simple to the highly sophisticated. In our experience we have found that there is no discernible relationship between the size of organization and the effectiveness of its cost-accounting system and methodology. Most mall and large companies, whether or not they are commercially-oriented, are known to possess in high degree the accounting talent and the expertise in costing contracts, product, and services. Such talent and expertise in cost-measurement is needed to cope with the challenges which arise in the competitive market place.

Contractors' books and records seldom provide the data regarding costs in a manner appropriate for negotiated contract purposes because they are primarily geared to the needs of financial reporting and furnishing information for management. This is true today under ASPR XV. When it becomes necessary for a contractor, large or small, to submit contract cost data for purposes such as price negotiations or claims for contract cost reimbursement, the data from these books and records is assembled on "working papers" and the contractor then makes the eliminations, additions, allocations, and summarizations which it believes appropriate to adjust the data to reflect the cost of performing a contract or a portion thereof.

For the most part, it is during this process of adjustment and summarization of data from the contractors' books and records on "working papers" that authoritative cost-accounting standards will eventually be brought to bear on the contractors' cost-accounting practices. In order words, we do not believe that cost-accounting standards would significantly change present procedures for determining costs under negotiated procurements. Moreover, in formulating the cost-accounting standards; those charged with this responsibility will take into account the practicality of imposing particular standards.

Other accounting authorities have expressed similar views, with which we concur, at the Senate and House hearings on cost-accounting standards. On page 555 of the Senate hearings, Mr. Leonard Spacek, Chairman, Arthur Andersen & Company, stated:

“* * * raised in the last IAC (Industry Advisory Council) meeting-was the question as to whether another set of books must be kept for defens econtracts if contract Cost Standards were established. The answer to this question is no.” * * * Every company has its own general system of bookkeeping and accounting. For special contracts, when statements are necessary for contract price negotiation or settlement, we start by assembling from these general books on "working papers" the costs that are believed to be the correct figures in accordance with that contract * * * This process is followed by both government and contractor. * * * The adjustments to book figures on working papers is the process by which each company arrives at its cost accounting statements that conform to "Cost Standards" deemed applicable. The government auditors and negotiators work from the company's working papers or prepare their own— this is the point where conflicting views arise. *** So, the working papers for contract audit, negotiation and settlement, as they are prepared, have always constituted a "third set" of books (the first and second books being the regular books used for general accounting and annual report purposes, and the second being the working papers used to support tax reports). The form of the defense contract working papers is controlled by the bookkeeping system of the supplier. *** That is the way that defense cost determinations for specific purposes are put together today; and that is the form that would be used to assemble costs when and if "Cost Standards" are established. ***"

On page 558 of the Senate hearings, Mr. I. Wayne Keller, Chairman, Committee on Management Accounting Practices, National Association of Accountants, stated:

“After the initial change the cost of continuing cost accounting under the standards as promulgated would be little or no different from the costs that those companies are expending now in recording costs under their present systems. There would be some minor cost of adapting to the new standards."

At the House hearings, Robert N. Anthony, Ross Graham Walker Professor of Management Control, Harvard Business School, stated:

"I want to comment briefly on the proposal that was made in the Senate to limit the application of cost-accounting standards to relatively large contractors. *** Those who favor this limitation imply that cost-accounting standards will create a paperwork burden, and that small contractors should be exempted from this burden.

"This argument is based on a complete misconception about the nature of cost accounting standards. All companies with cost-type contracts must have a cost accounting system. Such a system must be based on certain principles. Present

systems are based on whatever principles the contractor chooses to use. Presumably, these are principles that the contractor finds most advantageous to him, within the vague statements of Section XV of ASPR. A system based on other principles, those promulgated by the Comptroller General, should cost no more to operate than a system based on the principles that the contractor selects, unless the contractor now uses a system that does not do an adequate job of measuring costs at all.

"Indeed, it is likely that many contractors will benefit from the promulgation of a set of good standards. In the present situation, there is a great deal of confusion and uncertainty as to what practices are acceptable and what are not. With a good set of standards, the arguments with government auditors, and even the unexpected disallowances, that result from these uncertainties should be greatly reduced. Small contractors, who cannot afford large accounting staffs, should benefit proportionately more than the large contractors, who have experts knowledgeable in how to take advantage of the maximum latitude that is permissible under present regulations."

4. The enactment of the $25 million provision would result in major contractors and subcontractors being governed by cost-accounting standards, but would exempt companies with smaller volumes of defense business. Due to the high volume of subcontracting in defense procurement, it is entirely likely that a major weapon system, for example, would involve contractors with both over and under $25 million in defense business. If only some of the parties to the weapon system were subject to such standards and others were not, one of the major purposes of adopting cost-accounting standards-achieving a greater degree of consistency in the reporting of contract costs and the preparation of proposals would be defeated. Also, the calculation of overruns and underruns would be on a different basis.

In other words, if the $25 million floor or a similar provision were enacted, two sets of cost-accounting provisions would be incorporated into cntracts under a major weapon system, namely, the cost-accounting standards for contractors with over $25 million in annual Government sales and the cost principles of ASPR XV for contractors with under $25 million in annual Government sales. This would not only result in inconsistencies in the treatment of costs but would also present major difficulties in administration which are discussed below.

5. Administrative problems.-There are a number of problems which might be considered administrative in nature associated with the $25 million limitation of the applicabilty of cost-accountng standards. Some of these problems stem from the wordng of the amendment and others derive from the implications of the amendment.

a. The words "contractor or subcontractor" in the amendment have varying meanings as to the role of each due to diversity in organizational structure and degree of decentralization of corporations. Their meaning more or less depends on the organizational level at which contracts are executed. The words could variously mean (i) an entire corporation with all of its subsidiaries and operating divisions of vastly different sizes, (ii) parent company, (iii) subsidiaries, (iv) operating division, or (v) combinations of these.

Cost-accountng standards would apply to Litton with $300 million in contracts in 1969. Under definition (i), it would also apply to Clifton Precision, a subsidiary of Litton, although it has only $11,000 in contracts in 1969. On the other hand, such standards would not apply to other independent companies with, say, $10 million to $25 million.

Assuming that the $25 million threshold is intended to apply to individual profit centers such as plants, departments, divisions, etc., of contractors, the different components of a single contractor would be subject to different cost-accounting standards purely by reason of size.

It would appear that some profit centers of other contractors, with less than the $25 million threshold under negotiated defense procurements would not be subject to the same cost-accounting standards or ground rules even though they may be doing similar and even a substantial amount of negotiated Government contract work. Thus, some profit centers would be subject only to the guidance furnished by the ill-defined ASPR provisions although they may be in competition with profit centers of the same or other contractors which are essentially similar except that they are subject to the prescribed cost-accounting standards. We believe that, in the interest of eliminating controversy and providing equitable treatment to all contracting units, including profit centers, Government-prescribed cost-accounting standards should apply to all negotiated prime contracts and subcontracts regardless of amount or sales volume.

b. The term "sales" is too generic to insure uniformity and consistency. Controversies would result because of the diversity of opinions regarding the timing for the recognition of sales in the accounting records. For example, many contractors wait until completion of contract to recognize "sales" under fixed-price contracts, whereas most contractors recognize "sales" under cost-reimbursement contracts as costs are incurred. The questions of what are "sales" and when should they be recognized are very closely tied accounting-wise to the concept of cost of sales which is one of the areas for which cost-accounting standards are to be developed. Thus, cost-accounting standards might very well come into play to solve controversies over the questions of what are "sales" and when should they be recognized and to determine whether or not a contractor is exempted from cost-accounting standards by virtue of the $25 million threshold. Aside from the problem of what are "sales", it should be noted that while prime contract data is available at DOD, similar data on subcontracts held by companies are not available. If $25 million threshold on "sales" were established, Government would either have to maintain detailed rcords of data applicable to subcontracts of all companies or rely on the voluntary reporting of such data by subcontractors. While such data as pertain to first-tier subcontractors could reasonably be obtained and retained, reliable data as pertains to second and lower-tier subcontractors would be difficult to obtain by contractors.

In addition, in order to determine whether subcontractors at second and lower tiers meet this criterion, each subcontract let by the prime contractors and all successive subcontractors must be traced and verified. The time and effort required for such a determination would be very substantial considering the number of prime and subcontractors normally involved under any major procurement (weapons system) program.

c. The provision regarding "sales of commercial products sold in substantial quantities to the general public" has become a very familiar and infamous one to all parties involved with its application and administration. Past experience indicates that this provision is subject to varying interpretations and often results in extended difficulties and controversies. One could anticipate, for example, that the claim of "proprietary rights" would arise to prevent Government representatives from verifying whether a "sale" falls into this category. Also, a recent report to the Congress by GAO, entitled "Improvements Needed In Negotiating Prices of Noncompetitive Contracts Over $100,000 On The Basis Of Contractors' Catalog or Market Prices", B-39995, December 3, 1969, discusses some of the problems involved in the application of this provision.

d. The $25,000,000 limitation, as applied to some individual contractors. will be exceeded in some years and not in others. These intermittent changes in dollar volume of sales negotiated in connection with national defense procurements will generate certain questions as to the applicability of prescribed costaccounting standards under current and future contracts. For example, should the cost-accounting standards continue to apply to a contractor's cost reporting under current defense contracts if his sales under negotiated Government procurements fall below the dollar limitation in a fiscal year? Also, if a contractor's sales under negotiated defense contracts increased to an amount above the dollar limitation, would contracts already in being at that time come under prescribed cost-accounting standards?

It seems likely that a significant group of contractors could find themselves in the ambiguous position of having to conform to prescribed cost-accounting standards for some negotiated contracts while other contracts being performed at the same time would be subject only to the ASPR or the FPR. Furthermore, the Government's procurement officials and Government auditors, who at times find it difficult to reconcile their positions on contract costs under the present ASPR with each other as well as with those of the individual contractors, would encounter even greater difficulty in discharging their responsibilities under such circumstances. The requirement to follow two sets of cost-accounting standards for Government contracts would create an unnecessary burden.

Moreover, the phrase "the most recently completed fiscal year" would result in inequities and inconsistencies. For example, assume that in the year prior to the enactment of the bill, companies "A" and "B" doing similar work are awarded contracts totaling $25 million and $10 million respectively. Cost-accounting standards would apply to "A" but not to "B" even though in the year to which the standards apply "A" may have only $5 million or less in contracts. whereas "B" has $50 million.

A further implication of the fiscal year requirement is that multi-year contracts could result in the application of the cost-accounting standards in

one year and in the application of ASPR in another year. This, in turn, could result in frustrating the purposes of cost-accounting standards since many accounting alternatives without concomitant criteria would be available to contracts in the year(s) in which the standards do not apply.

e. Will cost-accounting standards, under the $25,000.000 limitation to sales volume, provide the guidance, support, and coordination required for better understood estimates and subsequent reporting of actual costs of various Government programs such as weapons systems?

In recommending the promulgation of cost-accounting standards without any dollar limitation either by contract or by sales volume, our objective was to provide a common framework for estimating prospective costs and the determination of actual costs of contracts. If the mandatory use of prescribed cost-accounting standards is limited to contractors having the $25,000,000 sale volume, there will be no common framework and cost-accounting standards will have limited impact on the problems involved in estimating and reporting of costs of weapons systems or other Government programs.

f. One of the primary provisions of the legislation as proposed by GAO would require all defense contractors to disclose which cost-accounting standards and practices they now follow and to agree to consistently follow these practices in order to minimize the adverse effect on both contractors and the Government resulting from the inconsistent use of cost-accounting standards in estimating and reporting contract costs. The limitation of the applicability of the regulations regarding the cost-accounting standards to contractors having $25,000,000 sales volume of negotiated defense contracts will severely limit the attainment of the benefit which could result from the disclosure of cost-accounting standards by contractors and their agreement as to consistent use.

CONCLUSIONS

We suggest that the $25,000,000 limitation of the application of cost-accounting standards to negotiated national defense procurements be omitted from the proposed legislation. During the task of developing and promulgating costaccounting standards it will be necessary for the Cost-Accounting Board to consider cost-accounting practices, methodology, and techniques considered appropriate for various types of contractor activities regardless of the size of contract or contractor's sales volume and to consider the probable cost of implementing such cost-accounting standards compared to the benefits to be derived therefrom. The matter of limiting the application of cost-accounting standards to negotiated national defense procurements, under these circumstances, could appropriately be left to the ultimate administrative recommendation of the Comptroller General and the Cost-Accounting Standards Board based on their findings during the process of developing the cost-accounting standards. This would on the one hand permit for exemptions, and the other hand would allow for administrative discretion and thus avoid inflexibility.

CLARIFICATION OF TESTIMONY GIVEN BY GAO REPRESENTATIVE OF JUNE 18, 1968 AND REFERRED TO BY INDUSTRY ASSOCIATIONS ON APRIL 1 AND 2, 1970, AT SENATE HEARINGS ON S. 3302

At the Senate hearings on cost-accounting standards on April 1 and 2, 1970, representatives of the Electronic Industries Association and the Financial Executives Institute referred to testimony on June 18, 1968, of Mr. James Hammond, Associate Director, Defense Division, U.S. General Accounting Office. We believe the reference to the statement of Mr. James Hammond of this Office has been misinterpreted and reflects a misunderstanding of the point which he was attempting to make. In testifying, Mr. Hammond stated:

"On occasion, we have problems because of the accounting system of a particular contractor, but I would say for the most part, in 99 percent of the cases, we are able from contractors' records to determine costs."

Mr. Hammond was referring, of cource, to postaudits of costs incurred under contracts; that is, material costs, labor costs, travel, etc., rather than breaking out cost elements as a part of contract negotiations. Even so, the process is a very detailed and time-consuming one and rarely does it involve an entire contract. Seldom have we made, for example, comprehensive audits of pools of indirect costs and their basis of allocation applicable to all Government and commercial activities. Under these circumstances, the auditors would not have nor could they 47-076-70---15

be expected to have complete knowledge of defense contractors' cost principles and practices at any given point in time.

While it is true that we have been able to determine costs from contractors' records on a selected cost basis, very often this determination requires an inordinate amount of time and the cost figures arrived at may not agree with those developed by the contractor, Department of Defense representatives, or other accountants. For this reason, at the June 18, 1968 hearing, Mr. Frank Weitzel, former Assistant Comptroller General stated that we were not unmindful of the need for firm and well-developed guidelines for contractors to follow in determining costs under Government contracts and that the establishment of certain accounting standards may be beneficial. Further, Mr. Weitzel suggested that: "If the committee should feel that action needs to be taken in the direction required by the amendment to S. 3097, or H.R. 17268, we would suggest that a study group be established to consider the advantages and disadvantages of establishing uniform accounting standards for Government contractors as well as what standards might be appropriate, with a reasonable time period, say not less than 18 months, to complete its work. We would suggest that this study be made by representatives of the agencies primarily concerned with procurement as well as representatives from the Bureau of the Budget and the General Accounting Office. Such a study should include appropriate consultation with industry and the accounting profession. The result of the study should be submitted to the Congress for its consideration."

In the absence of an authoritative set of cost-accounting standards, we believe that even the audits of selected contract costs will continue to require time-consuming efforts and that controversies as to what properly constitutes contract costs will continue to exist.

Another point concerning costing under contracts is the fact that contractors are currently not required to be consistent in the cost-accounting treatment afforded individual contract costs. This is particularly troublesome in situations where cost data in contract cost proposals are not presented consistently with the manner in which actual contract costs are recorded. It is often difficult, if not impossible, in such situations, to reconcile the contractor's actual costs with its proposal data without reconstructing the accounting transactions and records. This problem of inconsistency can, we feel, be solved only through means of an agreement under which the contractor discloses to the Government the cost. standards and practices it proposes to follow, and agrees to adhere to these standards and practices for the life of the agreement, or until it is modified by mutual consent. The requirement of an agreement providing for disclosure and consist. ency should be the initial step taken in the development of cost accounting standards.

Mrs. SULLIVAN. Mr. Lincoln, how often does OEP review its stock pile objectives and announce revisions in any particular one?

Mr. LINCOLN. Our procedure is one of continuing review of objectives item by item and I can't pick the time of our last announcement of a specific change. If I may I will ask Mr. Lawrence if he can remind me. He is head of my materials division.

(The following information was subsequently submitted for inclusion in the record at this point:)

Since Mar. 27, 1969, 70 materials and their subobjectives had been reviewed by OEP with the following results:

Objectives or subobjectives increased for 21 materials.

Objectives or subobjectives for 40 materials.

Materials deleted from the list of strategic and critical materials-6.
Subobjectives with no change-3.

Reviews are continuing on the remaining materials.

Mrs. SULLIVAN. Mr. Lawrence.

Mr. LAWRENCE. We review the objectives usually on the basis of about once every 2 years, although we keep all materials under sur veillance at all times in case there is a new material coming in or on that we have in the stockpile has become obsolete so we can dispos of it.

Mrs. SULLIVAN. And after the review comes the announcement.