DOD Contract Management: Greater Attention Needed to Identify and Recover
Overpayments (Letter Report, 07/19/1999, GAO/NSIAD-99-131).

Pursuant to a congressional request, GAO updated its previous report on
the Department of Defense's (DOD) overpayments to contractors and
subsequent refunds to the Defense Finance Accounting Service (DFAS),
focusing on: (1) DOD's efforts to identify and recover overpayments made
through fiscal year (FY) 1998; and (2) whether 13 contractors were
retaining overpayments and how quickly overpayments were refunded.

GAO noted that: (1) in the 5 years between FY 1994 and 1998, defense
contractors returned about $4.6 billion to the DFAS Columbus Center--in
FY 1998, $746 million; (2) the Center attributes most of the returned
money to overpayments caused by factors outside its control; (3)
however, payment errors by the Center were also a factor; (4) it took
about a year, on average, before the 13 contractors refunded
overpayments of $56.2 million to the Center; (5) in addition, four of
the contractors were still retaining overpayments totalling $1.1
million; (6) after GAO brought these overpayments to the contractors'
and the government's attention, the contractors refunded the
overpayments; (7) a Defense Contract Management Command area office also
instructed its personnel to ask contractors reporting overpayments to
immediately return the money; (8) in some cases, government personnel
were aware of the overpayments, but they did not take timely action to
obtain recovery; (9) under law, there is no requirement for contractors
who have been overpaid to notify the government of overpayments or to
return overpayments prior to the government issuing a demand letter;
(10) the Center has a sizable and growing backlog of contracts waiting
to be examined to ensure that contractors were properly paid--a process
called reconciliation; (11) reconciliation has often resulted in claims
against contractors for overpayments; (12) the longer a contract remains
unreconciled, the longer any overpayment identified through
reconciliation will remain undetected, and the greater will be the
government's loss of the timely use of these monies; and (13) further,
delays in seeking return of overpayments may result in increased
difficulty in collection or actual monetary loss to the government.

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

 REPORTNUM:  NSIAD-99-131
     TITLE:  DOD Contract Management: Greater Attention Needed to
	     Identify and Recover Overpayments
      DATE:  07/19/1999
   SUBJECT:  Department of Defense contractors
	     Overpayments
	     Federal agency accounting systems
	     Financial management
	     Contract oversight
	     Defense procurement
	     Refunds to government
	     Internal controls
	     Accountability
	     Contractor payments

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ns99131 

GAO/NSIAD-99-131

A Report to the Honorable Tom Harkin U. S. Senate

July 1999 DOD CONTRACT MANAGEMENT

Greater Attention Needed to Identify and Recover Overpayments

National Security and International Affairs Division

B-280329 Letter July 19, 1999 The Honorable Tom Harkin United
States Senate

Dear Senator Harkin: In October 1997, we reported to you that from
October 1992 through April 1997, defense contractors refunded $5.
1 billion to the Defense Finance and Accounting Service's (DFAS),
Columbus Center, the largest Department of Defense (DOD) payment
center, and we discussed the reasons for the

refunds. As requested, we (1) updated this information through
fiscal year 1998 and (2) visited 13 contractor locations to
ascertain if the contractors were retaining overpayments and how
quickly overpayments were refunded. We also obtained information
on the backlog of contracts waiting to be examined for possible
overpayment.

Results in Brief In the 5 years between fiscal year 1994 and 1998,
defense contractors returned about $4. 6 billion to the Columbus
Center-- in fiscal year 1998, $746 million. The Center attributes
most of the returned money to overpayments caused by factors
outside its control. However, payment errors by the Center were
also a factor.

It took about a year, on average, before the 13 contractors
refunded overpayments of $56.2 million to the Center. In addition,
four of the contractors were still retaining overpayments totaling
$1. 1 million. After we brought these overpayments to the
contractors' and the government's attention, the contractors
refunded the overpayments. A Defense Contract Management Command
area office also instructed its personnel to ask contractors
reporting overpayments to immediately return the money. In some
cases, government personnel were aware of overpayments, but they

did not take timely action to obtain recovery. Under current law,
there is no requirement for contractors who have been overpaid to
notify the government of overpayments or to return overpayments
prior to the government issuing a demand letter. 1 1 A demand
letter is a formal notification to the contractor to pay money
owed the government.

The Center has a sizable and growing backlog of contracts waiting
to be examined to ensure that contractors were properly paid a
process called reconciliation. Reconciliation has often resulted
in claims against contractors for overpayments. The longer a
contract remains unreconciled, the longer any overpayment
identified through reconciliation will remain undetected, and the
greater will be the government's loss of the timely use of these
monies. Further, delays in seeking return of overpayments may
result in increased difficulty in collection or actual monetary
loss to the government. We are making recommendations to the
Secretary of Defense to improve the process for identifying and
collecting overpayments.

Background In August 1988, the Defense Logistics Agency
established a finance center in Columbus, Ohio, to consolidate
contract payments and other functions

previously performed at 20 agency sites. In January 1991, the
Agency's finance operations at Columbus became part of DFAS, a
consolidated DOD finance and accounting function under the DOD
Comptroller. According to the Columbus Center, in fiscal year
1998, it paid about $70.5 billion on over 1 million invoices.

DOD's payment process involves several organizations, including
DFAS. Some of the organizations are the Defense Contract
Management Command (DCMC), which administers contracts, and the
Defense Contract Audit Agency (DCAA), which reviews contractors'
records, internal controls, and billing systems. The contractors
that perform the contracted work and bill the government are also
involved in the process. Contractors retaining overpayments is not
a new issue. In 1994, based on our work at nine contractor
locations, we reported that while each contractor had returned
some overpayments, all were retaining additional overpayments. 2

2 DOD Procurement: Overpayments and Underpayments at Selected Contractors Show Major Problem (

GAO/NSIAD-94-245
, Aug. 5, 1994).
2 DOD Procurement: Overpayments and Underpayments at Selected
Contractors Show Major Problem (  GAO/NSIAD-94-245 , Aug. 5,
1994).

Refunds Amount to Between fiscal year 1994 and 1998, the Columbus
Center received refunds Hundreds of Millions of from defense
contractors totaling $4.6 billion. The amounts have declined since
fiscal year 1996. (See fig. 1.) Dollars a Year

Figure 1: Refunds from Defense Contractors Dollars in millions

1,200 1,000

800 600 400 200

0 94 95 96 97 98

Fi sca l year

Total amounts received Source: DFAS, Columbus.

According to the Columbus Center, $3.6 billion of the $4.6 billion
it received was due to factors outside its control, such as
downward contract price adjustments that resulted in overpayments.
The remaining $984 million was attributable to Center payment
errors, such as paying the same invoice twice, making erroneous
progress payment liquidations, and misreading invoice amounts.

As indicated in figure 2, Center payment errors decreased from
fiscal year 1994 to 1997 but increased in fiscal year 1998.
According to Center personnel, the increase was due to a computer
problem resulting in two overpayments to one contractor, one for
$20 million and another for

$10 million. The overpayments were promptly returned, and DFAS
said the computer problem was immediately corrected.

Figure 2: Contractor Refunds by Reason Dollars in millions

900 800 700 600 500 400 300 200 100

0 94 95 96 97 98

Fiscal Year

DFAS payment error Contract administration and other non- DFAS
actions

Source: DFAS, Columbus.

Review of Selected From overpayments returned to the Center in
fiscal year 1998, we selected Contractors Discloses and visited 13
contractor locations to ascertain (1) if contractors were

retaining overpayments and (2) how quickly overpayments were
refunded. Additional Payment Problems

Some Contractor Locations Four of the 13 contractors were
retaining overpayments totaling about Retain Overpayments

$1.1 million. Contractor personnel at each location told us they
had not returned the money because each contractor had a practice
of retaining overpayments until the government issued a demand
letter. Under current law, there is no requirement for contractors
who have been overpaid to notify the government of overpayments or
to return overpayments before the government issues a demand
letter. Contractor officials at one location we visited in May
1998 told us that they were retaining an overpayment of about $36,
800 received in 1995 because their practice is to retain
overpayments until the end of a contract unless a

demand letter is received. They said without a demand letter, they
could not be sure that their account would be properly credited.
For that reason, they said they did not notify DOD about the
overpayment. At our request, the contractor reported the
overpayment to the government's administrative contracting officer
(ACO) who issued a demand letter. The

contractor refunded the overpayment in June 1998. After our visit,
DCAA issued an audit report on an audit that was ongoing at the
time of our visit, requiring the contractor to establish written
policies and procedures to

ensure overpayments are identified and reported to the government.
According to DCAA, the contractor has established such controls.
At another location, a contractor was retaining overpayments of
about $41,700 that it had known about since January 1997. A
contractor official said that it is company policy to first
resolve payment discrepancies with DFAS. The official also said
that unless this is done and a demand letter issued, DFAS does not
properly credit their account. At our request, the contractor
notified the ACO of the overpayment in June 1998. The ACO
requested the Center to verify the accuracy of the reported
overpayment. Initially, the Center concluded that no overpayment
had occurred. However, upon closer examination, the Center
concluded that the government had overpaid the contractor. In
October 1998, the Center issued a demand letter, and the
contractor refunded the money promptly. The DCMC area office also
issued a memorandum to its field operations personnel instructing
them to ask a contractor reporting an overpayment to immediately
return the money. We also found cases where the government was
aware of overpayments but did not take timely action to obtain
recovery. For example, the ACO at one contractor location told us
that he had identified overpayments of more than $400,000 in March
1997. According to the ACO, he notified the Center of the
overpayments because it had access to the payment records and

was, therefore, in a position to determine the amount of
overpayments and issue a demand letter. According to the ACO, the
Center informed him that the overpayments would be recovered from
the contractor's future shipment, even though he had informed the
Center that the contract had been completed and no future shipment
would be made. Notwithstanding this information, the Center did
not issue a demand letter. After our visit, the ACO issued two
demand letters for about $425,000, which the contractor refunded.

At another location, according to a contractor official,
contractor personnel notified the Center of overpayments beginning
in 1991 but did not refund the money because they were waiting for
a demand letter. According to this official, their experience has
been that their account was not properly credited when they
refunded money without a demand letter. As a result, the
contractor kept track of the overpayments and waited for the
government to issue a demand letter. At our request, the
contractor provided us a list showing accumulated overpayments of
about $627,000. In August 1998, we provided the Center the list
and requested it to recover the overpayments, and in December
1998, the Center requested that the

overpayments be returned. In April 1999, a company official
advised us that the money had been refunded and that the company
would revise its procedures to refund overpayments without a
demand letter.

Timeliness in Obtaining Obtaining timely return of overpayments is
important. If overpayments are

Refunds of Overpayments not recovered promptly, DOD forgoes the
use of these monies and may

suffer actual monetary loss if the debt becomes uncollectible. It
took about a year, on average, before overpayments of $56.2
million were refunded to the Center by the 13 contractors. This
varied from about 2 weeks to nearly 6 years in one case. At one
location, the contractor was overpaid $6.1 million between 1992
and 1996. In December 1997, the contractor voluntarily refunded
the money. According to a contractor official, the company's
practice was to retain overpayments in an advance payment account
until a demand letter was received or the end of the contract to
ensure the Center would properly credit the company's account. Due
to a change in company practice, the overpayments were remitted
before the end of the contract.

At a second location, the government's contracting officer did not
request a refund when, in August 1995, the government agreed to
replace contractor purchased material with government- furnished
material, resulting in the

contractor being overpaid. According to contractor officials and
the DOD contracting office, the amount of overpayment was
difficult to determine because the extent of use of the government
material was uncertain. Yet, even after production was completed
and contract items had been

delivered in November 1996, the contracting officer did not
request a refund. The government ultimately negotiated price
reductions of over $1. 6 million in July 1997 and requested
repayment in September 1997.

At a third location, the ACO did not take timely steps to recover
overpayments of over $4 million that had been identified as early
as June 1989 in contractor reports to the ACO. By June 1993, the
reported overpayment totaled about $8.5 million. Partial refunds
of about $2.9 million and $4.4 million were made in 1994 and late
1997, respectively. According to government officials, the total
amount of overpayment was not determined until November 1997 due
to staffing constraints, priorities given to new contracts, and
unknown requirements that could surface

during contract performance. Production requirements, however, had
been completed in March 1990. The timeliness of obtaining refunds
of overpayments is not a new issue. In March 1994, we reported
that the Center did not collect overpayments promptly when
reported. In some cases, contractors planned to return
overpayments but were told to hold the money until the contracts
could be reconciled and demand letters issued. 3 We found similar
problems in 1995

and estimated that delays in recovering about $84 million in
overpayments cost the government about $10.6 million in interest.
4 In that review, we also found that the Center did not pursue
timely recovery even after a contract reconciliation identified
overpayments. DCAA Did Not Identify A key procedure for
identifying overpayments is to have the contractor Overpayments

periodically reconcile its billings to the government with its
accounting data and with the payments it receives from the
government. Since June 1994, DCAA, as part of its periodic review
of contractor billing systems, has been required to ensure that a
contractor (1) has written procedures for periodically reconciling
its billing and accounting data and notifying the 3 DOD
Procurement: Millions in Overpayments Returned by DOD Contractors
(GAO/NSIAD-94-106, Mar. 14, 1994). 4 DOD Procurement: Millions in
Contract Payment Errors Not Detected and Resolved Promptly
(GAO/NSIAD-96-8, Oct. 6, 1995).

government of overpayments and (2) is effectively implementing
these procedures. At two locations, we noted that DCAA auditors
did not identify overpayments. For example, in September 1997,
while reconciling its accounts in preparing its final billing on
the contract, one contractor discovered it had erroneously billed
and been overpaid $591,000 in March 1994. The contractor said that
its procedures in effect at the time did not catch the

overbilling or the resulting overpayment and that it has since
established stronger controls that provide for periodic
reconciliation of billing and accounting data. However, we noted
that in reviewing the contractor's billing system in 1996, DCAA
did not identify the overpayment and concluded that the system was
adequate.

At another contractor location, the company's practice was to keep
overpayments in an advance payment account until it received a
demand letter or the contract was completed. The advance payment
account had a

balance of at least $6.1 million that had been accumulating since
1992 before the contractor refunded it in December 1997. DCAA
auditors said they were unaware of the overpayments in that
account. Moreover, DCAA did not test the contractor's comparisons
of amounts received to amounts

billed for each invoice and did not determine if the contractor
had a policy of timely notifying the paying office of
overpayments, which it should have based on its audit guidance.
According to the auditors, they used the standard DCAA billing
system audit program, dated October 1993, to conduct their audit
in October 1994. This audit program did not require

DCAA to evaluate the contractor's controls for identifying and
notifying the government of any overpayments. However, in June
1994, DCAA had revised its audit program to require such an
evaluation. The revised program was provided to DCAA regional
directors and field detachments in September 1994, before DCAA
began its review of this contractor.

Growing Backlog of In our March 1994 report, we pointed out the
large backlog of contracts Unreconciled requiring reconciliation
and the large sums of money owed the government that come about
through reconciliation. For example, we noted that the Contracts
Precludes reconciliation results of a public accounting firm
employed by the Center Timely Identification of

showed that from October 1990 through November 1993, about $208
Overpayments

million had been identified as being owed to the government. The
Center continues to have a sizable and growing backlog of
contracts to be reconciled. As of January 1999, the Columbus
Center had a backlog of

2,453 contracts requiring reconciliation. About 38 percent of
these contracts have been waiting reconciliation for more than a
year. (See fig. 3.)

Figure 3: Contracts Waiting Reconciliation Number of contracts

1000 900 800 700 600 500 400 300 200 100

0 0- 90 91- 180 181- 360 >360

Days outstanding

The January backlog of 2,453 contracts had increased from 1,660
contracts a year earlier. The number of unreconciled contracts may
increase before it gets better. According to the Center, while the
number of contracts requiring reconciliation has increased, the
number of staff available to perform contract reconciliation has
decreased. The number of Center

contract reconciliation employees decreased from 156 in March 1998
to 109 in January 1999, and staff obtained from a public
accounting firm to assist in reconciling contracts decreased from
60 staff years in 1997 to

40 staff years in 1998. The Center estimates that it will take 387
staff years to reconcile the January backlog.

In June 1998, DFAS revised its contract reconciliation procedures
to improve the timeliness and the accuracy of its payments and
reduce problem disbursements. According to the Center, these
revised procedures, issued in January 1999, are intended to
improve resource efficiency and provide for more timely
reconciliation.

Conclusions Contractors return overpayments to the Columbus Center
amounting to hundreds of millions of dollars a year. However, this
represents only the amount that has been identified and returned.
There are likely more overpayments that have yet to be identified
and returned. We found 4 of the 13 contractors were retaining
overpayments of about $1.1 million. In addition, there are likely
to be substantial overpayments in the Center's backlog of
contracts that are waiting to be reconciled. Given the past
problems that the Center has had making accurate

payments, and the Center's backlog of contracts waiting to be
reconciled, a number of steps can be taken to identify
overpayments and obtain timely refunds. These steps involve
actions by both the contractor and the government contracting and
payment personnel and should not place an unreasonable burden on
either the contractor or government personnel. These steps would
require (1) contractors to immediately notify the government when
they have been overpaid, (2) DOD to reemphasize the need for
government contracting or payment personnel to request refunds
immediately upon becoming aware of overpayments and not wait for
the more formal demand letter, and (3) the Center to consider
periodically

requesting contractors to provide the Center with the status of
their accounts with the government. The increasing backlog of
unreconciled contracts is of particular concern. The longer a
contract remains unreconciled, the longer any overpayments
identified through reconciliation will remain undetected and in
the contractors' possession and the greater will be the
government's loss of the use of these monies. Further, the longer
a debt remains outstanding, the greater may be the difficulty in
collection and the chance that the debt will become uncollectible.

Recommendations We recommend that the Secretary of Defense

 require contractors to promptly notify the government of
overpayments made to them;  direct the Director, DFAS, and the
Commander, DCMC, to reemphasize

the need to request refunds of overpayments promptly and to
perform timely reconciliation; and  direct the Director, DFAS, to
examine the cost- effectiveness of requiring

contractors to periodically provide a status of their accounts
with the government. Agency Comments and

In commenting on a draft of this report, DOD concurred with our
Our Evaluation

recommendations and agreed that it could strengthen its ability to
identify overpayments. However, DOD stated that it believes the
Federal Acquisition Regulation (FAR) and the Defense Federal
Acquisition Regulation Supplement (DFARS) contain appropriate
procedures to recover overpayments.

While the FAR and DFARS require that debts be collected as rapidly
as possible, they do not require contractors to notify the
government when they have been overpaid. In addition, we noted
instances where government personnel, when made aware of
overpayments, were not requesting refunds in a timely manner. DOD
should reemphasize to its contracting and payment personnel the
need to make timely requests for overpayment refunds. If, upon
final debt determination, these refunded amounts are found to be
in error, the erroneous amounts can be refunded to a contractor.
DOD took exception to our comment that DCAA failed to perform the
required audit steps and commented that the cited overpayment was
due to an inadvertent contractor error. We have revised our report
based on DCAA's comments. The key point is that DCAA's audit
procedures did not identify the overpayment at the subject
contractor location.

Scope and To update our prior data on checks received by the
Columbus Center and Methodology

the reasons for them, we analyzed the Center's database of checks
received, but did not verify the accuracy of the data. To
ascertain the reasons for the increase in checks received due to
the Center's errors, we reviewed the Center's policies and
procedures to ensure payment accuracy. We also discussed with
Center officials the controls to ensure that the policy to obtain
timely refunds is followed. We did not examine any

underpayments that may have resulted from the Center's payment
activities. To ascertain if contractors were retaining
overpayments, and how quickly overpayments were refunded, we
selected 13 contractor locations that had returned overpayments
from October 1, 1997, through March 31, 1998, for a

detailed review. These contractors were selected to represent the
various reasons, as determined by the Center, for the
overpayments, as well as to reflect differences in contractor size
and geographical location. We visited

each contractor location to obtain a better understanding of the
reasons for the overpayments and to ascertain the contractors'
controls to prevent erroneous billing and to ensure prompt
refunds. We also asked each contractor to provide us a
reconciliation of its accounts with the government to determine if
it was retaining overpayments. At each

contractor location, we reviewed contract documents, billing
records, contractor billing policies and procedures, and discussed
with contractor officials their policies or practices for
identifying and returning overpayments. We also discussed with DOD
contracting officials and government auditors the controls used to
monitor contractor billings and payment accuracy. We conducted our
review between April 1998 and February 1999 in accordance with
generally accepted government auditing standards. Because the
backlog of unreconciled contracts was a problem we had identified
previously, we obtained information from the Center on the current
status of the backlog and its progress in reducing the backlog.

As agreed with your office, we plan no further distribution of
this report until 30 days from its issue date unless you publicly
announce its contents earlier. At that time, we will send copies
to the Honorable William Cohen, Secretary of Defense; the
Honorable Jacob Lew, Director, Office of Management and Budget;
Major General Timothy P. Malishenko, Commander, Defense Contract
Management Command; and Mr. William

Reed, Director, Defense Contract Audit Agency. We will make copies
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 Charles W. Thompson, Odi Cuero, and Kenneth Roberts.

Sincerely yours, David E. Cooper Associate Director Defense
Acquisitions Issues

Appendi I x Contractors Reviewed Lockheed Martin, Tactical
Aircraft Systems, Fort Worth, Tex. Allied Signal, Inc., Electronic
Systems, Teterboro, N. J. Sikorsky Aircraft Corporation,
Stratford, Conn. Bell Helicopter, Textron, Fort Worth, Tex. Hughes
Aircraft (now Raytheon), Fullerton, Calif. TRW, Sunnyvale and
Redondo Beach, Calif. Raytheon, Bedford, Mass. Earth Tech, Long
Beach, Calif. Northrop Grumman Electronics & Systems Integration,
Melbourne, Fla.

Primex Technologies, Inc., Downey, Calif. Lockheed Martin Electro-
Optical Systems, Pomona, Calif. Harris Corporation, Electronic
Systems Sector, Melbourne, Fla. Boeing, Long Beach, Calif.

Related GAO Products Contract Management: DOD Is Examining
Opportunities to Further Use Recovery Auditing (GAO/NSIAD-99-78,
Mar. 17, 1999).

Contract Management: Recovery Auditing Offers Potential to
Identify Overpayments (GAO/NSIAD-99-12, Dec. 3, 1998).

DOD Procurement: Funds Returned by Defense Contractors (GAO/NSIAD-
98-46R, Oct. 28, 1997). Contract Management: Fixing DOD's Payment
Problems Is Imperative (GAO/NSIAD-97-37, Apr. 10, 1997). DOD
Procurement: Millions in Contract Payment Errors Not Detected and
Resolved Promptly (GAO/NSIAD-96-8, Oct. 6, 1995).

DOD Procurement: Overpayments and Underpayments at Selected
Contractors Show Major Problem (GOA/ NSIAD- 94- 245, Aug. 5,
1994).

DOD Procurement: Millions in Overpayments Returned by DOD
Contractors (GAO/NSIAD-94-106, Mar. 14, 1994).

GAO United States General Accounting Office

GAO/NSIAD-99-131

Page 1 GAO/NSIAD-99-131 DOD Contract Management United States
General Accounting Office

Washington, D. C. 20548

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Appendix I

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Page 16 GAO/NSIAD-99-131 DOD Contract Management

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