DOD Procurement: Overpayments and Underpayments at Selected Contractors Show Major Problem (Letter Report, 08/05/94, GAO/NSIAD-94-245). GAO testified in April 1994 that defense contractors were returning millions in contract overpayments to the Defense Finance and Accounting Service (DFAS). GAO was then asked to review whether all overpayments were being returned. A review of overpayments and underpayments to nine major defense contractors revealed $118 million in inaccurate payments that potentially could cost the government more than $20,000 a day in lost interest or late payment penalties. Each contractor had returned some overpayments, but the nine contractors were keeping some overpayments. Contractor officials gave several reasons for not returning overpayments, but none of the reasons appeared to justify not returning overpayments or delaying the resolution of discrepancies. Neither the Defense Department nor the contractors were aggressively trying to resolve the discrepancies, some of which had been outstanding for years. --------------------------- Indexing Terms ----------------------------- REPORTNUM: NSIAD-94-245 TITLE: DOD Procurement: Overpayments and Underpayments at Selected Contractors Show Major Problem DATE: 08/05/94 SUBJECT: Underpayments Overpayments Financial management Federal agency accounting systems Department of Defense contractors Defense procurement Accountability Military cost control Refunds to government Internal controls ************************************************************************** * This file contains an ASCII representation of the text of a GAO * * report. Delineations within the text indicating chapter titles, * * headings, and bullets are preserved. Major divisions and subdivisions * * of the text, such as Chapters, Sections, and Appendixes, are * * identified by double and single lines. 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We are unable to accept electronic orders * * for printed documents at this time. * ************************************************************************** Cover ================================================================ COVER Report to the Chairman, Committee on Governmental Affairs, U.S. Senate August 1994 DOD PROCUREMENT - OVERPAYMENTS AND UNDERPAYMENTS AT SELECTED CONTRACTORS SHOW MAJOR PROBLEM GAO/NSIAD-94-245 DOD Procurement Abbreviations =============================================================== ABBREV DFAS - Defense Finance and Accounting Service DOD - Department of Defense Letter =============================================================== LETTER B-256249 August 5, 1994 The Honorable John Glenn Chairman, Committee on Governmental Affairs United States Senate Dear Mr. Chairman: In April 1994, we testified before your Committee that defense contractors are returning millions in contract overpayments to the Defense Finance and Accounting Service (DFAS) within the Department of Defense (DOD).\1 Our testimony was based on an earlier report concerning $751 million in returns by contractors during a 6-month period ending in April 1993.\2 Virtually all returned overpayments were detected and returned by the contractors without a government demand letter. However, because of concerns as to whether contractors are returning all overpayments, you asked us to determine whether defense contractors were retaining overpayments. We initiated our work at nine major contractor locations. The magnitude and extent of overpayments not being returned, as well as underpayments not being corrected, show a major problem requiring immediate DOD attention. Accordingly, as agreed, we are providing this interim report and continuing to examine this issue. -------------------- \1 Financial Management: Financial Control and System Weaknesses Continue to Waste DOD Resources and Undermine Operations (GAO/T-AIMD/NSIAD-94-154, Apr. 12, 1994). \2 DOD Procurement: Millions in Overpayments Returned by DOD Contractors (GAO/NSIAD-94-106, Mar. 14, 1994). RESULTS IN BRIEF ------------------------------------------------------------ Letter :1 The nine contractor locations we visited had unresolved payment discrepancies totaling about $118 million--$30.3 million in overpayments and $87.7 million in underpayments. These overpayments and underpayments result in significant unnecessary costs to the government. At current interest rates, these identified overpayments could cost the government about $5,800 per day. Because the Prompt Payment Act requires DOD to pay interest on valid invoices that are paid late, the underpayments we identified could cost DOD about $16,800 per day. Each contractor had returned some overpayments, but the nine contractors were retaining some overpayments. Contractor officials gave several reasons for not returning overpayments; however, none of the reasons appeared to justify not returning overpayments or delaying the resolution of discrepancies. The payments were made by several different DFAS offices, and some discrepancies have been outstanding for several years. DOD officials had been notified of some discrepancies but had not taken corrective action. Neither DOD nor the contractors appeared to be aggressively pursuing resolution of payment discrepancies. DOD has not identified any comprehensive plans to mobilize resources to identify and correct current payment discrepancies. We believe such action is necessary to reduce (1) the cost to the government, (2) future payment discrepancies, and (3) the incidence of uncollectable overpayments. DISCREPANCIES INCLUDE BOTH OVERPAYMENTS AND UNDERPAYMENTS ------------------------------------------------------------ Letter :2 Our initial work, involving a review of payment records at nine contractor locations, identified significant payment discrepancies on DOD contracts. We found that contractor records identified over $30 million in overpayments from DOD and over $87 million in underpayments. Table 1 lists the overpayment and underpayment totals that we identified in each of the nine contractors' records during our visits in February and March 1994. Table 1 Overpayments and Underpayments by Contractor Location Overpaymen Underpayment Contractor locations visited ts s\a ---------------------------------- ---------- ------------ AT&T Technologies, Greensboro, $476,786 $24,101,282 North Carolina Bell Helicopter Textron, 181,127 1,285,712 Incorporated, Fort Worth, Texas Harris Corporation, Government 1,407,275 3,604,929 Electronics Systems Division, Melborne, Florida Hercules Aerospace Company, 159,820 1,017 Missiles, Ordnance & Space Group, McGregor, Texas Martin Marietta, Electronics, 19,820,679 417,994 Information & Missiles Group, Orlando, Florida Rockwell International 250,661 682,477 Corporation, Missile Systems Division, Duluth, Georgia Rockwell International 1,381,643 7,596,595 Corporation, Collins Systems International, Richardson, Texas Texas Instruments, Incorporated, 6,254,756 47,766,941 Dallas, Texas Tracor, Incorporated, Austin, 339,312 2,210,530 Texas ============================================================ Total $30,272,05 $87,667,477 9 ------------------------------------------------------------ \a Underpayments exclude current billings less than 30 days old. Both overpayments and underpayments result in unnecessary costs to the government. Overpayments increase the government's interest costs because funds are needlessly disbursed. Contractors are not assessed interest on overpayments until 30 days after a demand for repayment is made. At current interest rates, these identified overpayments could cost the government about $5,800 per day, or about $2 million per year. Overpayments also expose the government to a greater risk of loss because some overpayments become uncollectable. In our March 1994 report, we noted that DFAS' reconciliation of 4,300 contracts had identified about $17 million that was owed the government but could be uncollectable. Underpayments also increase costs because the Prompt Payment Act requires interest to be paid on overdue amounts.\3 The late payment penalty rate, which is set by the U.S. Treasury, is currently 7 percent. Late payment penalties on the underpayments at the nine contractors we visited could cost DOD about $16,800 per day, and some underpayments have existed for extended periods. At one contractor, about $5.4 million in underpayments had been outstanding for more than a year. Our review of the contractor's records showed that DOD was notified of most of these underpayments. Contractor officials said that DFAS paying offices were not always notified of payment discrepancies. However, according to these officials, even when DFAS was notified, DOD did not always take action to collect the overpayments. Our test of payment discrepancies identified instances of the conditions described by contractor officials. In one instance, a contractor notified DFAS officials on December 10, 1992, that the company had received duplicate payments on four invoices totaling about $360,000. When we reviewed the contractor's accounts receivable as of February 1994, over a year after DFAS was notified of the discrepancy, we found the contractor still had the duplicate payments. A contractor official said that DOD had not requested return of the duplicate payments. In another instance, a contractor notified DFAS officials on December 15, 1992, that it had been underpaid and was owed about $155,000 on two invoices. The contractor said DFAS had incorrectly deducted progress payments on one invoice and made an excessive price deduction on the other because DFAS had not updated its records. The underpayment was resolved after our visit. The final payment made in May 1994 was about 2 years after the original payments. In accordance with the Prompt Payment Act, DFAS paid a late payment penalty of about $10,000. In another case, a contractor returned three overpayments totaling about $160,000 identified during our review. DOD had been formally notified about one of the three overpayments. DOD was notified in a January 1994 letter of a $66,000 overpayment that occurred about 3 years earlier. The other two overpayments, $28,000 and $66,000, had been outstanding for 6 and 18 months, respectively. There was no record of DOD being notified of these two overpayments, but the contractor's accounting manager believes he discussed the larger overpayment with a DOD contracting official. Another contractor's long-standing overpayment was also resolved during our visit. According to DOD's records, in September 1993, DFAS temporarily suspended payments on one contract because available contract funding was not sufficient to pay the contractor's progress payment billings. DOD calculated that the contractor had been overpaid by about $28 million on the contract, mostly because progress payments on foreign military sales had been improperly billed. Our review of the contractor's accounts receivable records in February 1994 showed about $15.7 million in overpayments on this contract. During our visit, the contractor recalculated the payment status and returned $5.4 million in overpayments and applied the balance, about $10.3 million, against additional contract costs incurred between August 1993 and March 1994. The contractor's records showed that most of the overpayments on this contract had been outstanding over 200 days and one overpayment of $670,000 had been outstanding 695 days. The contractor sent a check to DOD in October 1992 for the $670,000 overpayment, but the DOD contracting official did not process the check and returned it because the contract was being reconciled. On another contract, this contractor had an overpayment of about $5,000 that had been outstanding since February 1988, over 6 years. The contractors we visited, although retaining some overpayments, returned a significant amount of overpayments between October 1, 1992, and March 14, 1994, to the DFAS Columbus Center, the primary contract payment center for DOD. (About 2,200 of the 26,000 contractors paid by the DFAS Columbus Center have returned overpayments.) The amounts returned, as shown in table 2, are the total for the contractor, not just the locations we visited, because data on checks received by contractor location were not readily available. Table 2 Amounts Received by the DFAS Columbus Center from Selected Contractors from October 1, 1992, to March 14, 1994 Number of Contractor checks Amount -------------------------------- -------------- ---------- AT&T 66 $5,960,307 Bell Helicopter Textron, 35 3,047,360 Incorporated Harris Corporation 57 3,820,944 Hercules Aerospace Company 21 5,207,666 Martin Marietta 540 134,592,55 6 Rockwell International 124 49,032,757 Corporation\a Texas Instruments, Incorporated 35 38,592,384 Tracor, Incorporated 39 1,147,458 ============================================================ Total 917 $241,401,4 32 ------------------------------------------------------------ \a We visited two locations of this contractor. Contractor officials provided one or more of the following reasons that they did not always return overpayments: (1) DFAS was reconciling the contract; (2) the amounts were relatively small; (3) DFAS did not issue a demand letter; (4) the overpayments compensated for underpayments; and (5) when overpayments were returned, DFAS did not always correctly account for the returns causing fund shortages on later contract payments. Contractor officials said that each payment discrepancy had a distinct cause that required research to resolve. The officials said that DFAS does not accept contractor information by itself as evidence of a payment error; consequently, the contractors often wait for DFAS to reconcile contract payments. None of the reasons provided appeared to justify not returning overpayments or delaying resolution of discrepancies. For example, the DFAS Columbus Center policy is to collect all overpayments offered without waiting for reconciliation to be completed, a process that can take several months. Additionally, the processing of demand letters can unnecessarily delay return of overpayments. Finally, overpayments should not be used to compensate for underpayments because the Prompt Payment Act provides contractors with interest on late payments. -------------------- \3 The Prompt Payment Act requires the payment of an interest penalty for payment made after the due date or 30 days after the presentation of a valid invoice. The act provides a 15-day grace period. ACTION NEEDED TO IDENTIFY AND CORRECT PAYMENT DISCREPANCIES ------------------------------------------------------------ Letter :3 DOD officials previously told us a number of actions were being taken to clarify and strengthen payment practices, reinforce prompt debt collection procedures, and issue clearly stated and complete contract documents to deal with future contractor overpayments. While these actions are needed, they do not specifically address existing payment discrepancies. On the basis of discrepancies identified by contractors' records, some of which had existed for several years, we believe unresolved discrepancies are significant and will continue to adversely affect future payments. DFAS' primary method of resolving payment discrepancies is through auditing or reconciling contracts with known or suspected problems. As of June 30, 1994, the DFAS Columbus Center had identified about 17,900 of its almost 400,000 contracts as requiring reconciliation. The Center had an additional 8,990 rejected transactions and unmatched disbursements on hand that might require additional contract reconciliations. The number of additional reconciliations required will not be known until the transactions are researched. In addition to those contracts already identified as needing reconciliation, we believe that many of the other hundreds of thousands of contracts being paid by DFAS could have payment discrepancies similar to those we identified in the contractor records. However, unless DOD uses contractors' records as a means to identify payment discrepancies, the extent of contracts requiring reconciliation will continue to be based on problems identified at DFAS. RECOMMENDATION ------------------------------------------------------------ Letter :4 We recommend that the Secretary of Defense mobilize available DOD contract, financing, and audit resources to identify, verify, and correct payment discrepancies identified in contractors' records. Using contractor records, DOD can research the payment status of contracts and use this information, along with government records, as a basis for further actions to reconcile payment discrepancies. SCOPE AND METHODOLOGY ------------------------------------------------------------ Letter :5 As part of our efforts to determine whether contractors are returning overpayments, we reviewed the open accounts receivable at nine contractor locations. All the contractors selected were in the top 100 defense contractors by revenue. Contractors maintain billing records that should agree with the DOD payment records when correct transactions have been completed. The contractor records should show the status of billings and payments and any unresolved differences between the contractor and DOD. If a contractor receives payments in excess of the amounts billed, the overpayments should be recorded in the contractor's accounts. Conversely, if payments received are less than the amount billed, the underpayments should be recorded in the accounts. The contractors' accounts receivables with DOD that were out of balance were totaled by overpayments and underpayments as of the date of our review. Accounts were considered out of balance if the amount paid by DFAS was more or less than the amount billed. Unpaid billings less than 30 days old were excluded from our payments analysis because they were considered current accounts. We discussed these amounts with contractor officials responsible for the financial records. In addition, we examined invoice documentation to determine (1) why there were discrepancies and (2) whether the government had been notified of them. We did not reconcile contracts. We used the DFAS Columbus Center's summary accounts receivable records to compile a list of contractor checks received from the nine contractors we visited. As part of its accounting process, DFAS' summary records include the name of the remitting contractor and the amount of the check. These records show the number and amount of contractor checks received by the DFAS Columbus Center. In addition, we reviewed laws and regulations pertaining to the administration and management of contracts and contract payments, including those related to collection of contractor debts. We also discussed payment discrepancies with the Defense Logistics Agency, the Defense Contract Management Command, and DFAS officials. We conducted our review between February and July 1994 in accordance with generally accepted government auditing standards. As agreed with your office, we did not obtain written DOD comments on a draft of this report; however, we discussed the results of our review with officials from the DOD Comptroller Office, the DOD Inspector General, the Defense Contract Audit Agency, the Defense Contract Management Command, and DFAS. We considered their comments in preparing this report. In general, they concurred with our report. ---------------------------------------------------------- Letter :5.1 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; 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 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 David Childress DALLAS REGIONAL OFFICE --------------------------------------------------------- Appendix I:2 David W. Frost Joe D. Quicksall Seth D. Taylor ATLANTA REGIONAL OFFICE --------------------------------------------------------- Appendix I:3 George C. Burdette Arthur W. Sager