Overhead Costs: Unallowable Costs Charged by Rockwell Corporation,
Rocketdyne Division (Letter Report, 12/09/94, GAO/NSIAD-95-41).

GAO reviewed the overhead cost submissions of the Rockwell Corporation's
Rocketdyne Division--a major NASA contractor--and found that about
$222,000 of the costs in Rocketdyne's fiscal year 1990 and 1992 overhead
submissions were unallowable. This amount represents about five percent
of the $4.8 million in overhead costs reviewed and 2.6 percent of the
$8.6 million charged in total to the reviewed accounts. These
percentages of unallowable costs cannot be generalized to the total
overhead charges of $8.66 million because GAO reviewed only those
accounts that it believed were more susceptible to unallowable charges.
Rocketdyne included the unallowable costs in its overhead submissions
mainly because accounting personnel did not have accurate instructions
on allowable membership fees and because of weaknesses in Rockwell and
Rocketdyne procedures for handling outside legal services. Rocketdyne
would have been reimbursed for the fiscal year 1990 unallowable costs in
part because the Defense Contract Audit Agency (DCAA) did not review the
company's legal expenses and did not follow up on information it did
obtain on membership fees. At the time of GAO's review, DCAA had not
audited Rocketdyne's fiscal year 1992 submission.

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

 REPORTNUM:  NSIAD-95-41
     TITLE:  Overhead Costs: Unallowable Costs Charged by Rockwell 
             Corporation, Rocketdyne Division
      DATE:  12/09/94
   SUBJECT:  Overhead costs
             Accounting procedures
             Contract administration
             Questionable payments
             Legal fees
             Lobbying activities
             Department of Defense contractors
             Contract costs
             Cost accounting standards compliance
             Aerospace contracts

             
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Cover
================================================================ COVER


Report to the Chairman, Committee on Government Operations, House of
Representatives

December 1994

OVERHEAD COSTS - UNALLOWABLE COSTS
CHARGED BY ROCKWELL CORPORATION,
ROCKETDYNE DIVISION

GAO/NSIAD-95-41

Overhead Costs


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

  DCAA - Defense Contract Audit Agency
  DOE - Department of Energy
  FAR - Federal Acquisition Regulation
  NASA - National Aeronautics and Space Administration

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


B-257598

December 9, 1994

The Honorable John Conyers, Jr.
Chairman, Committee on Government Operations
House of Representatives

Dear Mr.  Chairman: 

As you requested, we reviewed a major National Aeronautics and Space
Administration (NASA) contractor's overhead cost submissions to
determine whether they included unallowable costs.  We also attempted
to determine the extent to which questioned costs that the Defense
Contract Audit Agency (DCAA) identified in its audit of the
contractor's overhead submissions were sustained. 

This report contains the results of our work at Rockwell
International Corporation, Rocketdyne Division, Canoga Park,
California.  The results of a prior review of another major NASA
contractor were reported to you in June 1994.\1


--------------------
\1 Overhead Costs:  Costs Charged By McDonnell Douglas Aerospace's
Space Station Division (GAO/NSIAD-94-150, June 23, 1994). 


   BACKGROUND
------------------------------------------------------------ Letter :1

Overhead cost submissions are used to establish final overhead rates
that determine reimbursements under cost-type contracts and to
provide the historical cost basis for overhead rates that are used to
negotiate fixed- price contracts.  The Federal Acquisition Regulation
(FAR) cost principles require government contractors to identify and
exclude unallowable costs from overhead submissions. 

The Department of Defense provides administrative contract support to
NASA at Rocketdyne.  The overhead submissions are reviewed by DCAA
for allowability.  About 80 percent of Rocketdyne's sales are under
government cost reimbursable-type contracts. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

About $222,000 of the costs we reviewed in Rocketdyne's fiscal year
1990 and 1992 overhead submissions was unallowable.  This amount
represents about 5 percent of the approximately $4.8 million of costs
reviewed and about 2.6 percent of the approximately $8.6 million
charged in total to the reviewed accounts.  These percentages of
unallowable costs cannot be generalized to the total overhead charges
of $866 million because we reviewed only those accounts that we
believed were more susceptible to unallowable charges.  Rocketdyne
included the unallowable costs in its overhead submissions primarily
because accounting personnel did not have accurate instructions on
allowable membership fees and because of weaknesses in Rockwell and
Rocketdyne procedures for handling costs of outside legal services. 
Rocketdyne said it is implementing revised procedures to ensure that
unallowable costs are properly recorded in the future. 

Rocketdyne would have been reimbursed for the fiscal year 1990
unallowable costs in part because DCAA did not review the company's
legal expenses and did not follow up on information it did obtain on
certain membership fees.  At the time of our review, DCAA had not
conducted its audit of Rocketdyne's fiscal year 1992 submission. 

The extent to which DCAA-questioned costs were sustained was not an
issue because DCAA did not question any costs in its reviews of
Rocketdyne's overhead submissions for fiscal years 1988 and
1989---the most recent years for which final overhead rate
negotiations were complete. 


   UNALLOWABLE COSTS
------------------------------------------------------------ Letter :3

At the time of our review, neither Rocketdyne's fiscal year 1990 nor
1992 overhead submissions had been settled.  Rocketdyne has agreed to
withdraw the approximately $222,000 we identified as unallowable
costs in its overhead submissions.  The unallowable costs included
costs for legal fees, lobbying, public relations, contributions,
employee education, and training for consultants. 


      LEGAL COSTS
---------------------------------------------------------- Letter :3.1

According to FAR 31.205-47, costs incurred in connection with any
proceeding brought by a state government alleging a violation of law
or regulation that results in civil penalties are unallowable. 
Rocketdyne, however, paid civil penalties as a result of
environmental lawsuits brought by the State of California in fiscal
years 1990 and 1992 and included the outside legal expenses ($59,600)
incurred in connection with these lawsuits in its fiscal year 1990
and 1992 overhead submissions. 

Also included in Rocketdyne's overhead submissions was a double
payment of about $25,400 to the law firm that represented Rocketdyne
in one of the lawsuits.  Rocketdyne has received a refund from the
firm for the double payment and has agreed to remove the $25,400 from
its overhead submission along with the $59,600 in legal fees. 


      LOBBYING
---------------------------------------------------------- Letter :3.2

FAR 31.205-22 states that costs incurred in attempts to influence the
introduction of legislation or the enactment or modification of
pending federal legislation through communication with any Member or
employee of Congress are unallowable.  We identified about $42,000 of
lobbying costs that Rocketdyne included in its fiscal year 1990 and
1992 overhead submissions.  Rocketdyne has agreed to remove the
$42,000 from its overhead submissions. 

The lobbying costs were incurred primarily for outside professional
services.  For example, Rocketdyne paid a law firm about $33,200 to
lobby for Clean Air Act amendments.  Rocketdyne has agreed to remove
this payment from its overhead submission. 

Most of the remaining lobbying cost concerned membership fees paid to
an organization engaged in lobbying.  Rocketdyne included $6,300 for
membership fees paid to the American Nuclear Energy Council in its
fiscal year 1992 overhead submission.  Rocketdyne has agreed to
remove the $6,300 from its overhead submission. 


      PUBLIC RELATIONS
---------------------------------------------------------- Letter :3.3

FAR 31.205-1 identifies unallowable public relations costs as those
whose primary purpose is to promote the sale of products and services
by stimulating interest in a product or product line or by enhancing
a company's image.  We identified about $25,100 in unallowable public
relations costs in Rocketdyne's fiscal year 1990 and 1992 overhead
submissions.  For example, Rocketdyne included in its fiscal year
1990 overhead submission $25,000 for dues it paid to the U.  S. 
Council for Energy Awareness.  Representatives of Rocketdyne's
Atomics International component, which conducts business in both the
space and land-based nuclear power arena, justified this membership
on the basis that the Council does "more than any other organizatin
[sic] to educate Americans on the absolute necessity of a U.  S. 
energy policy.  .  .  leading to the construction and operation of
many of these [nuclear] power plants as soon as possible."
Furthermore, the Council's own literature shows that its mission is
to foster public understanding of the advantages of nuclear power
plants through advertising and public relations.  Rocketdyne has
agreed to remove $25,100 from its overhead submissions. 


      CONTRIBUTIONS
---------------------------------------------------------- Letter :3.4

Except for costs of participation in community service activities
such as blood bank or charity drives, contributions or donations,
including cash, property, or services, regardless of the recipient,
are unallowable under FAR 31.205-8.  We identified contributions
totaling about $21,800 that Rocketdyne included in its fiscal year
1990 and 1992 overhead submissions. 

Rocketdyne made the majority of these contributions, $7,000 in fiscal
year 1990 and $9,000 in fiscal year 1992, to California State
University, Northridge.  As a result of our review, Rocketdyne has
agreed to withdraw the $16,000 from its overhead submissions. 

Rocketdyne also included about $3,800 in its overhead submissions for
amounts it paid to a professional organization in excess of
membership fees.  Rocketdyne paid $5,000 to the Institute for Space
Nuclear Power Studies of the University of New Mexico, which was
$3,270 above the membership fee for that organization.  DCAA audit
guidelines identify such payments in excess of membership fees as
contributions.  Rocketdyne has agreed to withdraw $3,800 from its
overhead submissions. 

Rocketdyne included about $1,890 in its fiscal year 1992 overhead
submission for food and beverage services provided to attendees of a
Department of Energy (DOE) conference held at Florida International
University.  DOE held this conference to evaluate and monitor the
progress of grantee universities under two DOE educational programs
for minority students.  Rocketdyne was under contract with DOE to
help evaluate the progress of the universities under their grants. 
However, the contract did not require Rocketdyne to pay for food and
beverage services for this conference.  Consequently, we believe this
$1,890 is a contribution, since Rocketdyne had no contractual
obligation with DOE to pay for the services and had no business
interest with the DOE grantees.  Rocketdyne has agreed to remove this
cost from its submission. 


      EMPLOYEE EDUCATION
---------------------------------------------------------- Letter :3.5

Under FAR 31.205-44(d), costs associated with full-time education at
the undergraduate level are unallowable.  We identified about $18,700
in the fiscal year 1990 overhead submission for one employee's
full-time education at the undergraduate level and $18,030 in the
fiscal year 1992 overhead submission for another employee.  Both of
these employees were on leave of absence from Rocketdyne for about 36
months to obtain Bachelor of Science degrees.  During this time, they
attended school full-time, and Rocketdyne reimbursed one a total of
$18,700 and the other $30,220 (including $12,190 for an earlier
period) for educational expenses.  Rocketdyne has agreed to remove
these costs from its overhead submissions, and it said it is revising
its educational policy to discontinue reimbursement of full-time
education at the undergraduate level. 


      TRAINING FOR CONSULTANTS
---------------------------------------------------------- Letter :3.6

According to FAR 31.205-44(i), training or education costs for other
than bona-fide employees are unallowable.  However, Rocketdyne
included about $7,000 in its fiscal year 1992 overhead submission for
costs associated with training two Rocketdyne consultants. 
Rocketdyne has agreed to withdraw the $7,000 from its overhead
submission. 


      OTHER UNALLOWABLE COSTS
---------------------------------------------------------- Letter :3.7

Rocketdyne agreed to remove other unallowable costs totaling about
$4,500 from its overhead submissions, including costs allocable to
other Rockwell divisions and other erroneous billings. 


   FACTORS CONTRIBUTING TO
   UNALLOWABLE COSTS IN OVERHEAD
   CLAIMS
------------------------------------------------------------ Letter :4

FAR requires contractors to identify unallowable costs in their
accounting records and exclude them from any submission.  Rocketdyne
procedures require that unallowable costs be recorded in an
unallowables account.  However, Rocketdyne failed to identify certain
costs as unallowable and, therefore, recorded them as allowable. 
Also, inattention by DCAA contributed to the unallowable costs going
undetected. 

Rocketdyne's failure to record expenses as unallowable was primarily
due to erroneous instructions for recording the costs of membership
fees and weaknesses in procedures for handling the costs of outside
legal services.  Improperly recorded membership fees totaled over
$54,500 and, as previously discussed, concerned lobbying,
contributions, and public relations.  Improperly recorded legal
expenses totaled over $118,000 and, as previously discussed,
concerned legal costs for environmental lawsuits, lobbying, and
duplicate payments. 

The legal fees in question were paid by Rockwell International's
corporate headquarters.  For outside legal service fees, Rockwell
sends each benefiting division (including Rocketdyne) information on
its share of the cost.  Each division then enters the cost in its
accounting records, including unallowable accounts.  However, for the
costs we questioned, Rockwell did not advise Rocketdyne that the
legal expenses were unallowable until about a year after sending the
divisions the initial cost information, and then it did not identify
how much was unallowable.  As a result of our review, Rockwell said
it has revised its procedures and now provides information on
unallowable legal costs at the time it advises its divisions of their
share of the legal expenses. 

Rocketdyne also failed to properly record certain membership fees as
unallowable costs.  Rocketdyne relies on Rockwell instructions to
decide which organization's fee is an allowable cost and which is
not.  These instructions stated that membership fees for the
organizations we questioned were allowable.  Rocketdyne stated that
Rockwell was changing its instructions on the organizations we
questioned as a result of our review. 

DCAA had reviewed membership fees but not legal expenses in its last
two audits of Rocketdyne's overhead submissions.  It also raised
questions about Rocketdyne's failure to record certain membership
fees as unallowable.  However, it dropped the questioned costs from
its final report on Rocketdyne's overhead submissions because DCAA
believed that it would not be "cost effective" to settle "such
subjective" issues. 


   SUSTENTION OF DCAA FINDINGS
------------------------------------------------------------ Letter :5

NASA has delegated the authority for negotiating final overhead rates
at Rocketdyne to the resident administrative contracting officer. 
Since DCAA questioned no costs in 1990, and for the previous 2 years,
the sustention rate on DCAA-questioned costs during the negotiation
of final overhead rates was not an issue. 


   DCAA REPORT ON ROCKETDYNE'S
   NONCOMPLIANCE
------------------------------------------------------------ Letter :6

On September 26, 1994, subsequent to our review, DCAA issued a report
on its review of Rocketdyne's compliance with Cost Accounting
Standard 405.  This standard, in part, requires a contractor to
identify and exclude from any billing, claim, or proposal applicable
to a government contract those costs that are expressly unallowable
under FAR or mutually agreed to be unallowable. 

DCAA concluded that audits of Rocketdyne's overhead claims for fiscal
year's 1990 and 1993 disclosed that Rocketdyne's failure to comply
with the standard resulted in an increased cost to the government. 
Thus, according to DCAA, Rocketdyne was in noncompliance with the
standard and FAR. 

DCAA recommended that Rocketdyne reassess the adequacy of its
screening process for unallowable costs and ensure that individuals
responsible for the screening are fully trained.  While Rocketdyne
believes it has an effective system to comply with the Cost
Accounting Standards and FAR, it has agreed to strengthen its
screening process. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :7

We selected Rocketdyne because about 80 percent of its sales are to
NASA under cost-reimbursable contracts.  To select the overhead cost
accounts for review, we considered the sensitivity of the
accounts--high probability of unallowable charges--and the
significance of expenditures, including increases from year to year. 
In reviewing the accounts, we examined source documents to determine
the nature and purpose of the expenses in relation to FAR's cost
principles in effect at the time. 

The accounts selected had a total value of about $8.6 million, and we
examined transactions with a total value of about $4.8 million.  Our
findings, however, cannot be generalized to the total fiscal year
1990 and 1992 overhead submissions (about $866 million) because we
used a judgmental sample selecting accounts that we believed were
more susceptible to unallowable charges. 

We reviewed DCAA audit reports on overhead costs and related working
papers to determine the scope and depth of coverage and the adequacy
of transaction testing\2 necessary to establish allowability,
allocability, and reasonableness of expenses included in the overhead
submissions.  We also reviewed Rocketdyne audits and related working
papers to assess the adequacy of Rocketdyne's internal controls for
preparing accurate overhead submissions.  In addition, we reviewed
overhead negotiation records the government contract administration
office provided to determine the extent to which DCAA-questioned
costs were sustained in the final indirect rate settlements. 

We performed our review between July 1993 and June 1994 in accordance
with generally accepted government auditing standards.  As agreed
with your office, we did not obtain written agency comments on a
draft of this report.  However, we discussed our results with
officials from DCAA, NASA, and Rocketdyne and incorporated their
comments


--------------------
\2 Transaction testing is a process that traces expenditures to
supporting documentation to determine whether the expenditures are
allowable.  It also assesses the adequacy of a contractor's internal
controls. 


---------------------------------------------------------- Letter :7.1

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 NASA Administrator; the
Secretary of Defense; the Directors, Defense Logistics Agency, DCAA,
and Office of Management and Budget; and other interested
congressional committees.  Copies will also be made available to
others upon request. 

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

Sincerely yours,

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


MAJOR CONTRIBUTORS TO THIS REPORT
=========================================================== Appendix I


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

Charles W.  Thompson


   LOS ANGELES REGIONAL OFFICE
--------------------------------------------------------- Appendix I:2

Ronald A.  Bononi
Larry Aldrich
Kenneth Roberts
George Vissio
