counting principles should be examined in depth and on a continuing basis. Such an analysis has not been made either by the accounting profession or by the GAO.

Rather than to promulgate "standards" that have, thus far, eluded description we believe that the accounting profession should conduct a study which would have as its objectives:

(1) a codification of cost accounting principles which already exist, (2) an examination and evaluation of the degree of latitude and flexibility which exists in the interpretation and use of these principles,

(3) a diagnosis of the problems in the use of cost acconuting principles by defense contractors and the contracting agencies as suggested by the problem areas identified in the GAO report,

(4) recommendations for corrective measures to eliminate the problems diagnosed.

To undertake this task, we have proposed a Special Committee composed of representatives of the principal accounting associations and of industry. This Special Committee would review the independent efforts that are currently in process and would take steps to assure that these efforts are appropriately coordinated and directed toward achieving the objectives listed above. It would also define specific new projects for areas of investigation.

This proposed Committee made up of members of the accounting profession with a solid background and experience in industrial accounting has a better chance, we believe, of doing a thoroughly professional job and doing it more economically and more expeditiously than it could be done by the GAO with a GAO controlled Board.

If the Congress finds its duty to be the adoption of legislation, we firmly believe that a nine-man independent Board, appointed by the President with equal representation from the Government, the accounting profession and industry is a possible alternative arrangement. However, the Charter of this Board should direct it to make a thorough analysis of the problems and the development of appropriate solutions. Let the Board determine whether in fact a need exists for standards and shape its actions accordingly. This would be far better than authorizing a sovereign Board to promulgate standards where the requirement has not been established.

This concludes our statement. In closing, we express our appreciation for the opportunity to appear before you today.

Thank you.

POSITION PAPER ON UNIFORM COST ACCOUNTING STANDARDS OF THE FINANCIAL EXECUTIVES INSTITUTE

The Financial Executives Institute has, from the introduction of legislation in 1968, been deeply concerned with the subject of uniform cost accounting standards. We have followed closely the various lines of testimony offered prior to the legislation authorizing the feasibility study conducted by the General Accounting Office. We supported the efforts of the GAO during the study with specific comments and suggestions. We also provided a suggested mailing list of companies to receive the questionnaire who are not engaged in defense work. More recently, we have followed comments in the press relative to the reports submitted by the Comptroller General to the Congress on the feasibility of developing uniform cost accounting standards.

With the feasibility study completed, and with legislation pending to promulgate uniform cost accounting standards, the Financial Executives Institute believes that its position on this subject should be publicized. In summary, this position is:

Uniform cost accounting standards are not feasible in the sense contemplated by Public Law 90-370 and the Hearings which preceded its enactment in 1968.

No new evidence has been provided through the feasibility study authorized by Public Law 90-370, or through other sources, to indicate that legislation is required to promulgate UCAS or to demonstrate the need for UCAS.

The uniform cost accounting standards that the GAO believes are feasible have not been identified or defined adequately to provide an understanding of what is contemplated. There is no substantiation that such standards and advance agreements, as recommended in the feasibility study, are economi

cally feasible and practical, or that they would solve the accounting problems associated with applying sound cost principles to government contracts.

Legislation is not necessary and is not recommended as a solution to problems that have been identified. Desirable changes to present cost accounting standards can be accomplished within the framework of established procurement regulations and delegated administrative powers.

An Advisory Commission, to be established by the Secretary of Defense, is advocated as providing the best approach to equitable and practical solutions to existing accounting problems. This Commission, with equal representation from government, industry, and professional organizations, should examine the problems of, and relating to, defense cost accounting and proposal pricing and make recommendations for corrective action. This paper traces the legislative history leading up to the GAO study, discusses the evidence offered by proponents of the legislation and states the Institute's position on the subject of uniform cost accounting standards and suggests some specific actions we believe should be taken.

The paper is divided into several sections under the following captions:
Actions leading to the feasibility study.

Evaluation of GAO's positions.

Evaluation of the GAO report.

Support for UCAS other than GAO.

FEI position.

What should be done.

ACTIONS LEADING TO THE FEASIBILITY STUDY

During the hearings before the House Committee on Banking and Currency in April, 1968, Vice Admiral Rickover expressed concern regarding contract cost accounting. Under consideration was the extension of the Defense Procurement Act. His underlying theme initiating the uniform cost accounting standards proposition was that unless the government instituted uniform cost accounting standards for accounting, profits would continue to be hidden in contractor costs. He stated that because of "their varied and frequently changing accounting systems, contractors were able to charge more than they should for complex equipment." He also alleged that "profits on negotiated Defense contracts have increased substantially in recent years." In subsequent Senate hearings and floor debates this basic theme of hidden costs and excessive profits was voiced again and again with the charge that contractors have "virtually unlimited flexibility" in accounting treatment of costs.

In response to a question by Representative Griffin as to savings that could be accomplished as a result of uniform accounting standards, Admiral Rickover testified:

"I have pointed out that substantial profits can be hidden as 'costs' on Defense contracts. The true profit on negotiated contracts is, I believe, much higher than the average of 9.7% admitted by the Department of Defense and industry. Just how much I can't tell; no one can. But I believe it is realistic to assume that uniform accounting standards could save a minimum of 5 to 10% on costs. I believe the saving could easily be $2 billion a year."

Thus Admiral Rickover made two basic points in his testimony. His first point was that Defense profits are excessive because of the hidden profits in costing methods. His second allegation was that the government could "easily" save $2 billion a year from uniform accounting standards.

The difference between "going-in" and "coming-out" profit rates should be considered in discussion of defense profits. Government negotiators and auditors usually think of a contractor's profit as the negotiated profit or fee, the going-in rate. They choose to ignore as cost the costs actually incurred but disallowed by ASPR Section 15-205. Since these costs are incurred and must be absorbed, contractors appropriately and logically allocate them to all of their business. Overruns on negotiated costs of fixed price type contracts frequently occur, and these additional costs also reduce negotiated profit margins. The effect of disallowances and cost overruns is to reduce the total realized profit rate on government work, the coming-out rate, considerably below profit rates found in contracts.

With respect to the Admiral's second allegation, there seems to be no basis for the estimated $2 billion a year savings. It should be recognized that half or more of the procurements result from advertised or negotiated competitive bids from

which savings of this type could not result. At no time, either in the original hearings or subsequent thereto has Admiral Rickover, the GAO, or anyone else attempted to develop support for the Admiral's $2 billion number. In fact, no one has been able to show any specific savings that would result from uniform cost accounting standards. We therefore place no credence in the alleged savings. The Admiral repeatedly stated that profits can be and are hidden in costs and that the solution to the problem was uniform accounting standards. The following is a quotation from his testimony:

"It should be clearly understood that under existing procurement rules it is not possible to tell just how much it costs to manufacture equipment or just how much profit a company actually makes-without spending months reconstructing the supplier's books. Large additional profits can easily be hidden just by the way overhead is charged, how component parts are priced, or how intra-company profits are handled. The company may report as cost what actually is profit." "In one case Navy and General Accounting Office auditors conducted an extensive number of audits to determine one supplier's actual cost in making equipment for the Government. These audits and evaluations lasted nearly a year. Altogether there were seven reports containing eleven different estimates or evaluations of the supplier's costs, in addition to the estimates made by the supplier himself."

In that particular testimony, the Admiral has taken issue directly with some of the alternatives available in generally recognized accounting principles. For example, the various ways of calculating overhead, of pricing inventories, or of charging transfers between divisions. As a practical matter, no one contractor could use all of these alternatives. While the variety may be confusing to some people, particularly those not trained in accounting, there is no impropriety to using any of the accepted methods, as long as there is appropriate disclosure. These are not, as asserted, devices for converting cost to profit or of hiding profits.

The GAO in its testimony before the Senate disagreed extensively with Admiral Rickover's statements. During the hearings held in 1968, the GAO stated repeatedly that uniform accounting standards would be of little assistance in determining contract costs. Several quotations from their testimony are given below:

"The GAO auditors by and large have not had too much trouble in determining what the contractors' actual costs were, even though the contractors may be under diverse accounting systems suited to their own line of industry, their own management, and their own particular concepts of accounting."

"Our auditors have felt they could determine the contractor's costs and his profits on auditing his books. And even if he had a standard requirement for furnishing costs or profit information, it still would be necessary to aduit the contractor's books to determine whether he was following that requirement." "Speaking for our auditors, I have questioned them, and I have understood from them that in most cases, they are able to get cost information which they are able to use satisfactorily by looking at the contractor's books."

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

With respect to the cases cited by the Admiral in his testimony, the GAO representative testified:

"The GAO report cited by Admiral Rickover in his testimony did not involve lack of uniform accounting standards or standards for determination of cost or profit. But rather, we felt in the GAO that this case was a case where the contractor should have obtained cost information from its subcontractor which was a division of its own company before awarding the subcontract . . . I doubt whether the existence of a requirement for a uniform accounting system or uniform cost standards would have prevented this kind of a case."

During the hearings by the House and the Senate, numerous representatives of GAO, DOD, industry, and the accounting profession testified concerning the need for uniform accounting standards. The overwhelming opinion was that such standards were not necessary or desirable. In fact, aside from Admiral Rickover, only one witness testified on behalf of uniform standards. That witness was J. S. Seidman, an accountant from New York City. Mr. Seidman stated that in connection with his support for accounting standards, "the clincher is Admiral Rickover's statement: 'I believe the saving could easily be $2 billion a year.' Hence, I conclude that uniform accounting standards are necessary in defense

procurement." If this be the basis for his conclusion, the credibility of Mr. Seidman's testimony is certainly subject to question.

The substance of this testimony is that there are a lot of alternatives in accounting for costs available to contractors. It is inferred that because of this flexibility, the government cannot buy "prudently, intelligently or efficiently” without uniform accounting standards to provide meaning to contract price proposals or reported profits. The implication that alternatives equate with the caution of "buyer beware" or with some kind of subterfuge or dishonesty has yet to be demonstrated. The GAO testimony at the same hearings clearly stated they were able to determine contractors' cost 99% of the time.

EVALUATION OF GAO'S POSITIONS

As noted on the preceding page, the GAO stated repeatedly in its 1968 testimony on the value of uniform cost accounting standards that they would be of little assistance in determining contract costs without audit. In spite of this testimony, given by some of their highly qualified people, the feasibility study concludes that a greater degree of standardization is feasible and if coupled with advance disclosure agreements it would improve the ability for determining costs. Except for the so-called "horror cases" (which are discussed in more detail below), the report contains no objective proof that there even is a problem, and certainly no proof that any form of cost accounting standards would solve any problem that might exist. The report explicitly states that detailed standards cannot be developed which could be applied to all contractors in all circumstances. It also states that . . . "to require consistent uniform cost accounting practices for all contractors, whatever the circumstances, involved in contract performance, goes to such an extreme as to be unreasonable and unenforceable."

It is apparent that for some unknown reason the GAO did not want to adopt a position in opposition to cost accounting standards. It is also clear that any standards currently advocated by the GAO will not provide comparability of costs or proposal estimates between contractors. Although the report does not make this point, it seems inescapable that the over simplified comparisons envisioned by Admiral Rickover in his testimony cannot reasonably be achieved.

The report is unambiguous in stating that standards coupled with advance disclosure agreements would force individual contractors to be consistent between the way they price proposals and book their costs. It is clear to us that a more thorough analysis would have shown this approach to be clearly impractical not because of any objections from contractors but because of requirements imposed on bidders by the various procuring agencies. There is little consistency between agencies or in the Requests for Proposals (RFPs) in the required format for responses to RFPs. There is a requirement for consistency between contractors on the response to any one RFP in order to facilitate evaluation of proposals. These requirements frequently force serious deviations from the way a contractor normally records his costs. Uniformity in a contractor's practices between booking costs and pricing proposals, desirable as it may be cannot be accomplished by legislation and regulations imposed on contractors. We believe there is a way to improve this lack of uniformity as will be noted later in this paper.

The report also deals at some length in Appendix III with a number of socalled "horror cases." These are random cases based on "recollections" of field office personnel-mostly in the DCAA. They do not purport to be a statistical sample. This is rather inadequate research and documentation to support legislation that will have such a far reaching impact on industries engaged in defense work and perhaps other industries as well. There is no real evidence that standards will solve problems of the type cited.

EVALUATION OF THE GAO REPORT

There are many sections of the GAO report with which FEI can and does agree. For example:

1. The report stresses the need for understanding of the contractor's cost accounting practices. The DCAA and the local contracting personnel are intimately familiar with the cost accounting practices of the firms to which they are assigned. Companies supply the government auditors, cost analysts, and others with a need to know copies of cost manuals and instructions, estimating procedures and practices, and all other significant material. In addition, estimates and actual costs are audited in great detail by government personnel familiar with the accounting practices. While it might be true that a procuring

officer not stationed at the contractor's plant may not be familiar with the contractor's practices, he is assisted in the negotiation by the DCAA and DCAS personnel who are experienced with such practices.

2. The report stresses the need for consistency between the way a contractor prepares his pricing proposal and the way he books his costs and files his claims. With appropriate allowance for changes to practices that are inevitable over extended periods of time and for economic factors not reflected in cost records, we think most contractors would accept such a policy. Historically, industry has discussed major changes in accounting with the Government's contracting and auditing personnel, have supplied them with full details and disclosures; in many cases have even requested and secured agreements concerning such changes. Before this type of consistency can be fully implemented, procuring agencies must be constrained in the requirements they place on contractors in the RFPs.

3. We concur with the proposal that government procurement regulations be made uniform across all agencies. In that connection FEI endorsed the establishment of the Holifield Commission on Government Procurement and is prepared to support this effort in any appropriate way.

4. We subscribe to the proposition that steps can be taken which would lead to an improvement in cost accounting policies. This cannot come about from legislation or by hastily imposed regulations. It can only come about effectively through a joint effort over an extended period of time.

5. We subscribe to the conclusion that new machinery be established to tackle the problem relative to cost accounting-whatever that problem turns out to be. This machinery should be capable of studying the problem objectively and should be free from domination by any one faction either industry or the government. It must reflect a joint effort toward a common objective.

6. We subscribe to the proposition that significant progress on the above should not be anticipated over a short time span (18 months). Considerable research needs to be done. It must be recognized that the primary objective of cost accounting is to serve as an effective management tool. If greater uniformity can be accomplished without undermining the effectiveness of cost accounting as a management tool, this is a worthwhile objective that should be thoroughly explored.

There are also a number of areas and concepts in the report with which FEI cannot agree. We have identified the most crucial of these together with our reasons for disagreement.

1. The definition of a cost accounting standard, which was originated by the GAO for this study and used in its report, is so unduly broad that it proved to be nondefinitive. As a result, a variety of interpretations have been applied by those who provided the essential data for the study. Some of these are obviously not what was intended or what the GAO believes to be feasible. We cannot agree that anything is feasible until there is a clear communication and common understanding of what we are talking about.

2. Nowhere in the report is there any substantiation that such standards would be economically feasible. Other than Admiral Rickover's unsupported estimate of a $2 billion savings, there has not been any proof of any savings. On the other hand, our interpretation of what we believe the GAO had in mind, in concluding that some greater degree of uniformity is feasible, would unavoidably involve very large expenditures by industry and significant expenditures by the government for implementation. Effort expended over a long time span would automatically result in large expenditures.

3. We do not agree that major cost accounting problems exist. No substantial evidence is contained in the report to support this statement. The data provided in Appendix III supports the assertion that auditors have problems (which the GAO concedes were overcome) reconciling contractor's cost proposals with their cost records. We believe this is a pricing problem and relates primarily to format not to cost accounting principles.

4. The report states: "Our study indicates that a recurring problem in government contracting is that, in reporting to the government on both proposed and incurred costs, contractors may select from alternative accounting methods without specific criteria governing such selection." We believe that the use of alternative accounting methods is necessary and proper and that no harm is done the government as long as a contractor is consistent. For example, one of the cases cited in Appendix III disclosed that a study of four West Coast contractors with virtually 100% government sales showed minimum capitalization policies ranging from $100 to $500. So long as a contractor is consistent it makes no dif