STATEMENT OF HON. ELMER B. STAATS, COMPTROLLER GENERAL OF THE UNITED STATES; ACCOMPANIED BY ROBERT F. KELLER, ASSISTANT COMPTROLLER GENERAL; WILLIAM NEWMAN, SPECIAL ASSISTANT TO THE COMPTROLLER GENERAL; ROBERT RASOR, ASSOCIATE DIRECTOR, OFFICE OF POLICY AND SPECIAL STUDIES; RALPH KEE, CONSULTANT, OFFICE OF POLICIES AND SPECIAL STUDIES; PAUL DEMBLING, GENERAL COUNSEL; AND SMITH BLAIR, JR., LEGISLATIVE ATTORNEY, OFFICE OF LEGISLATIVE LIAISON

Mr. STAATS. Thank you very much. I will summarize and read only sections of the report in the interest of saving time and perhaps we can cover other points in the question-and-answer period.

As you have indicated, the General Accounting Office undertook an extensive study of the feasibility of applying cost standards to negotiated contracts. This study was directed in legislation involving the extension of the Defense Production Act 2 years ago. We completed our report and submitted it to the Congress last January. The directive was that we undertake a study of the feasibility of applying uniform standards in negotiated defense contracts. The bill that originated in the House, as you recall, would have called upon us to establish standards, but the legislation as finally enacted by the Congress directed that we undertake a study of the feasibility of applying such standards.

If I may, I would like to read parts of my statement. One of the matters which underlies consideration of this subject is mentioned on page 3 of our statement. We point out that total Government procurement for the fiscal year 1969 amounted to $53 billion, of which $45.9 billion, or 86.6 percent, represented negotiated procurements. That is procurements which are not formally advertised.

The CHAIRMAN. Not competitive bids?

Mr. STAATS. Not advertised competitive bidding, no. This has been an increasing trend over a number of years, growing in part out of the fact that so much of our procurement is in the form of major weapons systems. We point out this trend on page 4 of our statement. Figures are set forth with respect to both the Department of Defense and the civilian agencies. A large proportion of our procurement today is in the form of negotiated contracts.

Beginning on page 5, we outline from our report the potential benefits from cost accounting standards, and I will read two or three pages, if I may.

In contract negotiations, an understanding of the contractor's cost accounting practices is of vital importance to negotiators on both sides of the table. By providing a common framework for the buildup of the prospective and actual cost of a product or service in the light of the environment in which the costs are accumulated, cost accounting standards could

Supply the guidance, support, and coordination required for better understood cost estimates and subsequent reports of actual costs;

Facilitate the preparation and reporting of cost information by contractors and its audit and evaluation by the Government; and, third

Provide guidance in helping to insure that items of costs on a given contract are reported on a consistent basis; are comparable with costs originally proposed or projected and are comparable with costs cited in other reports such as financing requests, change orders, claims for reimbursement, price redeterminations or adjustments, and termination claims.

Standards could require that

The basis upon which forecasts of costs are predicated be disclosed:

That final reported costs incurred be supported by, or be readily reconcilable with, the contractor's accounting records; and

That costs identifiable with other products or services or with other contracts be excluded from total contract performance costs. Standards could also

Improve the communicative process between the Government, the Congress, industry, and the public generally;

Serve to identify for contractors the type of authoritative support for costs incurred that would be required to be accumulated by them for all contract administration purposes, including audit; and

Establish criteria for the use of alternative methods of cost accounting or could narrow the use of alternatives where criteria for their use cannot be established.

Properly administered cost-accounting standards, together with a written disclosure by the contractor of his cost-accounting practices, could do much to promote a common understanding as to the methods of cost determination to be used consistently. This would minimize subsequent controversy in the administration and settlement of the contract.

In our report we have recognized certain limitations on what costaccounting standards can achieve. I will not, however, take time to discuss them here, except to say that to require consistent uniform cost accounting practices for all contractors, whatever the circumstances, goes to such an extreme as to be unreasonable and unenforceable. Yet, consistency in the cost accounting practices for all contractors in similar contracting situations appears to be a desirable and attainable objective.

We have concluded that it is feasible to establish and apply cost accounting standards to provide a greater degree of uniformity and consistency in cost accounting as a basis for negotiating and administering procurement contracts.

It is not feasible to establish and apply cost accounting standards in such detail as would be necessary to ensure a uniform application of precisely prescribed methods of computing costs for each of the different kinds of cost, under all the wide variety of circumstances involved in Government contracting.

Emphasis should be directed to disclosure, consistency and establishment of criteria for the use of alternative cost accounting methods. To the extent that contractors or divisions of contractors could be grouped on the basis of similarities in the nature of their operations

or in contracting situations, the standards for such groups could be stated in more specific terms.

The cost accounting methods to be used in the reporting of costs in support of the bid proposal and interim administrative actions and in the settlement of the contract or contracts of a particular contractor could be specified in greater detail by the use of advance written disclosure agreements. In essence, these agreements would further elaborate upon the cost-accounting standards and thus would better ensure a mutual understanding as to the cost-measurement methods to be employed.

More explanatory material and better criteria for identifying and measuring direct and indirect costs and for the allocation of indirect costs should have high priority in establishing cost-accounting standards in the interest of providing a better understanding among the users of cost data as to their meaning and significance.

In our report we stated that cost-accounting standards should not be limited to defense cost-type contracts, but should apply to all negotiated procurement contracts and subcontracts, both cost-type and fixed-price. Further, they should be made applicable Governmentwide. We recognize that making their application Government-wide presents some practical problems so long as enabling legislation is provided through amendment to the Defense Production Act of 1950. We see no objection to confining it to defense production at this time; however, we would hope that the Congress will see fit to broaden their application when the cost-accounting standards are ultimately promulgated.

Mr. Chairman, we consulted very widely, as provided for in the legislation, with representatives of the various professional accounting and other organizations, and a large number of industrial organizations in preparing our report, and we took into account to the extent that we could the comments, suggestions and criticisms made by these organizations. All of the Federal agencies agree with the conclusion in our report as to the feasibility of applying cost standards for negotiated contracts. With one exception, all of the professional accounting organizations agree with our conclusions, although certain reservations and questions were raised with respect to the form of such standards and the manner in which they would be prepared and implemented.

However, the industrial organizations generally are opposed to the establishment of such standards and question the feasibility of applying them. Their concerns and reservations were extensively set forth in hearings before the Senate Banking and Currency Committee, corresponding for the most part to comments received by the General Accounting Office on the draft report which we circulated to the same organization in advance.

In our statement this morning we have grouped together the major criticisms and reservations expressed by these organizations. I will not take the time to go into those but we felt it would be useful to have them summarized in this statement inasmuch as we did not have an opportunity to appear before the Senate committee after the industry organization witnesses appeared.

We believe and hope our comments will be useful to you.

Mr. Chairman, if I may move over to page 18, and comment specifically on the bill before the committee.

I will comment briefly on the main points which I feel require discussion and introduce for the record our more detailed comments on both this bill and the Senate bill.

Title I of H.R. 17880 extends the Defense Production Act of 1950 for an additional 2 years and requires the Comptroller General, as an agent of the Congress, to promulgate cost-accounting standards. To assist the Comptroller General in this responsibility, a Cost-Accounting Standards Advisory Board of no more than five members appointed by the Comptroller General would be established.

I believe the responsibility for promulgating cost-accounting standards should rest in the executive branch of the Government. I favor this course of action because I question whether the GAO should become so deeply involved in the administration of negotiated contracts. The responsibility for administering contracts, including promulgation and the day to day interpretation and administration of cost accounting seems to us basically an executive branch function.

A cost accounting standards board within the executive branch having both the responsibilities for promulgation and administration of the cost account standards would greatly simplify their implementation. Such a board could delegate ancillary responsibilities to other agencies within the executive branch without raising constitutional questions regarding the separation of powers between the executive and legislative branches.

Though not specifically provided by H.R. 17880, I believe the CostAccounting Standards Advisory Board should be a permanent board with authority for its members to serve on part-time basis. An executive director, or secretary and a technical staff would, of course, serve on a full-time basis.

The bill would amend section 702 of the act by adding a definition of the term "defense contractor." This definition is being added to implement the new section 718 which provides for the promulgation of cost-accounting standards. Section 718 covers subcontractors as well as prime contractors and we therefore suggest that the definition be expanded to cover both.

We believe the bill should also be amended to make the legislation permanent rather than be subject to expiration every 2 years as is the case with other provisions of the act.

Further, it is recommended that the words "from indirect costs and the basis used for allocating indirect costs" provided in the bill be inserted after the words "direct costs" on line 2, page 3 of the bill. This was an inadvertent omission of words in the copy of the alternate legislative proposal No. 1 which we furnished your committee as a matter of drafting assistance earlier. These words are essential to a complete understanding of its provisions.

This completes the part of the statement which I wanted to mention. The CHAIRMAN. Your entire statement will be printed in the record. Mr. STAATS. I appreciate that very much.

(The prepared statement of Mr. Staats follows:)

PREPARED STATEMENT OF HON. ELMER B. STAATS, COMPTROLLER GENERAL OF THE

UNITED STATES

Mr. Chairman and members of the committee: We are appearing here today to discuss a report submitted to the Congress by the General Accounting Office on January 19, 1970, entitled "The Feasibility of Applying Uniform Cost-Accounting

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Standards to Negotiated Defense Contracts." We have also been asked to comment on title I of H.R. 17880.

The GAO report had its origin in section 718 of the Defense Production Act of 1950, as amended July 1, 1968.

WHY THE CONGRESS DIRECTED THE STUDY

The Congress in enacting section 718 was apparently influenced heavily by the growing proportion of defense procurements entered into on a negotiated basisthen approximately 86 percent of the total-and by testimony that different costaccounting practices followed in defense contracts and among different contractors could result in lack of adequate cost information and could impair comparability as among differing bidders and different contracts with the same contractor. It was pointed out that, in a negotiated bid situation, the estimate of a contractor's cost plays an important role in the establishment of the price and that the cost of any specific order can only be measured by the application of costaccounting principles.

House Report 1455, May 23, 1968, on the bill which originally contained proposed legislation on this subject, indicated that it was considered to be necessary mainly because of (1) substantially increased costs of procurement, (2) difficulties in safeguards to ensure against excessive profits, and (3) Government agencies' having to accept other contract terms substantially less favorable to the Government than would be necessary without enactment of the proposed legislation.

Among the views stated in the Senate debate were:

The essential function of cost accounting is to allocate direct and overhead costs to individual orders. Thus the cost-accounting principles followed have a large impact on the determination of contractor costs. For example, cost items such as depreciation, research and development, inventory, self-insurance, small tools, and lease financing can be treated two or three different ways.

Once a method of treatment for each of these and other items is decided upon, the contractor then may allocate costs in a variety of ways. The methods used (1) to apply general overhead to a specific product (2) to allocate overtime or premium time between Government and commercial work or between one Government contract and another, (3) to handle interest on investment or financing, and (4) to charge for work done by affiliated companies, all have an important bearing on cost determination.

In the absence of "uniform principles", the entire burden is placed upon procurement officials to evaluate the contractor's accounting practices without the guidance of authoritative support for the use of alternatives in specific circumstances and thus results in more work for auditors and procurement officials, delays in important technical work, and excessive procurement costs.

There is growing awareness within the accounting profession itself that more uniformity is needed. Testimony from professional accountants was offered to the effect that one of the weaknesses of "generally accepted accounting principles" which now constitutes a basic guide in negotiated procurements is ascertaining costs is that, although the alternatives are well known, the criteria for the use of each alterative have never been established or "generally accepted."

EXTENT OF GOVERNMENT PROCUREMENT

Total Government procurement for the fiscal year 1969 amounted to $53 billion, of which $45.9 billion, or 86.6 percent, represented negotiated procurements that is, procurements which are not formally advertised. Total Department of Defense procurement for the fiscal year 1969 amounted to $40.8 billion, of which $36.3 billion, or 89.0 percent, was negotiated.

The underlying significance of cost-accounting standards in the total contract negotiation activities of the Government is indicated by the large volume of negotiated contracts which has substantially increased in the past 5 years, as indicated below.