Defense Acquisition: Guidance Is Needed on Payments for Conditionally
Accepted Items (Letter Report, 12/12/97, GAO/NSIAD-98-20).

GAO reviewed the Air Force's procedures for payment to contractors for
work not completed at the time of delivery, focusing on whether: (1)
this situation occurred in other programs; and (2) additional guidance
was needed to avoid paying contractors for work not done at the time of
delivery.

GAO noted that: (1) its review of four selected Air Force, Army, and
Navy acquisition programs showed that each of the services accept items
conditionally; (2) however, federal and Department of Defense (DOD)
regulations do not provide guidance to contracting officers for
determining amounts to be withheld from payments in these cases; (3)
there is no consensus among Office of the Secretary of Defense and
service officials as to what policy should govern payments at the time
of conditional acceptance; (4) some officials agreed that the amount
withheld should reflect the estimated cost and profit associated with
the work to be done by a contractor after delivery while others
indicated that contracting officers should have discretion to withhold
whatever amount they determine appropriate; (5) the extent of service
guidance ranged from the Army providing no guidance to standard Air
Force and Navy contract clauses that leave determining the amount to be
withheld to the contracting officer's discretion; (6) such guidance does
not ensure that the amount withheld reflects the estimated cost and
profit to correct known deficiencies and perform other incomplete work;
(7) as a result, it lacks the safeguards necessary to reduce the
government's risk of financial exposure and is inconsistent with the
policy of paying only for completed work; (8) GAO's review of the four
selected acquisition programs showed that when items were conditionally
accepted, each of the services paid contractors the billing price,
assuming 100-percent completion, less some amount for nonconforming or
unfinished work; (9) in general, the amounts withheld were less than the
costs to correct known deficiencies and complete unfinished work and
resulted in contractors being paid for work that had not been performed
at the time of conditional acceptance; (10) for example, the estimated
price to correct known deficiencies and complete unfinished work on two
C-17 production contracts exceeded the amounts withheld by about $61
million, based on the contractor's cost estimates, or $127 million based
on the cost estimates used by the Defense Contract Management Command in
administering the contract; (11) the Hunter Unmanned Aerial Vehicle
program accepted five systems with six conditional waivers for which no
money was withheld; (12) program officials told GAO that they believed
the contractor would correct the deficiencies; and (13) the program
office was not able to provide an estimate of the potential cost of this
work.

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

 REPORTNUM:  NSIAD-98-20
     TITLE:  Defense Acquisition: Guidance Is Needed on Payments for 
             Conditionally Accepted Items
      DATE:  12/12/97
   SUBJECT:  Military aircraft
             Contract administration
             Contract specifications
             Waivers
             Contractor payments
             Defense contracts
IDENTIFIER:  C-17 Aircraft
             Family of Medium Tactical Vehicles
             Hunter Unmanned Aerial Vehicle
             
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Cover
================================================================ COVER


Report to the Secretary of Defense

December 1997

DEFENSE ACQUISITION - GUIDANCE IS
NEEDED ON PAYMENTS FOR
CONDITIONALLY ACCEPTED ITEMS

GAO/NSIAD-98-20

Defense Acquisition

(707227)


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

  AFMC -
  FAR -
  FMTV -
  DCMC -
  DOD -
  DFARS -
  NAVAIR -
  UAV -
  TACOM -

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


B-278211

December 12, 1997

The Honorable William S.  Cohen
The Secretary of Defense

Dear Mr.  Secretary: 

During prior work on the C-17 program, we noted that the Air Force
generally accepted aircraft with incomplete or deficient work, on the
condition that the contractor complete the work after delivery.\1

Although the Air Force withheld payment for the work not done, the
amounts withheld were less than the estimated cost and profit to
complete this work.  We conducted this review to determine if this
situation occurred on other programs and if additional guidance was
needed to avoid paying contractors for work not done at the time of
delivery. 


--------------------
\1 Conditional acceptance means that a contracting officer has
determined that it is in the government's best interest to accept an
item that does not conform to contract specifications or is otherwise
incomplete with the expectation that the contractor will later
correct nonconformances or complete other work. 


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

When acquiring goods or services by contract, U.S.  government policy
is generally to pay only for completed work.  The purpose of this
policy is to reduce the government's risk of financial exposure in
the event a contractor fails to perform.  In the case of payments at
the time of conditional acceptance, this would generally mean
withholding sufficient funds to cover the estimated cost and profit
associated with completing the work.  This policy of only paying for
completed work is grounded in the prohibition against advance
payments contained in title 31, section 3324 of the United States
Code, which states that "a payment under a contract to provide a
service or deliver an article for the United States Government may
not be more than the value of the service already provided or the
article already delivered." This policy is also evident in the
provisions governing progress payments,\2 which state that agencies
"shall ensure that any payment for work in progress .  .  .  is
commensurate with the work accomplished.  .  .  ."\3 The statutory
exceptions to this policy apply conditions or restrictions to the
transaction.  For example, a written determination is required from
the head of an agency, or his or her designee, that the use of
advance payments is in the public interest. 

These policies are implemented in the Federal Acquisition Regulations
System.  This system consists of the Federal Acquisition Regulation
(FAR), which is the primary authority, and agency acquisition
regulations that implement and supplement the FAR.  The Department of
Defense's (DOD) implementing regulation is the Defense Federal
Acquisition Regulation Supplement (DFARS).  In addition, each of the
military services' acquisition organizations has issued supplemental
guidelines for use in implementing policies and procedures in the FAR
and the DFARS. 

According to the FAR, contracting officers normally should reject
supplies and services that do not conform to contract specifications. 
However, FAR section 46.407 (Nonconforming Supplies or Services)
provides exceptions for those circumstances (such as for reasons of
economy or urgency) in which accepting such supplies or services may
be in the government's best interest.  This section addresses only
situations when the government has decided to accept items with
permanent nonconformances and not require a contractor to correct the
deficiencies after delivery.  In these situations, the FAR recommends
that the contract be modified to reduce the price or provide other
consideration to reflect that the items are less than were specified
in the contract. 


--------------------
\2 Progress payments are a method of interim contract financing in
which the government and a contractor share the financial burden of
contract performance. 

\3 41 U.S.C.  255(e)(1) and 10 U.S.C.  2307(e)(1). 


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

Our review of four selected Air Force, Army, and Navy acquisition
programs showed that each of the services accept items conditionally. 
However, federal and DOD regulations do not provide guidance to
contracting officers for determining amounts to be withheld from
payments in these cases.  We also found that there is no consensus
among Office of the Secretary of Defense and service officials as to
what policy should govern payments at the time of conditional
acceptance.  Some officials agreed that the amount withheld should
reflect the estimated cost and profit associated with the work to be
done by a contractor after delivery while others indicated that
contracting officers should have discretion to withhold whatever
amount they determine appropriate. 

The extent of service guidance ranged from the Army providing no
guidance to standard Air Force and Navy contract clauses that leave
determining the amount to be withheld to the contracting officer's
discretion.  Such guidance does not ensure that the amount withheld
reflects the estimated cost and profit to correct known deficiencies
and perform other incomplete work.  As a result, it lacks the
safeguards necessary to reduce the government's risk of financial
exposure and is inconsistent with the policy of paying only for
completed work. 

Our review of the four selected acquisition programs showed that when
items were conditionally accepted, each of the services paid
contractors the billing price, assuming 100-percent completion, less
some amount for nonconforming or unfinished work.  In general, the
amounts withheld were less than the costs to correct known
deficiencies and complete unfinished work and resulted in contractors
being paid for work that had not been performed at the time of
conditional acceptance.  For example, the estimated price to correct
known deficiencies and complete unfinished work on two C-17
production contracts exceeded the amounts withheld by about $61
million, based on the contractor's cost estimates, or $127 million
based on the cost estimates used by the Defense Contract Management
Command (DCMC) in administering the contract.  The Hunter Unmanned
Aerial Vehicle program accepted five systems with six conditional
waivers for which no money was withheld.  Program officials told us
that they believed the contractor would correct the deficiencies. 
The program office was not able to provide an estimate of the
potential cost of this work. 

The DFARS should be amended to provide departmental guidance on the
amounts to be withheld in cases of conditional acceptance by the
services.  This amendment should require that the amount withheld
when conditionally accepting nonconforming items reflect at least a
reasonable estimate of the cost to correct known deficiencies and to
do other incomplete work remaining at the time of delivery.  If a
contracting officer determines that withholding a lesser amount would
be in the best interests of the government, the determination should
be accompanied by safeguards adequate to protect the government's
interests. 


   GUIDANCE ON CONDITIONAL
   ACCEPTANCE OF ITEMS IS NOT
   ADEQUATE
------------------------------------------------------------ Letter :3

The FAR and the DFARS do not provide guidance for withholding payment
for work to be performed after delivery in situations where the
government conditionally accepts nonconforming or incomplete work. 
Moreover, within the military acquisition community, no consistent
way has been developed for determining whether payments should be
withheld or how to determine the amount to withhold. 

The DOD Director of Defense Procurement told us that a contracting
officer should withhold from payment the estimated cost and profit
for work to be done by the contractor after delivery.  However, Air
Force and Army acquisition officials told us that while the cost and
profit of the remaining work should be a consideration, the amount
withheld, if any, should be left to the discretion of the contracting
officer. 

Air Force supplemental guidance includes a standard contract clause
allowing contracting officers to use their discretion in determining
the amount to be withheld.  The Army provides no supplemental
guidance to the FAR for use in conditionally accepting items and
establishing a withhold amount.  At the Naval Sea Systems Command and
the Naval Air System Command (NAVAIR) procurement and contracting
officials agreed that amounts withheld should directly relate to the
anticipated cost of work to be performed by a contractor after
delivery.  However, contract clauses that the two commands use give a
contracting officer authority to withhold a lesser amount. 

From 1981 through 1992, the Air Force Materiel Command's (AFMC)
Aeronautical Systems Division supplements provided for a standard
contract clause entitled "Correction of Supplies Accepted With
Deficiencies," which called for withholding 10 percent of the price
when conditionally accepting items.  The clause allowed a contracting
officer to use a higher or lower percentage as conditions warranted. 

In July 1997, AFMC revised this clause and left the determination of
the amount withheld to the contracting officer's discretion.  The
revised clause provides a list of factors to consider when deciding
on a withhold amount, including (1) the cost to correct the
deficiencies; (2) any loss of value to the government due to reduced
reliability, increased life-cycle costs, or reduced availability; and
(3) any other factors that may affect government use or cost of
ownership. 

In ship construction and conversion contracts, the Naval Sea Systems
Command uses a standard payment clause that requires a contracting
officer to withhold a percentage of the contract price when a ship is
conditionally accepted.  The clause provides for withholding, as a
performance reserve, the greater of either 1.5 percent of the
contract price or $100,000.  This clause also provides that a
contracting officer may withhold more than the 1.5 percent if he or
she finds that the standard withhold amount is insufficient to cover
the cost to correct deficiencies or complete unfinished work.  The
NAVAIR standard clause entitled "Acceptance Under Fixed-Price
Contracts" allows a contracting officer, under certain conditions, to
accept nonconforming items and to withhold an amount, as he or she
determines appropriate. 

A policy that would require the withholding of at least the estimated
cost and profit in this circumstance or require written justification
for an exception would protect the government's interests and be
consistent with the treatment accorded payments for work that has not
been completed in other instances.  For example, FAR, subpart 32.4,
which implements the advanced payment statutes, requires that
approval of a contracting officer's recommendation for an advance
payment be based on a written determination by an approving official
that such advance payment is in the public interest or facilitates
the national defense. 


   INADEQUATE WITHHOLDS RESULT IN
   CONTRACTORS BEING PAID FOR WORK
   NOT COMPLETED
------------------------------------------------------------ Letter :4

Our review of four selected acquisition programs indicated that each
of the services conditionally accepted nonconforming items, with the
expectation that the contractors would correct known deficiencies and
complete unfinished work.  When conditionally accepting nonconforming
items, each of the services paid contractors the billing prices,
assuming 100-percent completion, less some amount that was withheld
for nonconforming or unfinished work.  The services differed in how
they determined the withhold amounts, but in each case, the amounts
were less than the estimated costs to correct known deficiencies and
complete unfinished work.  As a result, the contractors were paid for
work not yet done. 


      AIR FORCE'S C-17 PROGRAM
---------------------------------------------------------- Letter :4.1

To meet the need for additional long-range airlift, the Air Force
contracted with the McDonnell Douglas Corporation, which later merged
with the Boeing Company, to develop and produce 120 C-17 aircraft. 
As of October 1997, the contractor had delivered 34 production
aircraft, all of which were conditionally accepted by the Air Force
with a number of waivers and deviations that required corrective
action by the contractor.  We reviewed the adequacy of amounts
withheld for eight aircraft conditionally accepted under two
contracts for fiscal years 1990 and 1992, production lots III and IV,
respectively.  At the time of last aircraft delivery for each lot,
the Air Force had withheld a net amount of about $47 million for
problems with such things as computer software and assembly
workmanship and for certain components on which qualification testing
had not been completed.  However, the amount withheld was
significantly less than the estimated cost to correct known
deficiencies and finish other incomplete work. 

Both contracts stipulated that the contracting officer should
withhold a minimum of 10 percent of the contract price when
conditionally accepting aircraft until the contractor completed the
corrective actions.  The lot IV contract, however, allowed the
contracting officer to deviate from this requirement and withhold a
lesser amount.  C-17 program officials stated that they did not
believe 10 percent was reasonable given the aircraft's high price. 
Therefore, starting with lot III, instead of withholding 10 percent
of an aircraft's billing price, the program office and the contractor
agreed to categorize waivers and deviations and establish standard
withhold amounts for each category.  In addition, they agreed to
negotiate specific amounts for unique nonconformances.  However, the
program office did not modify the C-17 contracts to incorporate this
withhold policy. 

Program officials told us that the withhold policy implemented in the
C-17 program was not intended to cover the estimated cost and profit
of the work remaining to be done by the contractor after conditional
acceptance.  They said that withholds were intended only to be an
incentive to the contractor to correct deficiencies and finish other
incomplete work. 

Table 1.1 compares our estimate of what should have been withheld
after the delivery of the last aircraft in each lot with the amounts
actually withheld.  Our review indicated that the cost and profit to
correct deficiencies and complete unfinished work for production lots
III and IV exceeded the $47 million withheld by about $61 million,
based on the contractor's estimates of the cost of the aircraft at
completion, or about $127 million, based on DCMC's estimates of the
cost of aircraft at completion.\4

The final aircraft of lots III and IV were accepted in February and
August 1994, respectively.  At the time of our review, the contractor
was correcting deficiencies and completing unfinished work. 



                               Table 1.1
                
                 Estimates of Unearned Cost and Profit
                   Paid at the Time of Last Aircraft
                 Delivery For C-17 Production Lots III
                                 and IV

                         (Dollars in millions)

                                          Based on:
                        ----------------------------------------------
                        Contractor's estimate           DCMC's
                            at completion       estimate at completion
                        ----------------------  ----------------------
                           Lot                     Lot
                           III  Lot IV   Total     III  Lot IV   Total
----------------------  ------  ------  ======  ------  ------  ======
Price paid at           $1,202  $1,131          $1,202  $1,131
 delivery\a                 .9      .6              .9      .6
Less overpayment in               22.0                    13.2
 price\b
Adjusted price                  1,109.                  1,118.
                                     6                       4
Less earned cost and    1,136.  1,067.          1,082.  1,064.
 profit at delivery          7       2               5       1
Unearned cost and         66.2    42.4           120.4    54.3
 profit
Less amount withheld      29.0    18.3            29.0    18.3
Unearned amount paid     $37.2   $24.1   $61.3   $91.4   $36.0  $127.4
 at delivery
----------------------------------------------------------------------
\a Includes only aircraft contract line items. 

\b The contractor was overpaid due to the government's failure to
decrease the billing price to reflect a transfer of engineering costs
from the lot IV contract to the development contract.  The amount of
overpayment also depends on whether the contractor's or government's
cost estimate is used to compute an adjusted billing price. 


--------------------
\4 These cost estimates were in effect at or shortly after the
delivery of the last aircraft in each lot. 


      ARMY'S TACTICAL VEHICLES
      PROGRAM
---------------------------------------------------------- Letter :4.2

The Army established the Family of Medium Tactical Vehicles (FMTV)
program to replace its aging fleet of 2.5-ton and 5-ton trucks and
vans.  The Army plans to purchase about 85,000 FMTV vehicles over a
30-year period.  In October 1991, the program office awarded a
$1.2-billion contract to Stewart and Stevenson Services, Inc., for
the initial production of
10,843 trucks and vans over 5 years.  In August 1996, the program
office revised the contract to procure these vehicles over a 7-year
period.  As of June 1997, the contract price to produce 11,197 trucks
and vans was $1.36 billion. 

The contractor produced 3,040 vehicles during the program's low-rate
initial production phase.  Nearly all of these vehicles (2,936)
required a retrofit after production to resolve problems.  These
problems had been identified prior to acceptance during early
testing.\5 The government conditionally accepted 1,941 of these
vehicles prior to retrofitting them.  Many of these vehicles required
an extensive retrofit effort, dismantling them down to the frame. 

The program office applied three different payment withholds, related
to retrofit requirements, against the 1,941 vehicles.  One withhold
was for parts that were missing when the trucks were conditionally
accepted.  A second was imposed on vehicles accepted before the
completion of first article testing, and a third involved
deficiencies in the contractor's quality control system.  These
withholds were released to the contractor after each vehicle had been
retrofitted and accepted by the government. 

The second withhold was required by the contract's conditional
acceptance clause.  This clause required that 10 percent of the
billing price be withheld for those vehicles conditionally accepted
prior to completion and approval of first article testing.  The
10-percent figure was negotiated between the program office and the
contractor.  It did not bear any relationship to a projected cost
estimate for retrofitting delivered trucks after testing was
completed.  A contracting officer with the U.S.  Army Tank-Automotive
and Armaments Command (TACOM) said that this clause was included in
the FMTV contract based on experience with the previous M939A2 5-ton
truck program.\6

The third withhold was implemented later in the program because of
government concerns that the vehicles did not conform to contract
specifications because of inadequate contractor quality control.  In
July 1995, the program office modified the contract's conditional
acceptance clause to require an additional withhold amount on program
year 1 and
2 vehicles.  It involved withholding $2,000 for each vehicle built
prior to April 11, 1994, and $1,000 for each vehicle built on or
after this date.  FMTV program officials were unable to provide an
analytical basis for the two withhold amounts.  Contracting files
indicated that this withhold was implemented as an incentive to the
contractor to improve his quality control system, thereby reducing
the government's risk in conditionally accepting vehicles. 

DCMC had estimated that the cost could be as high as $24 million to
retrofit vehicles but had not developed a detailed estimate that we
could use to evaluate the reasonableness of the amounts withheld. 
However, on the basis of the actual costs to retrofit these vehicles,
we estimated the cost to retrofit the 1,941 vehicles conditionally
accepted and compared that estimate to the amounts withheld related
to the retrofit.  As shown in table 1.2, we estimated the cost to
retrofit the 1,941 vehicles exceeded the amounts withheld by about $2
million.  At the time of our review, the retrofit required at the
time of conditional acceptance had been accomplished. 



                               Table 1.2
                
                  Estimate of Unearned Costs Paid for
                Vehicles Conditionally Accepted Prior to
                                Retrofit

                         (Dollars in millions)

                                  Number                      Unearned
                                      of                Less    amount
                                vehicles            withhold   paid at
                                      \a      Cost    amount  delivery
------------------------------  --------  --------  --------  --------
Retrofitted                        2,917   $32.0\a
Accepted but not retrofitted          19       0.2
======================================================================
Total requiring retrofit           2,936      32.2
Less: vehicles not accepted          995       9.6
 prior to retrofit
Conditionally accepted prior       1,941     $22.6   $20.6\a      $2.0
 to retrofit
----------------------------------------------------------------------
\a Actual. 


--------------------
\5 The remaining 104 vehicles were produced when the other vehicles
were being retrofitted, and the modifications were incorporated
during production. 

\6 In that program, the contractor, which had been paid the full
price, was required to retrofit about 2,500 trucks to correct
nonconformances found during testing.  The contractor was planning to
do the retrofit work during breaks in new truck production or at the
end of the program.  TACOM officials convinced the contractor that
leaving the retrofit work until the end would not be acceptable. 


      NAVY'S CONVERSION OF
      COMMERCIAL CONTAINER SHIPS
---------------------------------------------------------- Letter :4.3

To improve the Military Sealift Command's prepositioning and surge
sealift programs, the Navy is converting commercial container ships
into roll-on roll-off sealift ships.  Three ships are being converted
under a contract with the National Steel and Shipbuilding Company. 
We reviewed the adequacy of the payment withholds for one of these
ships, the USNS Shughart, which the Navy conditionally accepted on
May 7, 1996.  The contract for these ships contained the standard
Naval Sea Systems Command clause that provides for a 1.5-percent
performance reserve at the time of conditional acceptance but allows
for a greater withhold as determined necessary by the contracting
officer. 

At the time of the USNS Shughart's conditional acceptance, the Navy
project officer recommended withholding about $10.3 million for
critical incomplete work and other deficiencies.  However, there was
only about $9.5 million available to withhold from the ship's $289.7
million billing price because the Naval Sea Systems Command, with
appropriate higher approval, had already released $5 million in prior
progress payment retentions to the contractor.  Accordingly, the
project officer recommended and the contracting officer withheld the
$9.5 million.  At the time of our review, the contractor had
generally completed work and corrected deficiencies identified at the
time of conditional acceptance. 


      JOINT TACTICAL UNMANNED
      AERIAL VEHICLE PROGRAM -
      HUNTER SYSTEM
---------------------------------------------------------- Letter :4.4

The Hunter Unmanned Aerial Vehicle (UAV) is a small, fixed-wing
aircraft piloted remotely from a ground control station.  The Hunter
system, a part of the Joint Tactical UAV program, began in 1989 as a
joint service effort to provide short-range UAVs for use by the Army,
the Navy, and the Marine Corps.  The Hunter system contract is
administered by NAVAIR.  In February 1993, this command exercised
contract options with TRW, Incorporated, for the low-rate initial
production of seven Hunter systems.  In January 1996, DOD decided to
end the Hunter Program at the end of the low-rate initial production
contract. 

Between April and August 1995, the government conditionally accepted
five Hunter systems, and it has since accepted, on an incremental
basis, the remaining two systems.  The cumulative billing price for
the five complete systems was about $128.5 million.  From this, the
government withheld about $1.6 million for missing parts,
nonconforming items, and other incomplete work. 

Although the contracting officer withheld payment for the above noted
work, he did not withhold for other deficiencies.  The contracting
officer had issued 34 separate contractual waivers to prevent
acceptance delays because the systems did not conform to contract
specifications.  Six of these waivers were temporary in nature and
were approved on the condition that corrective action would be taken
after delivery.  These waivers involved hardware and software
problems, subcontractor workmanship deficiencies, and incomplete
work. 

The contracting officer did not withhold from the billing price the
estimated cost to correct these deficiencies because program
officials believed that the contractor was committed to correcting
the deficiencies.  However, not withholding funds based on the belief
that the contractor will perform requires the government to assume a
major risk in the event of nonperformance and is not consistent with
a policy that requires paying only for completed work.  Because the
system had been terminated, we were unable to readily determine the
status of the unfinished work.  In commenting on a draft of this
report, DOD stated that the contractor has since corrected the six
deficiencies and the government has accepted, on a final basis, all
of the systems. 


   CONCLUSION AND RECOMMENDATIONS
------------------------------------------------------------ Letter :5

When the government chooses to conditionally accept nonconforming
items, the FAR, the DFARS, and supplementary service regulations do
not require that an amount sufficient to cover the remaining work be
withheld from the contract payment.  As a result, the services'
withholding practices are inconsistent and contractors are being paid
for work not completed at the time of delivery. 

We recommend that the Secretary of Defense amend the DFARS to require
that, when conditionally accepting nonconforming items, amounts
withheld be at least sufficient to cover the cost and related profit
to correct deficiencies and complete other unfinished work.  If the
contracting officer determines that withholding a lesser amount is in
the best interests of the government, such a determination should be
properly documented and justified in the contract files. 


   AGENCY COMMENTS AND OUR
   EVALUATION
------------------------------------------------------------ Letter :6

DOD generally concurred with the report's findings, however, it only
partially concurred with our recommendation.  DOD agreed that the
DFARS should be changed to include a requirement that when
conditionally accepting nonconforming items, amounts to be withheld
should at least cover the cost and related profit to correct
deficiencies and complete unfinished work.  DOD did not agree that
the contracting officer should be required to obtain higher level
approval before deviating from this general policy.  DOD's comments
are reprinted in appendix I.  Technical comments have been addressed
in the report as appropriate. 

While we continue to believe that certain safeguards would help
ensure adherence to the policy of only paying for work that is
completed, revising the DFARS to specifically include the requirement
is a good first step toward achieving this goal.  DOD assumes that
departure from the prescribed standard would be rare.  We do not have
information on a sufficient number of programs to address DOD's
assumption.  Accordingly, we have modified our recommendation to
delete the requirement for higher level approval of decisions to
depart from the prescribed standard.  We continue to believe,
however, that requiring such departures to be justified and
documented in the contract file will facilitate further oversight of
this issue as needed. 


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

We reviewed the FAR, the DFARS, and supplementary service regulations
regarding conditional acceptance of nonconforming items.  We also
spoke with the DOD Director of Defense Procurement and with
acquisition and contracting officials from the Departments of the Air
Force, the Army, and the Navy and the Defense Logistics Agency
located in Washington, D.C., to determine their policies and
procedures for accepting temporarily nonconforming items. 

We selected four acquisition programs that had entered low- or
full-rate production to obtain coverage of Air Force, Army, Navy, and
joint service programs.  In addition, our selections were based on
the size of the programs and the availability of documentation on the
acceptance process.  We reviewed contract files, billing and delivery
documentation, and cost data.  To gain an understanding of how
conditional acceptance was implemented in each of the services, we
interviewed contracting and procuring officials with the (1) C-17
program office in Dayton, Ohio; (2) FMTV program office located at
the Army's Tank-Automotive and Armaments Command in Warren Michigan;
(3) Supervisor of Shipbuilding and Conversion in San Diego,
California; and (4) Joint Tactical UAV project office at Redstone
Arsenal, Alabama.  We also discussed management of the various
contracts with contracting personnel at the DCMC offices located at
the Boeing Company in Long Beach, California; TRW Avionics and
Surveillance Group in San Diego, California; and Stewart and
Stevenson Services, Inc., in Sealy, Texas. 

Because we confined our review to defense programs, we have limited
our recommendation to the DFARS.  However, we will provide copies of
this report to the FAR Council, the group responsible for approving
changes to the FAR, for their consideration. 


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


Please contact me at (202) 512-4841 if you or your staff have any
questions concerning this report.  Major contributors to this report
are listed in appendix II. 

Sincerely yours,

Louis J.  Rodrigues
Director, Defense Acquisitions Issues




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


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


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

Thomas J.  Denomme
Noel J.  Lance
Carlos M.  Garcia
Dorian R.  Dunbar
John A.  Carter

*** End of document. ***