January 9, 1998
 
 
 
 
 

MEMORANDUM FOR:         PATRICIA W. LATTIMORE
                                                  Assistant Secretary for
                                                         Administration and Management
 
 

FROM:                                     JOHN J. GETEK
                                                   Assistant Inspector General
                                                        for Audit

SUBJECT:                            NEED FOR IMPROVEMENT IN FEDERAL CONTRACTING
                                                 PROCEDURES AND PRACTICES
                                                 REPORT NO. 18-98-002-07-001
 

During a recent audit of the costs claimed by a Government contractor under a cost reimbursable contract, we noted that this contractor, a Section 8(a) minority contractor, was also awarded three fixed-price contracts. Since Section 8(a) contracts are negotiated/awarded noncompetitively on a sole source basis (without price competition), we decided to review the Government's practices and procedures in connection with protecting the Government's interest when exercising the option years.

We were not questioning the Contracting Officer's (CO) decision to award fixed-price contracts to Section 8(a) contractors, as this is encouraged throughout Government, nor were we questioning the price that was agreed to for the initial year. We recognize that in fixed-price contracts, the contractor is entitled to the price negotiated regardless of the costs. Our review was centered on whether the prices for the option years, if approved, were equitable and reasonable after taking into consideration the costs incurred by the contractor in the base year and the negotiated profit fee, and whether the CO looked at this data.

Overall, we found no evidence to indicate that the CO had looked at any of the contractor's data before extending the contract. It is our opinion, that had this information been reviewed, the Government could have negotiated a price for the option year that would have been far more equitable and reasonable, and still have provided the contractor with the profit initially negotiated.

A description of the DOL contract, observations from our review and the actual costs are presented on the next page.
 

This contract was awarded for a base year and four option years. The fixed price for the option years consisted of the base year agreed-upon amount plus a 4 percent escalation factor each succeeding year. During the first year, two contract modifications were enacted increasing the price slightly.

This contract involved the services of 10 full-time employees who worked at the DOL Pension and Welfare Benefits Administration (PWBA) office. U.S. companies that have tax deductible pension plans are required to file reports with the PWBA. Among other things, the contractor checks the information submitted and transfers documents for computer processing and data storage .

The contractor had negotiated a fee of 7.5 percent of the total proposed costs. However, we found that for the base year that ended on September 30, 1995, the contractor's net earnings were over 21 percent of its contract costs, about three times the amount it had negotiated with DOL, as shown below.
 

Amount billed through 9/30/95                                                             $561,314

Costs Incurred:

Direct Labor (Off-site and On-site)                                            $293,073

Other Direct Costs                                                                           12,786

Overhead and G&A                                                                       156,262 

Total Costs                                                                                                     462,121
 
 
Net Earnings                                                                                                                     $ 99,193
                                                                                                                                            

Percent of Net Earnings to Total Costs                                                                           21.46%

This resulted from a number of factors included the following:

a.   LABOR HOURS

The labor costs presented to DOL were based on the premise that the contractor's employees would work 1,920 hours a year. This assumption, on average, overstates the actual number of labor hours (and their related costs) by 52 hours a year for each employee (1,920 hours less 1,868 hours = 52 hours). The more appropriate number of labor hours (1,868) is computed as follows:
 

Description                                                                                                                 Hours

Available number of hours (52 weeks x 40 hours                                         2,080

Less:

Vacation (2 weeks x 40 hours)                     (80)

Holiday (10 days x 8 hours)                           (80)

Sick and personal leave (average)              (52)

Total paid absences                                                                     (212)

Direct Work Time                                                                                    1,868

The costs of paid absences (vacations, holidays, and personal leave) were also included in the contractor's overhead costs which are based on indirect cost rates applied to direct labor costs. Therefore, the indirect costs were also overstated. We estimate that the additional income generated from the labor hours amounted to $8,200 and from the Overhead costs amounted to $12,030.

b.   HOURLY LABOR RATE

The bid proposed an estimated average hourly rate of $12.42. However, the contractor's actual hourly rate for the first year of the contract was $11.84. This difference (.58 cents an hour) resulted in the contractor realizing estimated earnings of $14,350. Because the employees who worked on this contract were not shown in the records by their specific labor categories as described in the bid proposal, we could not compute the precise amount of the earnings.

c.   OTHER DIRECT COSTS

The actual Other Direct Costs (ODC) incurred were $21,180 less than the contractor estimated in its bid proposal. This amount was determined as follows: