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These regional offices supervise over 300 field audit offices throughout the United States and overseas. We have approximately 2,800 professional auditors and audit over 6,000 contractors.

Essentially, our function is to provide financial advice to contracting officers. We perform two types of audits in regard to agent's fees: Audits of contractors' proposals for award of a contract, also referred to as preaward audits; and audits of costs incurred in performance of contracts, which we refer to as postaward audits.

Audits of contractors' proposals are accomplished when requested by the contracting officer. Audits of costs incurred are accomplished based on receipt of an auditable type contract such as a cost-plusfixed-fee contract.

Accordingly, DCAA does not audit all FMS proposals or the costs. incurred under all FMS contracts. Examples of contractor proposals that would not be submitted to DCAA for review include those submitted under formally advertised procurements, and proposals priced on the basis of catalog or market prices. Audits of costs on a postaward basis are not made where the contract is firm fixed price.

Later on in this statement, I will provide the subcommittee with information indicating the extent of our involvement in the review of agent's fees. However, to put the standards that we use in evaluating contractors' proposals containing agent's fees in perspective, let me briefly review with you some of the circumstances that result in us not being involved.

There are instances where the contractor may not choose to charge the agent's fee to the contract; arrangements with the agent may not be definitive enough at the time the contractor submitted the proposal which we review; and there are cases where the proposal is submitted to DOD as though the end item was to be used by DOD and proposed additive costs due to the foreign military sales aspect are subsequently submitted directly to the contracting officer. Consequently, the following audit procedures should be considered in this context.

In the review of a proposal we evaluate the acceptability of the proposed costs, as General Stansberry has outlined, based on whether they are allowable, allocable and reasonable in accordance with applicable procurement regulations, cost accounting standards and generally accepted accounting principles.

In regard to agents' fees, our audit procedures are primarily concentrated on the requirements of ASPR 1-500, dealing with contingent or other fees. Depending on the circumstances, this would include, but not be limited to:

a. Review the standard form 119, "Contractor's Statement of Contingent or Other Fees, etc." When an agent's fee is included in the proposal.

b. Examine formal agreements between the agency and the contractor as to all pertinent terms, that is, length of agreement, fees, et cetera, and the type of services to be rendered.

c. Review the activities of the agent or agency in the recent past as they relate to the contractor's products or services to determine the allocability of the agent's services to the proposed contract.

d. Examine available documentation or evidence of the agencies" qualifications or knowledge concerning the contractor's products. e. Review the previous payments of agent's fees to determine the customary rate paid for comparable contracts, that is, for the same

or similar products or services, dollar amount and scope of contract, et cetera, especially for commercial contracts.

f. Determine whether it is an initial or follow-on sale. The effort for follow-on sales of additional quantities, spares, and support equipment should not normally be as great as the effort for the initial sale. Consequently, the fees should not be as large. Additionally, agents' fees are not allowed for follow-on spares provided under DOD supply support arrangements.

Based on the above analysis our report is issued to the contracting officer setting forth the various data obtained. The contracting officer must make the final decision on the overall acceptability of the fees, taking into consideration our findings in conjunction with all other pertinent data available to him at the procurement level.

The contracting officer may have data available on the fees paid by other contractors in the same industry and possibly the fees charged by the same agents.

Despite these procedures, it is not uncommon for our audits to result in little or no information to provide the contracting officer on the reasonableness of the fees. For these procedures to be effective, there almost has to be a history of procurement related to a particular country.

Consequently, our auditors must exercise a considerable amount of judgment in making recommendations to contracting officers on proposed agents' fees.

Our audits of cost incurred on auditable contracts are generally dictated by the terms of the contract, particularly since the issuance of DPC 117 in November 1973.

As a result of DPC 117, contracts will often specify the amount of fees to be paid and the terms of payment. In such cases, our reviews of incurred costs are designed to assure the Government is not charged in excess of the amount specified by the contract.

Consequently, since there are so many requirements applicable to agents' fees to be met before a contract is let, postaward audit is primarily one of compliance. Even if the contract does not specifically address agents' fees, it is not difficult for the auditor to establish whether the contractor is paying an agent in accordance with the terms and conditions of the agreement that was consummated at the time of contract award.

Essentially, gentlemen, these are the audit standards applied to sales agents' fees.

With regard to what occasions our agency has questioned fees in the last 3 years, we have made two types of analysis.

The first covers all foreign military sales pricing actions over $15 million for the 15 contractors with the most foreign military sales during the period July 1, 1972, to December 31, 1974.

The second covers all DCAA audit reports issued since July 1, 1972, on proposals for foreign military sales, where agents' fees were included in the cost and pricing data.

The top 15 contractors accounted for $4.633 billion of the $5.61 billion of foreign military sales recorded by the Department of Defense during the period July 1, 1972, to December 31, 1974.

Of this $4.633 billion, $3.606 billion consists of 82 pricing actions for more than $15 million each. Our review of these 82 pricing actions disclosed that DCAA did not issue audit reports on 22 actions totaling

$625 million. Seven of these actions, representing $356 million were the subject of "should cost" team reviews.

DCAA audit personnel were assigned to these teams, but no separate audit report was issued. The remaining 15 actions, totaling $270 million, consisted of 6 letter contracts, 4 modifications of contract for funding, 4 advertised procurements and 1 contract modification for which procurement utilized the audit report on the original proposal as a basis for negotiations.

Of the 60 actions totaling $2.980 billion, DCAA was requested to review, only 4 totaling $465 million included agent's fees.

I hope that this analysis helps to put into perspective DCAA reviews of agents' fees on foreign military sales.

Our second analysis covered audit reports on proposals for foreign military sales, where agents' fees were included in the contractor's cost or pricing data. The proposals totaled $1.04 billion and included $30.3 million for sales commissions. However, not all of the proposals resulted in procurement actions. Some were by unsuccessful bidders, and some of the procurement actions are still in process.

Of the $30.3 million included in these proposals for sales commissions, $26.5 million was questioned. The reasons cited for questioning these commissions are as follows:

1. Fees were questioned as unreasonable because no commissions were paid on similar sales to other governments or commercial customers. In this connection, item VIII of DPC 117, dated November 23, 1973, states:

A comparison should be made of the proposed fee/commission with recent payment for comparable services under non-FMS, commercial sales of the same or similar items, or agent's fees/commissions awarded on previous FMS sales of comparable scope and dollar amounts.

ASPR 1-505.4(a) also provides that the fees

Should not be excessive as compared with the fees customarily allowed in the trade for similar services related to commercial (non-Government) business. 2. Fees were questioned because the agreement between the contractor and the agent stated that commissions would not be paid on commercial sales. In this connection, ASPR 1-505.4(e) states:

The fact that a selling agency confines its selling activities to the field of Government contracts does not, in and of itself, disqualify it.

However, the auditor felt it appropriate to bring this matter to the attention of the contracting officer, because this ASPR paragraph further states:

The fact, however, that a selling agency is employed to serve business generally, that is, to represent the concern in connection with sales to the Government as well as regular commercial sales to non-Government activities is a factor entitled to favorable consideration.

3. Fees were questioned as duplicative of other sales effort for which costs were included in overhead.

4. Fees were questioned pursuant to item IX of DPC_117, which provides that commissions on sales to the Government of Iran are not allowable unless approved by the foreign government in advance of contract award.

5. Fees were questioned or classified as unsupported because the contractor did not provide the contract or agreement with the sales agent which established the terms of sales commission payments. Item VIII of DPC 117 provides that:

When the contractor has included costs for agents' fees/commissions, the contracting officer shall require the contractor to submit a "Contractor's statement of contingent or other fee" (Standard Form 119),

which includes a copy of the written contract or agreement or, if not in writing, a detailed statement of the terms of such arrangement.

6. Fees were questioned because the procurement related to items or types of contracts not covered by the terms of the agreement between the contractor and the agent.

In summary, DCAA provides the contracting officer with as much information as possible concerning agents' fees. We are not involved in every case but we do our best to assist in this difficult area, based on information obtained from the contractor concerning his arrangements or experience with the agent involved.

I will be happy to respond to any questions the subcommittee may have.

Mr. Nix. I would like to refer to page 6 of your statement. Mr. Starrett. Specifically, where you say "our review of these 82 pricing actions. disclosed that DCAA did not issue audit reports on 22 actions totaling $625 million." Why did you not issue audit reports?

Mr. STARRETT. Let me begin by saying that the review of the 82 pricing actions was a survey that was made in order to obtain information for this testimony. We reviewed 60 proposals.

The difference between the 82 and the 60, and the reason that we did not audit these proposals is because, in looking at the statement, six are letter contracts, and in the letter contracts, the price is not established, so there is no proposal at that point in the procurement.

In connection with the four modifications of contracts for funding, these are just procurement actions which either add or take funds from those already in the contract. In this case, the four modifications actually resulted in a negative net figure. In other words, money was taken away from the contract.

In one contract modification the contracting officer used the prior audit report. If he has prior information concerning the contractor's rates and the type of information that he would use in a proposal evaluation on another procurement from DCAA, then he does not have to request another audit, which would be more or less duplicative of what he had before.

Mr. Nix. All of these transactions involved large sums of money. On one, you say that a previous audit had been made, and the others were contractual arrangements in which large sums of money were involved. Is that correct?

Mr. STARRETT. Yes, sir. In the case of the letter contract, there could be large sums of money involved. However, the amount that is finally put into a definitive contract would be established subsequent to the contractor submitting a proposal, our review of the proposal, and then a negotiation of the price.

In other words, I guess the best way to put it is that the letter contracts is more or less of a go-ahead to begin work, and money is provided for the contract, but the price is established later on.

Mr. Nix. What I am trying to get at, what is disturbing me is the question of whether or not an audit in those instances was later made, or was not made.

Mr. STARRETT. At the time that the contractor submitted his proposal, to definitize those letter contracts, an audit was probably made.

I have not checked that point, but our procedures would provide for an audit to be made at that time. Yes, sir.

Mr. Nix. In all of these instances, is an audit mandatory?

Mr. STARRETT. It is mandatory by the ASPR, if the proposed contract is $100,000 or over, and the contracting officer does not have sufficient information available to him to price the procurement.

Mr. Nix. Now, how many of these transactions amounted to $100,000 or over?

Mr. STARRETT. Let me add one more thing to my previous statement: As long as it was a negotiated procurement, a formally advertised procurement, we do not audit.

How many of these exceeded $100,000, I would say that probably all of the 60 pricing actions that we reviewed, most likely exceeded $100,000.

Mr. Nix. I am concerned with those that you did not audit, you did not review.

Mr. STARRETT. I think that I am really not explaining adequately, then. What I am trying to say is that those procurement actions are not necessarily contracts. Involved in those 82 are actions which amount to nothing more than taking moneys from a contract that is already in being, so there is no real reason for an audit.

General STANSBERRY. May I add something.

Everything that Mr. Starrett said is precisely right. A letter contract to start with is nothing more than a letter that directs the contractor to proceed. There is no record to audit. They have not submitted a definitive proposal.

A letter contract is used seldom. It is only used when the exigencies of the situation require it, to tell the contractor, "Go ahead, get started, and we will definitize the price later."

He submits a proposal, then Mr. Starrett's people would come in. With respect to the funding actions, it is an administrative action of moving the funds on or off a contract. It does not change the contractual obligation.

On advertised procurement, we depend on competition as opposed to negotiated procurements, to set a fair price.

The particular contract modification utilizing the previous audit report, I have no details on, but that does happen. If there has been a prior audit within a reasonable period of time, the contracting officer can make a determination that he does not need other support by the rules.

Generally, it is my experience that the contracting officers bend over backward to get audit support because they feel that they need it, and they regard it very highly. Often times, they go well below the $100,000 to request it, even though the rules don't require it.

Mr. Nix. That is in particular what I was concerned with. Thank you very much.

Mr. Whalen.

Mr. WHALEN. Thank you very much, Mr. Chairman.

Mr. Starrett, as I did with the general, maybe we ought to begin at the beginning.

Your agency serves all of the armed services. Is that correct?

Mr. STARRETT. That is correct.

Mr. WHALEN. I assume that the major part of your work deals with domestic contracts.

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