reception during a
trustee meeting in March 1994. 

Aerospace also incurred $106,200 for other miscellaneous expenditures
in fiscal year 1993 that included advertising, employee recreation
activities, and donations of capital equipment. 


         TRAVEL IN EXCESS OF PER
         DIEM
-------------------------------------------------------- Letter :4.3.4

Aerospace said travel expenditures in excess of per diem rates
included $25,000 for airline coupons used to provide business and
first-class upgrades for its corporate officers.  Under the FAR,
airfare costs in excess of the lowest customary standard coach or
equivalent airfare offered during normal business hours are generally
unallowable for cost reimbursement.  Accordingly, Aerospace did not
submit the costs of upgrades as cost-reimbursable items, although it
obtained SMC approval in 1992 to upgrade to business-class air
accommodations for corporate officers on trips longer than 2 hours. 
SMC accepted Aerospace's justification that these upgrades would
enhance officers' productivity.  SMC officials said they might need
to reevaluate whether airline upgrades should be cost-reimbursable
items due to DOD's study to limit fee and new federal guidelines on
travel costs. 


         INTEREST EXPENSE
-------------------------------------------------------- Letter :4.3.5

Interest expense at Aerospace amounted to $22,000 in fiscal year
1993.  Although neither the FAR nor DFARS specifically defines what
are ordinary and necessary expenses for FFRDCs, the contract
operating instruction at SMC cites interest expense as an example of
an unallowable but ordinary and necessary cost of FFRDC operations. 


         SUNDRY
-------------------------------------------------------- Letter :4.3.6

For purposes of this report, sundry includes $422,000 in costs for
(1) certain executive salary and benefits, (2) relocation and special
recruiting expenses, (3) achievement awards, (4) educational
assignments, and (5) bids and proposals.  According to Aerospace,
some of these costs are allowable for cost reimbursement under the
FAR.  However, Aerospace said it paid the costs out of corporate
funds to avoid potential controversies with the Air Force or the
Defense Contract Audit Agency regarding the costs' allowability.  For
example, through fiscal year 1993, Aerospace charged to corporate
funds the portion of the president/chief executive officer's salary
that exceeded the salary for Executive Schedule Level II.  Aerospace
said it charged the president/chief executive officer's entire salary
as a cost-reimbursable item in fiscal year 1994. 


   AEROSPACE'S DISCRETION OVER USE
   OF FEE
------------------------------------------------------------ Letter :5

Existing federal regulations provide general guidance regarding how
fee is to be determined, but do not restrict how a fee may be used
nor define what are ordinary and necessary expenses.  Further,
neither the Air Force sponsoring agreement with Aerospace nor the
annual contract specify how a fee may be used.  Although the Air
Force and Aerospace discuss Aerospace's need for fee and planned use
of fee by cost category, Aerospace exercises some discretion in
spending the fee and determining what expenditures funded from fee
are ordinary and necessary.  Since Aerospace's fee is based on its
need, the manner in which Aerospace uses its corporate resources,
including fee, in any one year may affect its need for an Air Force
fee in the following year. 

Aerospace stated that even though it has discretion regarding the use
of all corporate resources, including Air Force fee, it attempts to
use the resources in a manner that is consistent with the plan
presented to the Air Force.  Aerospace officials told us they
recognize that if Aerospace used its resources in a manner that was
inconsistent with the plan discussed with the Air Force, the Air
Force might attempt to negotiate a reduced fee in subsequent years. 
In this regard, Air Force officials told us Aerospace has an inherent
responsibility to spend its fee in accordance with the justification
of its need, even though it is not specifically required by the
contract to do so. 


   INADEQUATE DEFINITION OF
   ORDINARY AND NECESSARY EXPENSES
------------------------------------------------------------ Letter :6

In establishing the fee provided to defense FFRDCs, the DFARS says
that consideration should be given to funding unreimbursed costs
deemed ordinary and necessary to the FFRDC.  DOD's May 1995 report on
FFRDC fee management recognized that the guidance in the FAR and
DFARS concerning the granting of FFRDC fees is not clear about what
unreimbursed costs are considered ordinary and necessary to FFRDC
operations.  The report recommended that new guidance be developed
and that the use of the undefined and ambiguous term "ordinary and
necessary" be avoided.  The report also recognized the need for
specific examples of appropriate fee use. 

Implementing this recommendation should provide the Air Force with a
better basis for negotiating fee award.  An agreed-upon definition of
ordinary and necessary expenses would assist contracting officers in
resolving issues with other defense FFRDCs.  However, as long as
moneys provided through Air Force fee are commingled with other
funding sources, the Air Force may have difficulty determining how
Aerospace used its FFRDC fee. 


   DOD AND AEROSPACE COMMENTS
------------------------------------------------------------ Letter :7

In commenting on a draft of this report, DOD stated that it did not
dispute the facts contained in the report and indicated that the
report would be helpful in the ongoing DOD efforts to strengthen
FFRDC oversight and use of management fees.  However, DOD said that
none of the data in the report represented improper or illegal
activity, as defined by existing statute or regulation, on the part
of DOD or Aerospace. 

DOD further commented that it was taking positive steps to improve
its FFRDC fee management process.  For example, it said that in the
fiscal year 1996 Aerospace contract, the Air Force would address
specific uses of fee, such as personal use of cars and travel-related
items, through contract provisions or by disallowing the expense. 
Further, DOD said it was actively working to improve the fee
management process based on the findings and recommendations made in
DOD's May 1995 report on fee management, as well as work done by us
and the DOD Inspector General.  DOD's comments are included in their
entirety in appendix I. 

Aerospace provided specific language clarifications.  These changes
were incorporated where appropriate. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :8

We examined Aerospace's proposed fee expenditures and the Air Force's
and Defense Contract Audit Agency's evaluations of Aerospace's
proposals, including audit reports, supporting workpapers, technical
evaluations, and Air Force's price negotiation memorandums.  We also
examined documentation supporting the nature and purpose of selected
actual fee expenditures.  Further, we obtained the views of
Aerospace's officials and cognizant Defense Contract Audit Agency and
Air Force program and contracting officials at Aerospace on factors
affecting the use of fee. 

To determine the regulatory requirements governing the determination
and use of fee, we reviewed applicable Office of Federal Procurement
Policy guidance; FAR and DFARS provisions; Air Force operating
instructions and procedures; and Air Force correspondence, contracts,
and sponsoring agreement with Aerospace.  We reviewed Aerospace's use
of fee for fiscal year 1993 because, at the time we began our work,
it was the most recently completed year for which Aerospace had
submitted its schedule of unreimbursed expenditures. 

We also exchanged information with DOD staff involved in the
congressionally mandated DOD study on FFRDC fees during their study
of the current fee determination process and fee management issues. 

We conducted our work from October 1994 to July 1995 in accordance
with generally accepted government auditing standards. 


---------------------------------------------------------- Letter :8.1

Unless you publicly announce its contents earlier, we plan no further
distribution of this report until 30 days from its issue date.  At
that time, we will send copies to the Secretary of Defense; the
Director, Office of Management and Budget; the Administrator, Office
of Federal Procurement Policy; and other interested congressional
committees.  Copies will also be available to others upon request. 

Please contact me at (202) 512-4587 if you or your staff have any
questions concerning this report.  Major contributors to this report
are listed in appendix II. 

David E.  Cooper
Director, Acquisition Policy, Technology,
 and Competitiveness Issues




(See figure in printed edition.)Appendix I
COMMENTS FROM THE DEPARTMENT OF
DEFENSE
============================================================== Letter 



(See figure in printed edition.)


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix II


   NATIONAL SECURITY AND
   INTERNATIONAL AFFAIRS DIVISION,
   WASHINGTON, D.C. 
-------------------------------------------------------- Appendix II:1

Charles W.  Thompson


   OFFICE OF THE GENERAL COUNSEL
-------------------------------------------------------- Appendix II:2

Ernie E.  Jackson


   LOS ANGELES FIELD OFFICE
-------------------------------------------------------- Appendix II:3

Odi Cuero
Benjamin H.  Mannen
Amborse A.  McGraw