Policies and procedures of the Renegotiation Board

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Title:
Policies and procedures of the Renegotiation Board a review of selected cases : a report
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v, 57 p. : ; 24 cm.
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English
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United States -- Congress. -- House. -- Committee on Banking, Currency and Housing. -- Subcommittee on General Oversight and Renegotiation
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Renegotiation of government contracts -- Cases -- United States   ( lcsh )
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At head of title: Committee print.
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Issued Oct. 1976.
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by the staff of the Subcommittee on General Oversight and Renegotiation ; submitted to the Committee on Banking, Currency, and Housing, House of Representatives, 94th Congress, second session.

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University of Florida
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aleph - 026304824
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lcc - KF861 .A25 1976
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[COMMITTEE PRINT]




POLICIES AND PROCEDURES OF TILE RENEGOTIATION BOARD: A REVIEW
OF SELECTED CASES



A REPORT
BY THE STAFF OF TMHE

SUBCOMMITTEE ON GENE gAJ-IOVERSIGHT
AND RENEGOT T ON,
SUBMITTED TO E

COMMITTEE ON BANKI URRX ,.
AND HOUSING

HOUSE OF REPRESENTATIVES
94th Congress, Second Session







OCTOBER 1976


The report has not been officially adopted by the Subcommittee on General
Oversight and Renegotiation and may not therefore necessarily
reflect the views of its members

Printed for the use of the Committee on Banking, Currency and Housing

U.S. GOVERNMENT PRINTING OFFICE 77-950 WASHINGTON : 1976












COMMITTEE ON BANKING, CURRENCY AND HOUSING HENRY S. REUSS, Wisconsin, Chairman LEONOR K. (MRS. JOHN B.) SULLIVAN, ALBERT W. JOHNSON. Pennsylvania
Missouri J. WILLIAM STANTON. Ohio
THOMAS L. ASHLEY, Ohio GARRY BROWN, Michigan
WILLIAM S. MOORHEAD, Pennsylvania CHALMERS P. WYLIE, Ohio ROBERT G. STEPHENS, JR., Georgia JOHN H. ROUSSELOT, California FERNAND J. ST GERMAIN, Rhode Island STEWART B. McKINNEY, Connecticut HENRY B. GONZALEZ, Texas JOHN B. CONLAN, Arizona
JOSEPH G. MINISH, New Jersey GEORGE HANSEN, Idaho
FRANK ANNUNZIO, Illinois RICHARD T. SCHULZE, Pennsylvania
THOMAS M. REES, California WILLIS D. GRADISON, JR., Ohio
JAMES M. HANLEY, New York HENRY J. HYDE. Illinois
PARREN J. MITCHELL, Maryland RICHARD KELLY, Florida
WALTER E. FAUNTROY, CHARLES E. GRASSLEY, Iowa
District of Columbia MILLICENT FENWICK, New Jersey
LINDY (MRS. HALE) BOGGS, Louisiana RON PAUL, Texas STEPHEN L. NEAL, North Carolina JERRY M. PATTERSON, California JAMES J. BLANCHARD, Michigan CARROLL HUBBARD, JR., Kentucky JOHN J. LAFALCE, New York GLADYS NOON SPELLMAN, Maryland LES AuCOIN, Oregon PAUL E. TSONGAS, Massachusetts BUTLER DERRICK, South Carolina PHILIP H. HAYES, Indiana MARK W. HANNAFORD, California DAVID W. EVANS, Indiana CLIFFORD ALLEN, Tennessee NORMAN E. D'AMOURS, New Hampshire STANLEY N. LUNDINE, New York PAUL NELSON, Clerk and Staff Director WILLIAM P. DIXON, General Counsel MICHAEL P. FLAHERTY, Counsel GRASTY CREWS II, Counsel ORMAN S. FINK, Minority Staff Director GRAHAM T. NpRTHUP, Deputy Minority Staff Director



SUBCOMMITTEE ON GENERAL OVERSIGHT AND RENEGOTIATION
JOSEPH G. MINISH, New Jersey, Chairman
PARREN J. MITCHELL, Maryland GEORGE HANSEN, Idaho
BUTLER DERRICK, South Carolina JOHN H ROUSSELOT, California
PHILIP H. HAYES, Indiana STEWART B McKINNEY, Connecticut
HENRY B. GONZALEZ, Texas FERNAND J. ST GERMAIN, Rhode Island DAVID W. EVANS, Indiana STANLEY N. LUNDINE, New York ROBERT Lorus, Staff Director JACK ZACKIN, Counsel
(II)










LETTER OF TRANSMITTAL

OCTOBER 20, 1976,
To Members of the Committee on Bankivnq, Currency and Housing:
Transmitted herewith for use by the full Banking, Currency and Housing Committee and the Congress is a report by the Staff of the Subcommittee on General Oversight and Renegotiation, entitled Policies and Procedures of the Renegotiation Board: A Review of Selected Cases. The Report was prepared by William F. McQuillen, Jack M. Zackin and Bernard Treseavage who was on temporary assignment from the General Accounting Office.
I believe that the report will prove to be of utmost importance to Congress in its efforts to improve the renegotiation process.
JOSEPH G. NISH, Chairman.
(III)


















Digitized by the Internet Archive
in 20-13












http://archive.org/details/polidurOOu nit













CONTENTS

Page
Introduction- 1
I. The renegotiation process -----------------------------------1
II. Screening operations --------------------------------------- 4
III. Renegotiation of assigned cases ------------------------------12
IV. Untimely filings/data submission -----------------------------31
V. Workload statistics/court of claims actions --------------------35
VI. Hypothetical excessive profits -------------------------------37
VII. Other matters ---------------------------------------------40
Appendix A.-Section 103(e) of the Renegotiation Act ------------------43
Appendix B.-Section 103(m) of the Renegotiation Act ------------------43
Appendix C.-Administrative Letter 75-15 ----------------------------44
Appendix D.-Administrative Letter 75-8 -----------------------------46
Appendix E.-Renegotiation Board Regulation 1471.1 and Bulletin No. 15- 4S Appendix F.-Renegotiation Board Regulation 1457.5 ------------------ 49
Appendix G.-Selected Regulations of the Renegotiation Board --------- 52

ABBREVIATIONS
CWA-Clearance without assignment DCAA-Defense Contract Audit Agency DOD-Department of Defense
ERRB-Eastern Regional Renegotiation Board FTC-Federal Trade Commission
FYE-Fiscal year ending
GOCO-Government owned company operated IRS-Internal Revenue Service
SIC-Standard industrial classification WRRB-Western Regional Renegotiation Board
(V)














POLICIES AND PROCEDURES OF THE RENEGOTIATION
BOARD: A REVIEW OF SELECTED CASES

INTRODUCTION
This Staff Study analyzes the renegotiation of selected cases conmpleted by the Renegotiation Board in fiscal year 1976. The cases selected for review included those that had undergone full-scale renegotiation by the regional offices as well as those cleared without assignment (C.W.A.) in the headquarters screening operation. WVe selected five cases that has been C.W.A., three Class "A" cases (renegotiable profits of more than $800,000) cleared by both the Regional and( Statutory Board, 11 Class "B" cases (renegotiable profits of $800.000 or less) cleared by the Regional Boards, and two excessive profit determination cases. Our review of these cases, recent Board minutes, and other documentation resulted in a limited review of other cases as well.
The report is divided into seven major sections, beginning with an overview of the general manner in which renegotiation is conducted. Other sections are devoted to the screening operation, the renegotiation of assigned cases. Board workload statistics and Court of Claims actions, and the problem of untimely filings and data submissions. The sixth section, "Hypothetical Excessive Profits" is an counting exercise which computes excessive profits for selected contractors based on FTC and IRS industry statistics, and compares these to the much lower excessive profit determinations actually made by the Renegotiation Board. The final section. "Other Matters" discusses in greater detail some important points raised briefly in the previous sections.
Throughout the report, the staff has indicated its findings, conclusions and observations with respect to the cases reviewed, and to Board practices and policy in general. In several sections we have pulled these observations together under the heading "Concluisions." We believe this report documents the serious problems and short-comings in current Renegotiation Board practices, and points up the need for statutory and regulatory reform.

I. THE RENEGOTIATION PROCESS
In the early stages of World War II, renegotiation was conducted on a contract basis. A standard percentage on contract price was employed as the criterion for determining excessive profits. Renegotiation on that basis proved unwieldy, however, and the Renegotiation Act of 1943 established a fiscal year basis for renegotiation.
Section 105 of the Renegotiation Act of 1951 (the present Act) states:
The [Renegotiation] Board shall exercise its powers with respect to the aggregate of the amounts received or accrued during the fiscal year. Renegotiation on a contract basis will be conducted, however, if requested by a contractor.
(1)






2

Until recently, the Renegotiation Board interpreted Section 105 to mean that corporate structure must be viewed in the aggregate; that is, the parts were unimportant when the whole viewed by itself did not reflect excessive profits. This interpretation overlooked the fact that the emphasis on aggregate sales developed at a time when contractors were producing the same or similar products under several contracts at one or more plants. In 1951 when Section 105 was enacted, conglomerate corporations manufacturing a diversity of products in a multidivisional/subsidiary structure were virtually unknown.
The language of the Act grants the Board broad powers with respect to the manner in which renegotiation shall be conducted. Product line or related types of analyses are not proscribed, nor does the Act dictate the manner in which review year losses/deficient profits among corporate segments are to be treated. Logically as the business and economic environment changed the Boa rd's policy should have followed suit. The word "aggregate" in practice should be interpreted to mean bringing the results together after segmentation analysis since the efficiency, management, manufacturing process. economy in the use of materials, manpower and facilities can and do differ for each segment.
As the Board's General Counsel pointed out in a recent opinion, the language of the Act and its legislative history, indicate that Congress intended to stress the recognition and reiward for efficiency. Section 103 of the Act directs that "favorable recognition must be given to the efficiency of the contractor." No mention of "favorable treatment" is made in regard to the six "statutory factors" listed in Section 103.
To determine efficiency, the Act specifies that "particular regard" should be given to economy in the use of materials, facilities and manpower." Thus, factors suich as a decrease in the quantity of materials or the number of employees utilized in relation to production, and the reduction of waste would appear to be vital. The degree of economy differs, however. depending among other things, upon what types of products are being manufactured, the extent production is done inhouse or subcontracted out. and the manufacturing process employed.
When corporate segments, product lines or divisions are renegotiated on a consolidated sales/profit basis, no attention can be given to the varying nature of the segments within the whole. An analysis on a consolidated basis. therefore, does not explore these essential ingredients of contractor efficiency in the detail necessary for its proper evaluation.
The Board has argued that it has renegotiated contractors on a segmented basis. To some extent this is true in that the Board has obtained segmented data. The important consideration, however, is how adequately the individual segments were analyzed to insure that offsets were justified. A thorough analysis would recognize the different product-mixes, processes and efficiencies of each of the operations. In the final analysis, emphasis on overall corporate profit and the averaging effect has been routine Board policy and practice. The Board's Administrative Letter on Segmentation Analysis dated November 17, 1975 does. however, recognize that relevant differences in each segment can exist, and that segments need to be separately analyzed. It is still too early to judge the seriousness with which the Board is approaching segmentation analysis.





3

Ii1ctiatnll Of jf1Uilt-ii8;~O~i (or1o:'atw(d (111(1 c(oilowc( (U (
The Boardl miay renegotlte a, contractor i iidividiailv o. 4as a iie i
I er of a, relatted group-)-sO calIled "coI Isol i (lit ted rclieot i Ii ')ih' rjTile Board also preparYes '"pro-lor-inai. -AOldat iolls" Xw-le ill tile iconsoli diated(l rouip Is- reniegot iated (along with contractors t hat are rebated. bt not el ifrible for ilsini the coniul ita ted fiji g.T i uoedr is also known aIs 'conteinporaiieois renei).otiation.:" tCfteinpjoflaleoi Is reiieootiat ion is also coiiducted *l ( vil were the fil I I is of relat1,ed, colntractors cover slight t-l y different periods and are, there lore, not pormitted to be combined into one filing. Prior to FYL 19'(,)7 the B3oard also enoraredl ill "(,-ofii( eflrt ree lriit i i h11 eae otrr tors, filhinr sepa rate v. were aggr-jeq.ated byv the Board -itsellI.
Th e effects of pro-formna cons olidation are difficult to lies ire n termis of the averaging effect. II la recent. case the, Board (ondItw'tl a concurrent renegotiation which left the contractor w-ith1 85' et iirn on sales overall, but higher returns on some segments. Tile stalfi be1 jeves that separate subsidiaries of a pro-forina consolidation sIholild all be tr-eated separately without the avrgn fetitrly
fl-ow flue Boah i Rnqttic (iOnfraeLYi('t.
While renegotiation has clianceol fromJ a contract. basis to a ii pn
crate fiscal vear sales basis. the criteria, usedl for (1eternni(r tile e-xistence of excessive profits mnay not have changed. The percent-a Board regulations. however, specify that the amount of profit thle contractor is allowed to retain shall be the. controlling criterion. The rate of profit or ai percritaqe of costs are not to be used as bases in the determination. Simlilarly, prior year settflements are not to be. conlsidlered as controlling'( precedents. Despite these regulations. both returns on sales and prior year settlements are of the utmost importance. to the Board in the actual processing of cases.
In making its determinationss. the Boa d alwvays' cites return oil salc A-igUres. These fio-ures are thena compared to 'the returns on sales reflected in prior y ear fillings of the contractor under review and] sim'ilar contractors. While, returns on capital and net worth may als-o be citedl) the same iniortance is n-iot attributed to them. Board tict jons reviewed b-v the staff reveal that contractors are being CAV.A. even thoug1(h returns on capital and net worth are well above indistiv averages.
The Board's reliance on return on sales calls into question its utiIzation of the statutory factors. Is thle Board, for example. ensirincr that proper recoo-nition is given to the. chara'(cter of a contractor's operations? This is questionable whven one com-pares the Board's actiolls to industry returns onl sales. capital andl net -worth as reflected in FTC statistics. These statistics dem-onstrate that complex manufa ctiirngr operations expect to realize 2rreateirduu on sales than (d0 simpler operation-s.
FTC statistics reveall thle vast (lif-rerenvces that exist ainon!,z contnactors in different industries:
77-950-T6-2





4

Capital
Sales (percent) Net worth
Aircraft and parts ------------------------------------------------ 0.6 8.8 26. 6
Primary metal industries ------------------------------------------ 8.4 8.1 14.2
Instruments and related products -------------------------------- 15. 3 19.8 31.5
Miscellaneous manufacturing and ordnance -------------------------- 7.6 12.5 24.0
Apparel and other finished goods --------------------------------- 4.5 10.5 23.8
Petroleum refining- ------------------------------------ 12.2 9.1 13.9

(FTC statistics are based on book income rather than taxable income. Renegotiation business is reported on essentially a taxable basis, reflecting profits below those of book income.) Rules of thumb, without recognition of the type of industry, probably create advantages for some industries and disadvantages for others.
Emphasis on the return on sales can, moreover, leave contractors with high returns on capital and net worth. Republic Corp., an instruments manufacturer, was left after refund, in FYE68 with returns on sales, capital and net worth of 14.6%, 53.5%, and 320.5%, respectively. FTC's Statistics for instruments contractors showed ratios of 15.3%, 19.8%, and 31.5%, respectively. In clearing a recent case, the Board compared the contractor's returns on sales and net worth to the postrenegotiation returns of other contractors. While the range of returns on sales was 10.6% to 14%, the range of returns on net worth was 48% to 317%.
Because of the subjectivity of the statutory factors, the Board has apparently used a rate of profit as a guideline in renegotiating contractors. Reliance on precedents was established when the Board began citing prior year settlements as a basis for reaching review year decisions. Today, decisions to C.A.A. non-war year filings are being based, in large part, on references to Board decisions in war year cases.
In summary, primary emphasis on return on sales ratios and prior year actions creates a situation wherein the distinction between different types of contractors is probably not totally recognized, the efficiency of a contractor among all contractors is not fairly evaluated, and the, reasonableness of profits among all contractors is not accurately judged.
latter for Coiisaideration' by the Covq '. s
The Congress may want to consider amending the Act to require the use of industry statistics along with the efficiency factor, as the basis upon which the Board will make its determinations of excessive profits. The other statutory factors could continue to be used for the purpose of positioning the cont actor within the relevant contractor group and measuring the contractor's efficiency.

II. SCREENING OPERATIONS
The screening" operation is the first stage of the Renecotiation process. The Board's Office of Accountin, performs a cursory examination of a contractor filing and conipletes an RB-11 or Screening Report. Based upon information developed in this manner, the decision will be made to:
-clear the filing, without assigning it to a regional office for full-scale renegotiation, because it is felt that there is no likeLihood of excessive profits.






5

-refer the filing to a region for some further analysis prior to the fiial decision to clear the filing without assignment or to assiglI it for full-seale renegotiation.
-assign the filing to a region for full-scale renegotiation. The screening procedure is guided by Administrative Letter 7-8 entitled "Rules for the Screening of Filings at IHeadquart es, dated February 28, 1975. The letter discusses analysis in terms of the propriety of the filing (whether it is completed, signed, etc. andl appears valid on the surface). Industry statistics must be obtained for returns on sales, capital and net worth (the Board uses FTC industry statistics source data).
According to the letter, a filing will not be cleared if any of the contractors three returns (ratios) are above the appropriate industry ratios, without a, statement on the RB-11 citing reasons for the higher :,wceptability. Similarly, in assigning a filing, the Office will make reference to the three ratios.
Other factors to be taken into account in the screening operation are the presence or absence of Government assets, the turnover ratio, the amount of long term debt. and the ratio of net worth to long term debt. Prior year settlements with the same contractor are not specified as a basis for decisions to assign or clear filings. Loss Carryforwards
Administrative Letter 75-8 also states that the screening report should indicate whether losses reported( by the contractor have been rerified for carrvforward purposes.' The Renegotiation Act itself, however, Board regulations. and recent opinions by the Board's General Counsel state that loss carrvforwards will be examined to ensure they are not due to gross inefficiency and that the contractor has pursued available remedies for obtaining relief from such losses.
Although none of these sources specify that examination of losses should be limited to cases signed to the regions, this is, in fact, the procedure followed by the Board. Contractors who are cleared without assignment routinely avoid close scrutiny of reported losses. Even the Regional Boards' clearance notices (RB-S2s). in fact. currently contain the following printed statement: "These data are not to he considered as establishing actial loss. if any, for future con..silderation." This can be interpreted as an admission that the Board has not determined, to the degree necessarv, that the amount of loss upon which it has made its decision is accurate. The possible consequence of the Board's failure to a(leo atel- examine losses in cleared cases will be discussed under the heading Sereonno-r Decisions."
In a leal opinion cldated Aril 1. 1976. the Board's General Counsel states that los carryforwa-ds. if jutified. are applicable to the consolidated contractor and are not to be allocated to a particular rnmber, product line or seonnt. The Genernl Conn el based his opinion on the fact that "neither the Ac t nor the regulations provide for the allocation of loss carrvforwards to prodcluct lines or divisions." This overlooks the fact that the InntoInre of the Act was formulated at a time when consolidated rene rot nation and conglomerate corporations were unknown or in their infanciy. In the staff's opinion, the

"See Appendix B




6

Board should carefully analyze the question of applying loss carryforwards to individual divisions or subsidiaries in order to ensure that current Board policy is consistent with the purposes of the Act.
In a legal opinion dated May 6, 1976, discussing the legislative history of the loss carryforward, the General Counsel points out that the 1951 Act as originally passed by the House contained no such provision. The Senate Finance Committee, however, concerned primarily with providing relief to contractors for losses due to start-up costs,
amended the Act to include a one-year loss carryforward. (The Board, through regulations later provided similar relief to contractors realizing "deficient profits" due to start-up costs). liThe House accepted the provision in conference but insisted that losses due to gross inefficiency not be carried forward since the intent of the Act was to give favorable recognition to efficient contractors. In light of this legislative history, it is interesting to note that the Board does not limit loss carryforward to start-up situations only. Regmentation Ana!ysis
Administrative Letter 75-8 "Rules for the Screening of Filings at IHeadquarters" does not address segmentation analysis of the filing under the statutory factors. Administrative Letter 75-15. dated Novenel)r 17. 1975. however, which deals specifically with "Segmentation Analysis". is by its own terms, applicable only to assigned cases. Thus, the breakdown and analysis of individual corporate segments is not a part of the screening operation. creen ;ng Decisions
Board Regulation 1471.1 "When assignment is made" and Bulletin =415 (1499.2-15) "Assignment or withholding of contractor's filings" set out the Board's policy of when contractors' filings may be cleared without assignment. The Regulation states:
No assignment will be made when the Board can readily decide on the basis of the information contained in the Standard Form of Contractor's Report that the contractor has not realized excessive profits for the fiscal year and that no useful purpose would be served by making an assignment to a Regional Board.
The Bulletin states that withholding of a filing signifies that the Board is satisfied the contractor did not realize any excessive profits for the fiscal year represented by the filing and that further proceedings are unnecessarv. It also points out that as a, result of the decision to C.W.A. the government and the contractor have been spared much time, effort and expense while the interests of the government have beeln adequately protected.
As indicated above, the screening operation is only a cursory review. It is geared almost entirely to determine the likelihood of excessive profits and far less to ensure that amounts reported by the contractors are accurate. This fact casts doubt on the validity of the Board's contention that tlle interests of the government have been adequately protected in the decision to C.T.A.
In reviewing filings, the Board relies upon IRS and DCAA audits of the contractor in question. While the Board probably should utilize these audits to support their own analyses, they are clearly not adequate for the Board's purposes. IRS audits are concerned with total business, whereas the Board must concern itself with sales segregation/cost allocation between renegotiable/nonrenegotiable business.






7

DCA.N midits are on ii, contract. rather 411(1,11 8, 1,)"I Is. 'and li'lav. in addition. not cover all rem,()rotiable Stales diu-111(f i 11t, velar. actions. such as claims settled. m(aY (also III-11)"Ict oii tile review vetar aml, the. Board iflust, be alert to flies.
The importaiwe of (aii adequate review HI(i screellilig proi-('S -4
is exeniplified bN, tfie, foll()v;jljor two (,,,ISeS: Suspi.ebawpa Corporatio,,,6 (FYF, 6,9) J.pfleeted ('111 ovendl los:-; of' $3.563,309. The case, was assigned to t1w 11'esterii Roglom whicli (adjusted the loss to a, profit, of "Flw effect of Hie exaiiiiiiat loii 11116
resnIting adjustii-wi-it Nvfls, to NN-1pe out ta potelitial lo:- s ('('Irrvfor v"Ird.
In 61(,ar ("ort. FYA' 74, flie, lVestern Regloji (adjusted renegrotiable, profit, iipwkard by ',; 1.2292,640 tmid re(fiice(t pi-jor year lo,-; carryforward by $1.809,396. 'I'lle loss carrvfol-Nv"ird vears ju-)(t beell C.W.A. A significtuit factor in the RegloWs, adJu,-,tl11vj)i \%-(,ts Hie appliCation of settled elftillis 0 the loss carrvforwar(l ve(I'll's. Altliomrh, tli(scileelilliff 1111les strife Oat, t,1M, "Possibility of cb1*1-11s bY ot. a,,ral1)4 tjl(, conti-tactor will be, investigated" the screenii)gr operation was apparently unawaiv of tlie clinics wheii peudingy or settled. Olilv whell the case was assigned did t"he efittims oon-ie to light.
These cases illustrate the short-comings inlierent In the sc11(1(1l)11)Cr operation's exclusive micern -with deternilnincr the likelihood of excessive, profits. Pip, failure to elisilre that an-101-111ts reported bY contractors are accurfite ma-v allow contractors to claim iinwarralited loss earrvforwards in fiit.ure, v--a-rs. Once a fillnu had been C.W.A., the possibifit.v of discoverMcr tidjustments to cmitractors" profit fi(yures or the existence of settledd clinics. is left to chance.. Ilwovsistcv( y of Boa),d", TW(-is;0,1, s
The consistency aiid imi.f ornilty of scm-,iening decisiolls appea rs qlui, :tionable when one considers, as a.n example, flike liand1iii(y of tlic followil-lor two (-",Ise,- :
A 1) oidrob?. bw. i
0'r i e C I k
-"-L' 9 )0/71 submitted aii 1111-1 oii .5, 19/75 covering ta period of !S days. CoiAn,,iotor% total sales Nvere
-.446.000. Renego6able sales aii-d profits were, million aiid
t1musand respectivelY. Althoutvh all critical j-,,itl()S NVOIle below relevallt iridush-v statistics the cas( Nvas a sinned to tliv, Eastern Peo-imi. Few adjustments) were subsequeiAly una(l(-- by the ivp ioii and tlai filing was Cleared.
Ti Wh;te Cwt. o7idatrd FYL" i- flie p-irelit collipally
,showed a, profit/sales ratio of rwo S.110\ve(i returns
mi sales of -allA tmd al)"othel. subsidial-., ShoNve'd 11, retill-li
oti sales of 51.;- on its fixed pric(-, emitract sales. The filling was cle <,t red without, assiprmnent on the grounds that tlie dollar animint of t1w profits of fl)o parent, w,is small compared to the, total prolit" M14 Hie overall, returns compared to industry avera"eS (111d oiller colltractors

Selected cases:
F;),r8fov,0- T;),e aild Rttbbrr Co. subniitfeld renecrotiable sale,, liml profit data. hy six major product lines for FATE fl)). I WO Of tll(. six product lilies Ireflected losses (and the, contractor showed ,i los cm tl)e ('011--,olidated bfisis. Additiomilly, loss (".11-1--vi'mm-ard of ]IJ111011
-\Vtl,.; vaifilble from four prior Y vd
e-irs, all of wl6cli Iwd 1)(T11 Cleal
I it,11011t,11(, RP-11 (Screenillgr Report) dovi ; not St,It('






8

whether the loss carryforward had been verified. The Administrative Letter requires such action effective 4/75, thus no such verification may ever have been performed on those losses.
The reason for the loss in one of the product-lines was obtained from the contractor, who stated that the loss was due to changes initiated in production that obsoleted a large quantity of the work-in-process inventory. The Board did not determine who initiated the change (Government/contractor), whether the Government obtained a better product for the same price or whether the contractor had benefitted with an improved process at Government expense. The change conceivably could have resulted in an inefficient operation.
One product-line, a munitions loading and storing effort that returned 4.1% on sales (and the only subsidiary in the consolidated filing) was a non-production, Government-owned (GOCO) effort. A comparison of this product-line to the contractor's prior year return on this line which was production oriented, and to similar contractors' returns on production oriented lines after determination by the Board and the Court of Claims showed the return to be about twice the others. (The Board reduced Remington's production lines to about
2.5% in 1968 & 69, after refund determinations.)
This case demonstrates the need to verify the loss carryforward and to explore the reasons for the review year losses before making a decision to C.W.A.
North American Philips Corp. FYE 73 provided renegotiable sales and profits for each member of the consolidated group, by type of contract. The contractor showed a consolidated return on sales of 3.1% before the application of a loss carryforward.
Prior years 1970-72 were C.W.A. FYES 70 and 71 had a loss carryforward of $2.426 million. FYE 72 reported a profit before the loss carryforward was applied. The RB-11 for FYE 73 does not state whether the loss carryforward had been verified.
One member of the group reported a loss, but the Board did not obtain reasons or determine causes for the loss before offsetting it to more profitable operations. The amount of loss carryforward for years after FYE 73 is approximately $1.5 million.
The Board prepared a pro-forma consolidation of the group and six subsidiaries that filed separately. The pro-forma statement reflected profit on the overall basis of 3.7% before the loss carryforward was applied to the consolidated group.
Several members of the consolidated group and of the six subsidiaries showed rather high returns on sales. Whereas FTC statistics reflected returns on sales of 7.9% certain members reflected returns of 14.2%, 14.7% and 17.7%. Whether an excessive profit determination could have been made would depend upon verification of the loss carryforwards and the reason for the review years loss of one member and the low profits of others. A verification was not made, however, nor were reasons sought.
In justifying the review *year C.W.A. the Board relied in part on the clearance after assignment of Phillips' FYE 67 filing. The contractor's FYE 67 consolidated returns compared with FTC industry averages as follows:






Sales Capital Net worth
North American Philips --------------------------------------- 13.9 13.9 60.8
FTC ..... ---------------------------------------------------- 8.0 12.1 23.4

The Board also based its C.W.A. decision on a comparison of Philips with FYE66-68 filings of similarly situated contractors. The retu rns shown by these contractors were all greater than the FTC ratios. The high returns in fiscal years 66-68 were perhaps justified by the fact that these were war years. In view of the statutory factors it would seem that a wartime contractor should be allowed to garner greater profits than a peacetime contractor if the efficiency and sales volume of the contractors are about the same for both periods. The Board's failure to consider the difference between war and peacetime periods casts doubt on the validity of comparison to previous years as grounds for decision.
The RB-11 contains a notation that some adjustments were not pursued, apparently because of the low consolidated profit and the impact of applying the loss carryforward. The adjustments apparently related to the total allocation of royalty income of $78,,000 and administrative income of $4,858.000 solely to non-rene:otiable business. The contractor reported, on the consolidated basis, renegotiable profit of $531,000 and the reallocation of that income, if warranted. may have had a significant effect upon the decision to assign or clear the filing, and upon the amount of loss carryforward available in future years.
Remington Arns Co., Inc. was a sole contractor-a DOD 100 contractor-whose business was almost totally a GOCO operation. Remington reported a return on sales of 2.4% for FYE 73.
The Board compared the review year to five prior years. The review year return was below that for four of the five previous years. A review of those five previous years (two refund/three clearances) shows remarkable differences. The contractor agreed to reftind determinations for 1968 and 1969 provided the Board found no excessive profits for 1970 to 1972. The Board agreed. As a result. both 1971 & 72 reflect higher overall returns than the returns, after refund. in 1968 & 69. For FYEs 70 to 72, the ratios of the predominant. GOCO sales all reflect higher returns than the returns, after refund, in 1968 & 69. The Board determined excessive profits in 1968 & 69 in the GOCO operations but offset significant amounts of the excessive profits by the low profits of non-GOCO operations.
In the review year, the contractor showed a significant increase of General and Administrative (G& A} expenses over the prior year. The Board disallowed $207.000 of the amount became DCAA had disallowed a similar amount. The amount allowed was still significantly greater than the prior year. The Board did not pursue the possibility that the contractor may have included the $207.000 in its filings, knowintr it had been disallowed by DCAA. For a similar contractor (Federal Cartridge), none of the general and administrative expenses were






10

allowed to GOCO operations. Thus, there is apparently an inconsistency in how G&A expenses are treated for renegotiation purposes.
A self-applied commercial article exemption in an amount of $45,000 was approved during the review year. The exemption was justified on a number of items sold basis rather than use of the sales ratio basis as prescribed by the statute and regulations.
The Board compared the review year to comparable contractors as a basis for arriving at its C.W.A. decision. In one case. the Court of Claims left the contractor (Mason & HTanger-Silas Mason, Co., Inc.) with return on sales on Army GOCO of 1.77%'c, 1.97% on all GOCO, and 2% on total renegotiable business. The Board showed that another contractor-ICI America-had been C.W.A. in 1972 and 73, with return on GOCO sales of 1.3% and 1.8%, respectively.
The Board showed four fiscal years for another contractor-Federal Cartridge. Remington's return on sales was below the returns of those four years. The four years were also handled as a package and certain inconsistencies are evident between the refund FYE 68 & 69 and the cleared FYE 70 & 71. For instance, the contractor realized a return on sales, overall, of 4.1% in FYE 70 :& 71 but was left, after refund, with returns of 3.2% and 2.8% in FYE 68 & 69, respectively. More importantly. the Board determined excessive profits to have been realized in the GOCO operation and left the GOCO operation with 2.6% and 2.4%, respectively, after refund, whereas FYE 70 & 71 each showed returns of 4.1%. In FYE 69, the Board d(ecreased the excessive profit determination significantly by offsetting a purported deficient profit of the non-GOCO operation. The effect of that offset was to raise the return on sales of that non-GOCO operation from 7.9% to 12.4%.
In summary, while the possibility of Remington having reaped excessive profits may be arguable. the decision to clear the case seems less defensible. Knowing the outcome of a Court of Claims decision on contractor with the same sales volume would seem to be reason enough to deviate from the historical reliance upon prior year settlements and return on sales and to assign the case for full renegotiation.
Rohr Indwatries, Inc..filed on a consolidated basis with one subsidiary for FYE 73. Data on one small divisionn was also provided. Contractor, overall, reported 1.7% return on sales. The four prior years had been C.W.A., with losses in each year that amounted to a loss carryforward to FYE 73 and beyond of $16.630.000. The RB-11 did not state whether the losses had been verified for carryforward purposes. The contractor's non-renegotiable business has been continually profitable. The RB-11 containd a statement that the cost allocations were not explained but were not worth pursuing because of the effect of the loss carryforward. (Cost reallocations in other cases that we reviewed accounted for significant adjustments to profit.) A downward adjustment of cost would have the effect of increasing the profit and although an excessive profit determination might not be made, the amount of the loss for carryforward purposes would be reduced.
The Board obtained reasons from the contractor for losses on some contracts, but it did not appear to verify the accuracy of the statements or otherwise state they were valid ones for offsetting purposes. The efficiency/inefficiency of the operations was not explored.
On termination claims, the contractor realized a profit of $226,000 or a return of 64.4%. In prior years, the contractor had reflected losses






11

and a low profit on such claims. yet the Board did not explore the reasons for the high returns on claims, because of the effect of the loss carryforward. (A question never raised in renegotiation, but one that 1)erhap)s should be, is whether such a high return should ever be conpletely offset, even if some offsetting is warranted.)
JVhite Con dated Indlustbies filed on a consol i(lated basis anid renegotiable sales and profits were presented for each meml)er by type of contract for FYE 73. The Board cleared the contractor (C.W.A.) )ecause the consolidated returns on sales, capital and net worth were below FTC ratios, and below the returns of si nilar contractors and the contractor's own prior years, after Board action.
The contractor realized 4.1% on a consolidated basis. FTC reflected a return on sales of 8.6%(. Three members refle(ted(l returns above FTC, one being. 0.6%. One subsidiary reflected a return of 51.1% on its fixed price contract business and, when merged with its other businesses reflected an overall return of 8.2%. Reasons for the low profits of other subsidiaries were not explored before the offsetting occurred and the overall return of 4.1% was used as the basis for coImparison to other contractors.
The contractor was also C.WA.A. in the three preceding years. In FYE 70, the consolidated return was 7.6%.
The Board compared the contractor to simnil ar contractors cleared by the Board. White's fil ing for FYE 78 was compared to other contractors' 1966 & 67 FYEs (wartime period). Rates of return permitted the other contractors ranged from 9.8% to 1 .%o on sales, 19% to ,2.6% on capital and 31.9% to 114.5% on net worth. The FTC ratios
(%) for 1966 & 67 were as follows:

Sales Capital Net worth
1966 -..--------------------------------------------------- 11.6 18.5 30.6
1967......... --------------------------------------------------- 10.2 15.4 25. 5

As stated earlier in this section, the Board justified the high profits of some segments on the grounds that they were relatively small when compared to the total renegotiable profits. and the favorable comparison of the consolidated returns to industry averages and to similar contractors. Reasons for the low profits do not appear to have been explored. Conceivably, inefficient operations may have been subsidized through the offsetting, at the expense of the profitable operations. It would appear such reasons should lhave been explored, especially when two operations realized the very high returns of 30.6% and 51.1%.
The Board compares contractors, on an overall basis. to similar contractors or the contractor's own p)recedino" fiscal years, but the comparison only serves to limit review year work. Even if se"mented analysis were performed, the results could be negated through such conmparisons. The Board announced its policy on segmnentation analysis for assigned cases on 11/75 and any analysis in the past of either assigned or C.W.A. cases would most probably have been conducted on an overall basis, without the reasons for losses and low profits obtained and explored for offsetting purposes. Thus. reliance on past returns is not at all well-founded. Similarly, prior year losses inost probably were never properly examined for carrvforw'ward )rpo- es, and. tl erefore, should be scrutinized when applied in the review year.
77-950-76--3 -






12

Conclusion
The adequacy of the screening process, in terms of ensuring that excessive profits are not escaping, that the contractors filing is ac-, curate, and that the losses have been verified for carryforw-arci purposes is questionable in view of the following.
1. C.W.A. decisions appear inconsistent when compared to other decisions to assign filings.
2. Statements on whether losses have been verified for carryforward purposes do not appear on the Screening Reports.
3. The policy on segmentation analysis applies only to assigned cases. Analysis in the screening operation is performed on an overall basis. Such analysis limits the amount of adjustments that may b~e made to renegotiable profits. Neither the' efficiency of members nor the review year losses/deficient profits are adequately examined when analysis is performed on an overall basis.
4. Supporting statements make reference to prior Board actions on similar contractors. However:
a. peacetime and wartime renegotiable business is being compared,
b. dissimilar sales volumes are being compared,
c. reliance upon prior year Board actions and returns on sales assume that
.such analyses were adequate and that the efficiencies of the contractors are
similar.
5. Little if any effort is made to verify the accuracy of reported sales/profit figures.
111. RENEGOTIATION OF ASSIGNED CASES
The renegotiation of cases assigned to a Regional Office is the mostin-depth of the examinations performed by the Board. Even theseexaminations, however, can and do vary in degree, depending upon whether the regional accountant and renegotiator decide there is any, likelihood of excessive profits.
Regional decisions to clear or enter into refund agreements with contractors in Class "B" cases (renegotiable profits of $800,000 or less) are final. All Class "A" cases (renegotiable profits greater than $800,000) and Class "B" unilateral order cases are reassigned to the Statutory Board for review.
This section discusses the renegotiation of both Class "A" and "B cleared and refund determination c,9ses. We consider the depth and quality of the Board~s examination of these cases ,nd discuss the problems or shortcomings in their processing. Fiinally, overall effects,' shortcomings and problems are summarized and analyzed. Examination of RB-1.s
The degree of examination of fihingrs differs significantly between the screening operation and full-scale renegotiation. The Board's examination of the filing in the screening process is a cursory one, to ensure the propriety of the filing and to determine the likelihood of excessive profits. The regions' examination of assigned cases is intended to verify the accuracy of the sales segmentation and allocation of costs. The regional reviews sometimes result in significant adjustm ent s t~o sal es, costs and profits.
The difference in the two operations is exemnpli fied by a November 17, 1975 administrative letter entitl ed "Segment ation Analysis." By its own terms the provisions of the letter are applicable to all future assigfled cases. Thus the detailed examination and analysis of corporate segments called for in the letter is not required in the screening operation or in referrals to regional offices for further analysis.
The letter is, in itself, interesting and important since it is the first attempt to explicitly state the manner in which segments are to be






13

analvzd nd I created ill terilis o" rev ev- Ios, es alld deficient,
protit.s. (4' Ile A ct, I I "I I I oil S, a I It! (rul (Ite I I D CS "t IV s I ot t I iis subje(-f 'Ind th" Boar(I 11"s k'(,11 wl(l(l), crt I -iZed for rel;alice oil collsoI* dated sales aii(I profit, figrurcs.) A o i -C, I Ig to the 1 t (' I .. I o ) s I I I t I I review ve(ar "Ire to be (- "mmled fo ii1sure thev llot (ltw 'to o-ross
illefficiellcY. simil".111Y. low profile ,lre to b"), CY(IMMIC(I . It I"llstkil-wilt, to hivh profits ill vl, 1 ;Illejli, ill cflc(-t ;I Jhreo-f 1.0JIwtion of Profits. Low lwolits. if jiiA-ifi','d would elthel. 1-eccive collSlderation mider tlie f8filtorv f-,ictors, oi- be tivate(l in :i, sl).iiihar fashlOll
a s losses. Tlw lefter, lik" the (*4 Vl(I I.(. I mij.",hol) ;, doe. ; 11("t (1*, clls t1w
treatment of s,(OCQ I'(11.1-ItNI to the 1 lw("Wc -ifter adjIlstnients 1)eell made. I t i ",_ theirefol.e. ]lof Cle,41. x1letller, (Is h"I", his
torically beeii IH)e s-m-1) stiles Avill be iiielude(I ill t1w consolidated

It is still too early to i)re(11.-t vhvf effect the al)JAiccatioll, of the re(Illiremetits ill the se(rmoiAtaltion aiialysis letter, if coil scent lolls] Y alld
7, -iatioii pi-w-eedimrs. ctual
exper"ellce will Sbow how S:Ile ; rkeh!te(l to los :es/deflcielit, profits llave been ti-eated, as ivell (as how thoroli ffhtv the Board is qllalvzlll(r SeCrinei-tts Imd seekin(r justificatiwis for losses/defleient profits.

AV(_ selected t1irce (M-iss "A** c,,Is(,s I-wd 11, Class "B" for review. Limited work performed wi mie, other Chiss "A" case, Standard
T I i o -M 84/ s C o i -p., ( F _) E 73
Class A Cases
Boeing Company (FYE TI), Rkock- vell lifterTiation.il Coi-i (FYE
12)., and Ambac lildlistries c0:1 Sol idat ed -Nvitli Pacl :ii-d Tiistriimeiits
1 0 _; J)V tlle P(,.r'oil a] Bom
(FYE '2) were recolliineii (led for clearance I (- I I 1XIS
and cleared by tlie S'-,qtiitory Board.
_J0,-?*1?g Compai fileJ an interim R13-1 that reflected renegotiable Profits of $13.197,000 for a retill"ll On sales. _.X revised RB-1
t-bat both thn Board and contractor kilew was fortlicomilirr was submitted because of adjustlimits to t2x r -tur-lls and si)ec.ial accounting a,(rreeme.rit. Those a(liustli-leiAs ;lt tlie Westemi Rvaion Increased tll(, reneffotial)le profit, to Tlie mttijor adjust mentS were, reallocation of certain costs and exIviises, Ti 11
t oiv re:1loc,,it;oii of
"otlier dedi-wtim-ts" I)ased lipon the ratio of becrjjjnlll(r rene(rotiablet capital t-o totV.1 o--(,mit,d resulted in additiom.1
renegotifible 1)rofit. About S,,62.5,000 of iliterest -mcome -was offSet, to iliterest, expel)se. iiiereaslmq t1w renegotiable. iWoRt by tliat. Imimilit.
The Ref.rioii's Reiierrotiation Report, did not com-melit on any wmdimr or settled chl-Ims. However. whell the W,-C s rPaS'-,TllC'd to tll(,
Statutory Bo,,,ird, tlie Board leflimed tli,,it, *'13,207.000 ill c1fliltic, had been recovered alld $9.S.24,000 IN-Is apnlied to FYP 71. Profif ; were fiu-ther iiiereased bv that inmoMit. Also, tlie Po.lrd im-reasod I)oth nles alid costs by ,'6,12,52.477 related to termination exIvilse- Oil a certain contract: however. tliere waS no iiiere.tise. iii T-)mFit's iii t1li -l iiistaiwe. Tbe coiltraotor iiiformed tl)(, Boar(] that it m"Ido kilow'.1 to the _TAp!rjOjjql 1309y(j t1le -1,,jjjjjS Sptt-led at 1-110 1.) fi1iii0r,,indTFYT,, 72 ,iwelide(l filiiigr. Tji(-, claims liowever li:id been Ivi)(1iiig before that time. but the Re-(Xioli was imawure. of thrill.






14

IUpon reassignment of the case to the Statutory Board, the then Office of Review requested these specific items, among others, be obtained from the contractor:
-sales, elements of costs, and profits by program, by types of contracts, by division. (Aerospace Group also by division and/or plants.)
-Government and commercial assets by division and/or plant.
-interest, claim recoveries and IRS adjustments similarly identified, with interest allocated based upon asset identification.
(The Office of Accounting, about seven months prior to this action by the Office of Review. had queried the contractor about program/divisional data and had been informed by the contractor why it was unreasonable to use and rely upon such data.) The Office of Review took such action because the adjusted return on sales of 5% made the case. in its opinion, a borderline one. The case was returned to the Western Region where its accounting division was directed to obtain such data.
The contractor complained about the long period of time the case had( been in processing-18 months at headquarters at that time. The contractor consented to supply the data although it said the data was not normally maintained that way and may not be available at all. The contractor felt that profits were reasonable.
Boeing apparently provided all data requested except cost of sales breakdown by division or plant. The contractor argued it was unable to provide a meaningful breakdown and that this particular matter had been discussed with the Board in the past. Capital and net worth were provided by segments but the Board felt it was not suitable for use without further refinement. The Western Region apparently aIreed with Boeing that it was a special case and data on a segmented basis would not be meaningful. Rather than request such data, the Board noted that the "worst" possible situation was considered for the contractor (and in the Government's favor) in computing amounts of renegotiable capital and net worth.
The Office of Review obtained data compiled by the Western Region and then. prepared its analysis. It recommended clearance based on its analysis of contractor's programs, comparison with prior year filings of Boeing and similar contractors. and comparison of the overall returns on capital and net worth. The two similar contractors to which Boeing was compared were McDonnell Douglas and Northrop Corporations. Those contractors had been the subject of dissents by Boird member Chase in a prior year.
Responding to queries by Board members, the Office of Rev;ew commented that termination claims were for the convenience of the Government and that reasons for losses in one division were obtained from the contractor. Reasons for loss under another type of contract in that division and losses and low profits under programs in the Aerosp ece Group were apparently not obtained.
The Board's final opinion stated that divisions and/or Groups were individually evaluated. It considered the returns reasonable when compared to the level at which the contractor was cleared in the prior year and in comparison to the similar contractors. The following table s 1ows that comparison:






15

fin percent]

Sales Capital Net worth

Boeing:
1970....... ........-------------------------------------------------. 4.7 13.0 43.0
1971 ....---5.7 14.6 44.7
Northrop:
1968.......------------------------------------------------- 7.6 16.0 64.0
1969 ----------------------------------------- 7.3 15.2 31.4
McDonnell Douglas:
June 30, 1966 -------------------. 8.1 32.0 63.0
December 31, 1966, --------------------------------------- 8.5 28.0 55.0
1967 .......------------------------------------------------- 7.8 29.0 59.0
1968 ------------------------------------------------- 7.6 26.0 49.0
1 After refund determination.
'lhe FTC and IRS reflect these ratios for FYE 71:

fin percent]
Sales Capital Net worth
FTC ......---------------------------------------------------- 3.2 3.6 10.4
IRS.. ..----------------------------------------------------- 3.9 3.4 9.0

Although there was no loss carryforward to apply, the importance of adequately reviewing a large contractor with low profit or loss is demonstrated here where the profit increased significantly and would have adjusted such carrvforward had there, been one.
Rock ell Infernatioal Corp. reported renegotiable profits of $59.800,000 for FYE 72 for a return on sales of 5.1%. capital of 11.% and net worth of 30.7%. FTC showed these returns at 4.0%, 4.2%, and 12.2%. respectively. The case was assigned to the Western Reg'ion in March 1974 and reassigned to headquarters in May 1975 as a recoimmended clearance.
The Western Region requested the following data, among others, from the contractor:
-summary of sales by products in a form similar to that of prior years.
--discussion of the possible reallocation of a portion of interest expense solely
to nonrenegotiable business. (Contractor had allocated interest income, dividends received and other interest expense solely to nonrenegotiable
business.)
-discussion of the use of divisional or product line data for determining
renegotiable profits by categories.
Certain other expense and income items were allocated wholly to either renegotiable or nonrenegotiable business. The balance was allocated on the cost of sales ratio. (In the Boeing case, the Board reallocated such income and expenses on the ratio of beoinnino renegotiable capital to total renegotiable capital which resulted in an i crease to profit of $15,788,395 or from about $13 million to about $30 million.)
The Western region received renegotiable sales. total cost of sales and gross profits by iimajor product groups. It obtained sales and profit by contract type on the consolidated bais. Co(st of sales ireakdown into materials, labor and overhead was app)areitly not provided on any type of basis. Capital and net worth were obtained only on






16

the consolidated basis. The contractor convinced the Board that divisional profit and loss data were impractical to obtain. Rockwell had 16 divisions with renegotiable business.
At this point it should be pointed out that the Board has no policy concerning the reallocation of interest expense between renegotiable and non-renegotiable business, the treatment of long-term debt, and the computation of capital and net worth used in renegotiable business. Contractors sometimes dictate to the Board how such items should be handled. On the interest expense issue the basis used by the Board in reallocating Bocmng'8 interest expense resulted in a 15 million dollar increase in Boei ng's profits. The basis used in the Rockwell case was different than that in the BoeiJng case. Partly because Rockwell was able to convince the Board that long-term debt could be identified to renegotiable business the Board did not pursue similar adjustments to Rock e7l s profit. However, the final allocation of long term debt by the Board does not appear to support the full amount of interest expense charged to renegotiable business. This is because the ratio of long-term debt allocated to renegotiable business vs. total business is actually lower than the ratio of interest expense allocated by Rock well to renegotiable business vs. total business.
On the lone-term debt issue, the Western Region's Division of Accounting had previously taken exception to the fact that McDonnellDouglas identified debt to renegotiable business, reasoning that assets only could be specifically identified to renegotiable/nonrenegotiable business and that the net, worth should, therefore, be allocated on the assets ratio. The Western Board, however, accepted the contractor's basis which resulted in a reduction of profit return on net worth from approximately 90% to approximately 60%. The specific identification of long-term debt decreased the amount of net worth that was allegedly used in renegotiable business thus decreasing the return on net worth.
In the Rockwell case, the contractor stated that long-term debt should be added to net worth to avoid distortions when comparing companies with differing debt-equity structures. It argued that a company should not be penalized, in determining return on net worth, because it used debt instead of equity capital. In effect, the return then would be on capital employed. The situation reflects concern, similar to that expressed by McDomnell-Douglas, with the net worth factor.
The region explored the possibility of computing returns on capital and net worth allocated to renegotiable business on the basis of Government oriented and commercially-oriented operations (aerospace and electronics operations and automotive and industrial operations, respectively). The region did not pursue this breakdown accepting contractor's own explanation of why the breakdown was not feasible.
The region had allocated beginning capital and net worth on the cost of sales ratio of the consolidated group. The region reduced the amount of the capital and net worth by the amount of the investment in subsidiaries and included one-half of the long-term debt on assumption it was used as a source of financing a portion of these investments. The problem of arbitrary allocations is encountered when Government furnished assistance in the form of plant, equipment, materials and progress payments is significant and in fact finances the renegotiable business. The region did not explore the degree of utilization of Government-furnished property. There was no discussion of






17

progress payments in the Regrion) and only a pjassillg r'eferene( in h u(1lquarters. Thus, the extent of Government assist iance was unknown arnd the capital/net worth employed in renegotiable bulsilless was not pr(ecisely identified.
The Western Region's Report of Renegotiation reflected a downward adjustment in renegotiable profit from $ 9,800.000 to .,8.123.000. The adjustments were made to price revision contracts per the Special Accounting Agreement. Inll effect, t lie downward adi1nstient was about $22 million. ()ur review of the fles showed one schedule indicating such total adjustment but the degree of examination by the regional accountant was indeterminable. The initial RB-1 was based on book data whereas, under the Special Accounting Agreement, the Board attempts to match profit and cost with contract performance and moves sales into the period in which costs were incurred. In this instance, the Region decreased renegotiable sales and profits by $17,743.000 and $21,675,000, respectively or 1.5% and 36%.
The reviewer's comments supporting the recommended clearance cited performance reports which indicated the contractor was efficient. Overall returns on sales, capital and net worth were compared to prior years. One particular product-line however showed a gross profit return on sales of 46.6%. No comment was made with regard to this high profit.
The Board had requested reasons for difference in the profit margins between the review year and the prior year. The contractors attributed the loss in the Automotive and Industrial Products Group to:
-abnormally high expenses incurred by a new axle plant in its initial operations.
-loss sustained by a division on a contract.
-the net total of other income (deductions) was a deduction in 1972 but income in 1971.
-renegotiable sales were depressed because of the limitations imposed by the price escalation provisions of the sales contracts, which precluded the
contractor from raising prices in proportion to escalating costs.
The board did not question the validity of the contractor's explanation.
This Group had renegotiable sales of $70,358,000. In one submission of data however, the contractor showed renegotiable gross profits of $6,069.000 on sales of $55.420,000 or 11% on automotive products. When the remaining $15 million of industrial products sales and related costs and losses were included in the Group's totals, the Group finished with a loss. The Board did not obtain reasons for the losses and low profits in the Aerospace and Electronics Group which accounted for most of the renegotiable business.
.4m(rbac Indu8strie8. Ive. filed on a consolidated basis with two subsidiaries for FYE 72. The case was assigned to the Ea4etrn Region to examine the propriety of an abandonment loss. That loss was attribute able to the contractor's decision to phase out of renegotiable m)si ness in one division.
The Eastern Region requested and received divisional data in a form similar to that in the RB-1. The abandonment loss was permitted under Board regulation 1459.10 entitled "Costs incident to discontinuance of a renegotiable operation," and was permissible for IRS purposes. The Region performed little review of the loss, appar-






18

ently satisfied with contractor's submission outlining the items both for renegotiation and tax purposes. Board regulation 1459.10 states that a portion of the costs of disposing of tangible property, the original cost of which was deducted as an expense rather than treated as a capital expenditure (and depreciated) shall be allowed. The contractor, however charged losses of disposal of fixed assets. No comment was made whether the items had been expenced or capitalized. The regulation does not specifically state whether such losses are allocable to renegotiable business.
The phase-out was effective 12/31/72, with the losses and expenses occurring later. The loss was applied to the renegotiable business of FYE 72.
The renegotiator recommended a clearance because returns on sales, capital and net worth were reasonable compared to industry statistics and prior year actions. He stated that although profits were high in one division, that division represented only 20% of the renegotiable business.
The headquarters reviewer commented that the contractor should receive special consideration for risk because of the hazardous nature of materials used in the division to be abandoned. (The language relating to the "character of business" factor would seem more appropriate to support this reasoning.) FTC revealed a return on sales of 11%, and while the contractor realized 3.3% on a consolidated basis, two divisions realized returns of 15.9% and 18.2%. Disallowance of the abandonment loss would have left the contractor with about 6% on a consolidated basis. The zero and low profits of the subsidiaries and loss on operations of the division to be abandoned were not explored because of the effect of the abandonment loss and the resulting overall profitability when compared to the industry and prior years.
Standard Thomson Corp. filed on a consolidated basis with Joseph Pollack Corp. for FYE 73. Both the Regional Board and the headquarters reviewer recommended a clearance. When the case came before the Statutory Board, decision was deferred for about six months to determine why the profits of Joseph Pollack had increased significantly in 1972 and 73 over 1970 and 71. The reviewer telephoned the contractor and obtained such reasons as:
-increased volume,
-better budgetary controls, and
-addition of new products and discontinuance of loss items. The reviewer used 1969 and a base year for Joseph Pollack and determined that sales had increased significantly in 1972 & 73 while total costs had decreased substantially. The reviewer however, did not determine whether the Government had received the benefit of lower unit prices. If such benefit should have accrued to the Government but did not, the regulations state that the benefit shall accrue through renegotiation. The Court of Claims took such action in the Jason Hagqer-Silas Masov, Co. case when it recogonized that the benefit of lower prices had not accrued to the Government.
The Director, Office of Review, had also recommended clearance, prior to the Board requesting the additional data. Tie stated it was his ?Jithrvtamhnq that rene;gotiable./nonrenegotiable produ cts of Joseph Pollack were similar and the contractor had earned abouf the same return on sales on each. The regulations state the Board






19

wvill consider the contractor's commercial business, amiong(, other -onlsiderationls as one factor in reachino~ its dlecisionl.
The regional accountant, according to the reviewer. had verified the accui'i'y of the start-uip costs xvhich accounted foi- t le loss ca n'vforward from FYE 70. FIE 72 had been (W.A. when the FYI] *T6 loss ca rivf orwa r( had red i ced thI at. yas )i-oht to zero. Tlie accountant, for PIE 73. had apparen-tly deterinfled the(, loss was duew to star-t-up costs. and as such allocable to future year-s. t 7poi reasiiment of the case to headquarters. the reviewer pr-elare( 1 a b)realkout of the consolidated flinl() onl a divisional basis. Tis may have b)eenI the first time such a presentation was made.
Finally, the comparison of FTC. sti atisties to the contr-actor, oil a consol idated basis. midl Joseph Pollack alone sh owed thei following():

[In percent]

Sales Capital Net worth
FTC-------------------------------------------------------- 7.3 12.4 25.0
Contractor:
Consolidated --------------------------------------------- 11.5 20.2 39.2
Joseph Pollack -------------------------------------------- 21.6 59.3 129.0

07as. R cases.The 11 Class "11" cases were renegotiated by the Regional Offices as follows:
IVcr.tern region:
Air Borne Controls, Inc. EYE 74
Wy! e Laboratories EYE 74 Evans Products Co. FYE 7-4
Dayton Electronic Products Co., Inc. FYE 7 3
"usquehanna Corp. FYE 69 Western Gear Corp. EYE 713
Ea-,crn Region:
Vincent Piro EYE 69
Center Manufacturing Co. EYE 73
Moore Business Forms, Inc. EYE 73 & 74
Insileo Corp. EYE 7 1
Vth Bomiw Conlro!.s FYE 74 was assigned because a. related company had been assigned. Thie contractor hia( reneeoot able sales ai jproiltS of $1,79.OOO an] 92.00 0. respec-tively. -All returns were below FTC statistics. A refund dletermninat ion of S200.000 was ma(IC awi inst the contractor in FYE 7-8 onl reiieiotiable, sales andl profits of S'2,3-33.00 'Ind I.0'/u2. The return oni sales wtis adjusted from 23.7%11 to1(.+ Tii F YE 73, 1)0th irenie(ot iable ionrieniect1 able products were similar and both had returns of about 24%1-. Under the clearance cases previously dliscussed, J.JONp/i Po/llok had been cleared because the. ratios AYeile the same. Aii nB o)-e was eiim-ifedl i1eetia ali~ n
harn-iessing. C 1-)z
1Vy/~ Lolhoiyitorw.e i F I 741 reported renie(.rot i al1e sales of $ .6.
000 and a loss of $225.000. The case was assignledl it appears. to chee1(k out exemptions erronecously talkeii and to verify sales seyj --re-tion Prior years 1968-73 had tall been C.AY.A. a11d a loss carrvforward from FYE 7-2 of $2.827.991 was available. The Western 11e-crion took





20

excCit-io to sales made to the Bureau of iMines (not covered by the Act) and adjusted sales and profits to $16,996,736 and $410,261, respectively. The loss was thus converted to a profit, another loss for carryforward purposes was prevented, and the amount of the FYE 72 loss carryforward that would have applied beyond FYE 74 was reduced. The region did not investigate whether the prior years that had been C.W.A. also had been charged with similar sales and losses. The region stated that there was no indication the loss carryforward was the result of gross inefficiency, but the file is devoid of data as to how that decision was made.
Eans~ Products FYE 74 was handled contemporaneously with a subsidiary. Comparison of FTC and Evans as computed in the screening operation showed the following:

Sales Capital Net worth
Evas-----------------------------------14.1 27.1 523.0
FTC-------------------------------------------------------- 10.6 14.7 28.3

The subsdiary showed a return of 16.6% on sales of $709,000 and a profit of $117,00.
While $2,633,000 of Evans renegotiable sales of $2,753,000 was. conducted in one division the Board chose to allocate the contractors total capital and net worth on the ratio of renegotiable cost of goods sold to the compay's total cost of goods sold. It cannot be determined from the files whether that allocation would agree with those assets that had been employed by the one division. The contractor was cleared with adjusted returns on sales, capital and net worth of 12.1%7,, 21.4%7 and 45.6%7. The subsidiary's return of 16.6% was not adjusted. (The difference in the return on net worth between the screening function and the Western Region was due to an incorrect calculation on the part of screening.)
Dayton Electronics Produtcts FYE 73 -was a small contractor that reported renegotiable sales and profits of $2,385,538 and $403,758, respectively. The screening. function increased profit to $549,000, without any explanation. The case was assigned to check out claims against the Government and because returns on sales and capital were 23% and 66.3%7, respectively versus FTC ratios of 7.8% and 10.8%o respectivel y.
Tlhe Western Region reviewed the claims further and found review year sales included $1,030,538 of claims, received for equitable price adjustment of two contracts and refund of $.58,535 from the Navy for liquidating damages which had previously been assessed against the contractor. The profit of $4035758 which the contractor had reported was attributed to sales of $972,003 and included the $58,535 refund. The profit did not include any of the price adjustment.
The price acljsutment, in effect, applied to prior loss years that had been CAX.A. In reality, the contractor's sales would be around the statutory floor, excluding the claims recoveries.
The Region considered the profit as $403,758 and reduced the $1,868,393 loss carryforward by that amount. The region said the carryforward was not due to gross inefficiency presumably because of the successful claims settlement. The Region, however, did i'ot adjust the carryforward by the amount of the claims recovered and conceivably






21

an amount of about $1 million may be erroneously carried folw ,rd to future years.
sque hana Corp. FYE 69 filed an RB-1 on 5/17/71 on an individual basis. Assignment of the contractor was made on 11/8/72. The Board questioned why a consolidated filing was not considered. On 6/8/73, the Board approved the contractor's request of 5/23/73 for consolidated renegotiation. The consolidated cases were reassigned to the Western Reg-ion on 3/26/75. In both the initial filings and the consolidated, one subsidiary with sales and profits of $340.000 and $146,625, respectively (43.1) was not included. The final consolidated filing including that subsidiary, was received in July, 1975. With regard to that subsidiary, the Statutory Board stated that renegotiation was commenced 2/13/74 and assigned to the Western Region on 9/30/74. The nonfilig of the subsidiary had not been discovered until the case had been assigned to the region. The contractor stated it assumed it didn't have to file because sales were below the floor.
The consolidated RB-1 required significant adjustment as follows:

Sales Profits Percent Sales Profits Percent
Consolidated ...--------------------- 57,248,880 (3,563,309) (1) 57,030,212 221,656 0.4
Susquehanna --------------------47, 919, 541 (3, 830, 450) (1) 47, 700, 923 (257, 918) ()
Brooks Res./Manufacturing ------------ 2, 594, 827 397, 388 15.3 2, 594, 827 397, 388 15.3
Quadratec -----------------------8,989,319 (276, 872) (1) 8,989,319 (64, 439) ()
Digital Development Corp --------------- 340, 020 146, 625 43.1 340, 020 146,625 43. 1
I Loss.
The table reflects high profits of two subsidiaries. MJore iJmportawtly, it reflects the fact that the consolidated loss was adjusted to a profit a nd thus a potential loss canyforward of $3,56.309 was eliminated.
The renegotiator concluded Susquehanna and Quadratee suffered losses on substantial renegotiable sales, while Brooks and Digital both earned high margins of profit on combined renegotiable sales just under $3 million. Because on a consolidated basis the profit margin was only 0.4%o, he concluded there was no likelihood of excessive profits. No performance reports were obtained except for Digital and calculations which would assist in evaluating reasonablenless of costs and returns on capital and net worth were not made. The Western Board stated that in view of the very low profit on the consolidated basis, the clearance was issued. The Western Re,,ion asked the contractor reasons for losses on Susquehanna and Quadiratee. The Regional Board relered the contractor from reporting that data, however because it wanted to conclude the case. The Board experienced continual delays in obtaining data.
lWestern Gear Corp. FYE 73 filed on a consolidated basis after initiallv filing on an individual basis. The Screening operation increas-ed the RB-1 profit from $6.009,961 to $6,01.000. The case was assigned because the profit, before loss erryforward, was high and to verify that loss carrvforw'ard. The contractor had a potential loss carrvforward of $ 9.58,9)07 front prior years that had been (A.A.
The Western Region asked the contractor the reasons for the losses in the prior years. The contractor explained that the economy was caught in a period of inflationary trends with sales volume declining faster than expenses could be correspondingly reduced. The contractor





22

stated that profit suffered from provisions which recognized uncertainties as to inventory values, doubtful accounts and contract costs. Provisions of $1,316,800 were established for these categories. The contractor attributed the loss in the other prior year, in summary, to unforeseen technical problems and risks encountered in the items to be manufactured. Overruns on long-term contracts and additional development costs were written off. The contractor stated he had pursued available channels for recoupment of the loss but was unsuccessful in obtaining relief. The Region also requested and received reasons for losses in the review year. The degree of examination of the veracity of the reasons is difficult to determine from the file. The Region did not comment on the contractor's reasons. Rather, it explored another avenue-the adjustment to the prior year losses and consequently to the loss carryforward.
The Region adjusted the review year profit upward to $7,302,601. Te. lararest adjustments resulted from claims settled of $859.074 and reclassified interest income as offset to interest income of $220,939. The loss carrvforward was reduced from .9,585,907 to $8,276,511 due to reallocation of costs of $609,046 and claims settled of $700,350. The Board had apparently not known of the pending claims until assigniiient of the review year. The Region did not comment upon the provisions the contractor had established for losses and apparently f At the reasons given for the losses justified offsetting. In reality, the Board adiuted the loss carryforward available to future years by $2,602,036 because of the increase in review year profits of $1,292,640 and the decrease of $1,309,396 to the loss carryforward.
The Region had discussed the feasibility of obtaining divisional data for the review year. The contractor stated that although it could be done, it would be a considerable undertaking for the review year, but that it would provide such data for future years.
On the consolidated basis, the contractor realized return on sales ,of 16.2%, while the parent company with the bulk of the sales realized 18.8%. On the consolidated basis, the contractor realized returns on capital and net worth of 32% and 67%, respectively. The Board did not compute these final returns because of the impact of the loss carryforward.
V'nce.t Piro FYE 69 is a manufacturers' representative earning commissions on sales of manufacturers' products. The FYE 69 filing was due 5/1/70. The Board finally received it 6/8/73, after repeated requests. The contractor argued that he had no renegotiable business, even after filing, but the Board discovered otherwise from tax returns. The Region attempted from 12/13/73 until 4/4/75 to obtain data and on that date received an unsigned revised RB-1. The agent was cleared on 1/16/76 with referable sales of $1,502,303 and commissions of $44020, a return of 2.9%.
Center Manufacturnq Co. FYE 73 was assigned because the Eastern Region so requested. The prior year was still open at the Region. Contractor showed returns on sales, capital and net worth of 9.5%,, 20.1% and 24.6%, respectively. Total business was renegotiable with sales and profits per RB-1 of $3,647,000 and $346,000 respectively. The contractor was a clothing manufacturer. The Region adjusted profit downward to $334,958 and cleared the contractor with returns on sales, capital and net worth of 9.2%, 22%, and 19.6%.






23

Moore Lusi8s P 7 Iorm .s Incw. (FYL 73 & 74) filed showing renierotiable sales and profits iF YI 73 of S,4,54t0,000 and( $,421).00 ec tively. The case was assignedl with thle, notationt tlat, the past sexval years which had been C.AV.A. showed losses onl renegotia}Ie business/! hligh profits 0il flflreneot'(jta1le, busineCss. nfottion state el at thle allocation of costs and expenses sliouldl be care fully elleckel as slioild dilerences in the renegotiable pricing. Thei loss carrvforward fi-ol 1968-72 was $1,81 1.000. ie cont ractor shlowedl returns oil sales atal, and etworth of 9.8 13 1,4 it 1. 7 (/ anld 117 $2 res})ect- i ely whxile FcT(-, showed 8.6 4 .12.8 and 2..1(c resjpectively. O 'ugta~ ae
FYEi 74 was assigned because hfIigh profits.Oi e(,_ota,), aes
afld profit of ',.'10.968,000, and $2,083,000, respectively thle contl-iulor reported returns on sales, capital andI net wortli of 19%/. 84.1%/ and1 46.1%7c respectively. FTC reported 8.4%/c 13(7(. and r Vespecfivelv.
The Region requested and rec-eived detailed dIivisioiial (laft frcom the contractor for FYE's 68-74-. (Cost, of croods sold was broken into eleinents for each division. The Region decided to verify thie loss carryforward by telephoning thie contractor. to be followed IyWwritten conlfirmnation, bc'cause of theo (a) relatively low percent ale, of ue)tble 17olnme, (b) favorable performance data, and (c) uiihkelihood o1 enoughli adjustments to make it a refund case.
The losses were said to be due to competitive Government bidding~ and the fact price levels were, below those, of similar comnmnercialI w(')T.C The Board did verify\ that tHie contractor, in tie, review year. -waq low biddcer on some contra cts. The, cm itractor att ributedl p rofit able V YE #. c 74 operations to a reduction in Government discounts c' I;-Od by a1 chlangre in market, conditions. Because of the application of thie loss carryforward, both years were reclassified from Class "A"' to Class "B" cases and the ReIrion issued the final clearance n~otices.
The Regir-on did not, (bsorso whether the significant increase in FYF 74 sales and profits should lmfve resulted in better prices to thle Government. Verification of tle loss carryforward was apn)arently made by reviewing tlie divisional state-ments and by determining thle contractor was low 1)vilder on some contracts. No statement was niade, that thte loss carryforward w.as not, due, to gross ipefflciency. The con1tractor said that higher profits -were dule to hicrher price,; clbar~red because of the paper sliortacrc. and- I )Prlter sales duie to I'l a 1.1et coniditions, paper shiortacre. antd QTiowtli of thie company. The Region statJe( that favorable consi de rat iofn sh ould b~e !riven to the. fact thia! nortrenecrotiable profits were, conisider.bly h oliler than the.O comlpa rallle
ren~o~el~e wrk.(MIR I I (0.10b (2)) states that nollrenleoot >1 ld profits sboidl be con,-id(ered' ;in ri The losci carryforward redliced 1 J1?~;c or)P. file.1 Oil a c1Oliatl)'ls;s reflectin ren~a ) sales anl loss of 2 :f 79l .rmietyJ um
re"View adillshtel thle, l)o' ii a iI 14,1.01 0 to) an aIuse ot aqbout (k875,000) Thle NVCslker Rleroi on re~ iiiste~ Ys7 2v the( -t-eview year (7)was fowArt11ded( toyconltinuitv.
The Pe~7on adiiistCe tile losc, to k24-. nariv~ at thIll, oln thie~~y shwe ne(lVW I'( ad %st~mellt of thle loss of ~19b
(upward adjustmlient of profit of ,_t'69.890 and (lowliwanda U-ti i






24

of $320,394). The significant upward and downward adj ustments represented reallocation of general and administrative expenses of $150,503, reclassification of adjustment from books to tax of $294,147 and reclassification of research and development expenses of $308,618.
The final opinion reflects rounded renegotiable sales and loss of $8,366,000 and $29,000. The business was produced by two subsidiaries, one with return on sales of 12.2% (sales of $3,940,000 and profit of $482,000) and the other with a loss. The Region asked the contractor to explain any substantial difference between profits/losses between review year and prior years. No explanation appears in the file, however. The reasons for the loss were not explored.
Contractor was cleared because of an overall loss and the belief that the profitable subsidiary couldn't absorb a minimum refund (10% return after refund) and still leave the company the profit it deserved. The potential loss carryforward was reduced from $177,930 to $28,434. The Board indicated on its Clearance Notice Report (RB82) that the data should not be considered as establishing loss, if any, for future consideration. Thus, the Board appears to be saying the loss hasn't been verified and justified for carryforward purposes. IRS apparently had some adjustments but the contractor stated it would contest them, and the Board did not pursue. The Board concluded that the contractor's operations were efficient. The Board compared the contractor to two T)rior years; FYE 69 which was cleared by the Region reflected overall return of 13.2%, but an 18.2% on fixed price business. One company had a return of 25.9%. Excos.0?e Pirofit D e tei-mnatiom3
The Renefotiaticn Act states that the existence and amount of excessive profits shall be determined through analysis of the contractor's renegotiable business under the statutory fact orc. Board regulations state the determination shall be made through an overall evaluation of the factors and not by the application of a percentage of cest. The favorable/unfavorable determination will be reflected in the amount of profit the contractor is ,llowed to retain. The regulations also state that prior year settlements are not controlling precedents.
As previously stated, however, the Board has primarily relied upon return on sales and prior year settlements/actions in reaching its decisions. Constant references. in all phases of the Board's operations, are made to these factors. Supporting documentation to new screening proposals emphatically states that the Board historically has been oriented toward return on sales.
The following discussion reflects our review of three excessive profit determination cases.
John Wood Company was determined by unilateral orders to have realized excessive profits in FYEs 67 & 68 of $450,000 and $150,000, respectivelv. The contractor appealed the unilateral orders to the Court, of Claims and offered to settle the $600,000 determination for $150,000. The Board advised the Department of Justice not to accept the offer. Another offer of $325,000 was made and the Board deferred the decision to Justice, based upon its judgment of risk in the case.
After Justice received the case, several important events took place. First, a Government witness, aiding Justice, determined that renegotiable profits were understated by about $400,000 for the two years. Secondly, the contractor argued that it was entitled to consideration






25

for contribution to defense effort because of an engineering vallie suggestion it had made.
The Board agreed with the finding concerning thie ulndersitated profits. While Board member Chase believes the excessive profits should be increased by $400,000, others feel the adjustirient should not be so used, suggesting instead that the $32),000 settlement offer should be accepted.
The contractor's claim of contribution to defense effort involves its design for inverted bomb fins. The issue is unclear because it has not been determined whether, as John Wood contends, the fins were responsible for a cost-savings packaging design.
This case demonstrates the (degree of error and the questional)le adequacy of the Board's examinations. Profits were increased 1h7.8%, from $2,206,000 to $2,599,000, as a result of Justice's investigation.
Republic Corp.'s FYE 68 filing reflected renegotiable sales and profits of $8,846,592 and $1,424,884, respectively, on returns on sales, capital and net worth of 16.1%, 412.38%/, and 135.7%, respectively. Tihe screening report stated that officers' salaries had increased threefold from the prior year ($87,000 to $250,000 on a sales volume increase of about 65%). The case was assigned apparently because the profits were high, although no comparisons to industry averages or other comments were made stating reasons for the assignment. We found FTC reflected returns on sales, capital and net worth of 15.3%, 19.8% and 31.5%, respectively.
The Eastern Region subsequently adjusted sales and profits to refleet adjusted returns of 16.7%, 60.0% and 289.0% on sales, capital, and net worth respectively. The Region stated the officers' salaries were not unreasonable. (One officer was a non-employee of the company.) Independent audit reports found significant amounts of unrecorded inventory, over valuation of inventory, and sales and profits recorded in the wrong period. The Region requested such reports from the contractor but it cannot be determined whether they were received, and if received how these issues were treated.
The Region did not exclude appraisal surplus in computing returns on capital and net worth. If excluded, the returns would be 63% and 376%, respectively. The renegotiator determined excessive profits in the amount of $150,000. The contractor's argument that the profit was overstated because it had failed to properly charge material during the year was rejected l)ecause the contractor was unable to support that contention. The effect of the determination was to leave the contractor with 15.3% on sales and 259% on net worth.
At the renegotiation conference in the Rerion, the Regional Board redetermined the excessive profits to be $70,000 in part because:
-the contractor argued assets were understated as evidenced by the price Republic paid for Polan 31 days after this review year. The Board felt the originally calculated returns did not have the significance accorded them.
Later at the Statutory Board, Board member Chase would learn that no
audit was made of the purchase.
-the contractor submitted non-aiditable worksheets to convince the Board that non-recorded materials I)robahly existed. Later at the Statutory Board.
the contractor's contention was rejected and the consideration given by the
Regional Board removed.
The Eastern Regional Board left the contractor with returns on sales and net worth of 16.1%. and 273.5;, respectively.






26

The Statutory Board's division assigned to the case brought up the issues of inflated value of stock and unrecorded materials. The contractor was referring to the latter as "residual materials" and arguing that by not costing these, profits were being overstated. The Board refused to accept this position.
The Board also discovered a $262,000 discrepancy in inventory figures submitted by Repablc to it and to the S.E.C. The Board apparently chose, however, not to increase profits by the amount of the discrepancy as it arguably might have done.
The Board considered the contractor efficient even though delivery dates on certain major contracts were not met. The contractor attributed these delays to late delivery of government furnished assistance (tooling, etc.).
The Statutory Board cited the fact the Government hadn't received reduced prices on the increased sales volume. The Region had not cited this as a reason for the excessive profits. The Board determined excessive profits of ,225.000. leaving the contractor with returns on sales. capital and net worth of 14.6%,53.5% and 320.5% respectively. The Board rejected contractor's offer to settle for $125,000.
Chatmberain Corp. was handled as a package, in that FYEs 68-72 were renegotiated together. The final opinion reflects excessive profit determinations for FYEs 68 & 69. while FYEs 70-72 were cleared.
Before proceeding to FYEs 68-72. a brief discussion of FYE 67 is necessary since the operations of FYE 67 are referred to in the renegotiation of subsequent years. FYE 67 appeared as follows:
[Dollar amounts in thousands
Fixed price CPFF Other FP GOCO Total
Sales ------------------------------- $25,774 $600 $2,890 $29,584 $58,848
Profits ----------------------------- 3,807 42 306 1,072 5,227
Percent ----------------------------- 14.8 7.0 10.6 3.6 8.9

The final opinion of FYEs 68-72 made reference to the fact that high profits of one plant in 1968 were partially offset by nonrecurring costs due to early stages of production in 1967. The plant was a GOCO operation for which the contractor had received several million dollars for plant reactivation and modernization. The Board's files of 1967 and 1968 do not discuss the start-up costs in any way. The final opinion for 1967 concluded that although contractor's returns were high, profits and costs were reasonable in the context of all other considerations. The renegotiator had commented that excessive, profits at the contractor's facilities were offset by the deficient profits at. the Government-owned facilities. (See Remnqton and related cases of Fed ra7 Cru bridge and iI[ason-rlinfer on the issue of GOCO operation profits). The. final opinion for FYE 68 also stated there were no deficient profits to offset to high profits as had been the case in FYE 67. The profitability of the contractor's FYE 67 was discussed by renegotiator and headquarters reviewer alike.
Divisional sales and profit data were obtained for FYEs 68-72. For FYE 68, the renegotiator determined the excessive profits to be






27

$2.000000. A redetermination of $1,.400.000 was subsequently nrIl at the renegotiation conference, when thie (contractor sublnlitted additional data and responded to the first determination. The dletermiliation was decreased because:
-the product was redetermined to be more complex,
-more consideration was given for risk in view of precontraet material
ordering.
-partial consideration was given for contribution to the defense effort, and
-.New Jerse. state use tax of $103.801 was applied to 1968.
The contractor at one plant dferrtid start-u) costs over the lives of contracts, and thus would not absorb) such costs in one year. Onl the New Jersey tax. the contractor had a liability from 1 9 7-72 hut the. review year was dropped from a negotiated settlement Iby the state. The Board. however, chose to allocate a portion of the tax from the other years to 1968 and thus directly impact on the refund determination.
For FYE 69, the region adjusted contractor's profit upward $126.5S7 by reallocating interest expense. By using divisional data, the region adjusted returns on capital and net worth from 29.6% and 73.9 respectively, to 50.7% and 129%, respectively. The Eastern Region reflected this breakdown of the contractor's business:
[In percent]
Government owned Contractor owned
Tctal
New renegotiProfit return on- Scranton Burlington Total Waterloo Bedford Total able
Sales 6.2 11.3 8.2 11.8 2.2 8.1 8.1
Capital _---------------- 33.0 92.4 50.7 77.3 12.7 50.8 50.7
Net worth -------------- 70.4 268.0 117.6 227.0 35.3 145.1 1?9.0

The Region displayed IRS returns on sales and capital of 10<, and 13.8%. For FYE 68, the Region showed returns on sales and net worth, after the $1'00,000 determination, of 8.5% and 140.4%. respectively. on an overall basis. The Regional Board recommended clearance on the basis of comparison to the contractor's FYEs 67 & 68 and to other contractors.
FYE 69 was reassigned to the Statutory Board which redeteimined that the contractor realized excessive profits of $1.000.000. It said profits on fixed price contracts were high at 12.1% and 13.31 but partially offset by deficient profits at the New Bedford operation. The Board said the low profits were attributed to purchasing in the prior year. old plant and equipment and using a new production pro-ess. The contractor had stated. however, that such start-up costs were deferred over the life of the contracts. The returns on sales and net worth. after refund, were 7.3%/ and 114.2%. respectively.
The final opinion for FYEs 68-72 also stated that the operations of all nIants were separately analyzed.
The Board analyzed the contractor's returns on allocated net worth and capital on a divisional basis (except 1972) and on an overall basis. The returns were as follows:







28

[In percent]

I industry
Waterloo Scranton Burlington New Bedford Total averages I Net Net Net Net Net Net
worth Capital worth Capital worth Capital worth Capital worth Capital worth Capital

1968______ 261 83 158 52 179 56 375 668 205 67 24 12 1969______ 237 81 67 31 240 83 42 15 127 50 22 11 1970______ 38 37 68 47 38 34 31 10 44 30 19 10 1971______ 54 24 431 83 217 40 58 28 132 46 18 9
1972______ NA NA NA NA NA NA NA NA 14 7 18 9

1 Source: Quarterly financial report for manufacturing corporations, Federal Trade Commission, SIC No. 39, miscellaneous manufacturing and ordnance.

The renegotiable sales and profits considered by the Board in these proceedings were as follows:

[Dollar amounts in thousands]

1968 1969 1970 1971 1972

Sales -------------------------------- $101,118 $124,709 $105,656 $99,703 $65,360
Profits ------------------------------- 9,941 10,014 6,393 8,035 1.508
Percent ------------------------------ 9.8 8.0 6.1 8.1 2.4
Return on:
Capital --------------------------- 67.0 49.9 44.2 46.3 13.5
Net 204.9 126.9 30.4 131.6 6.6


The renegotiable profits for 1968 are $99,000 higher than those considered by the Eastern Regional Renegotiation Board (ERRB), and the renegotiable profits for 1969 and 1971 are $157,000 and $60,000 lower than those considered by the ERRB. These adjustments were made for the, following reasons:
(1) In the Board's opinion, in these cases the most equitable method of allocating interest expense was on the basis of the contractor's assets employed in renegotiable and nonrenegotiable business rather than by the ERRB's method of allocating on the sales ratio, exclusive of sales recorded at Government-owned plants. 0
(2) Subsequent to the review years, the contractor was assessed $408,419 in use taxes by the State of New Jersey. On the basis of the contractor's settlement with New Jersey, this amount was repositioned to the contractor's fiscal years 1969 through 1972, the years against which the assessments were made.
The final opinion states that the Board found that in fiscal 1968, the returns on allocated net worth and capital were significantly higher in all four divisions and also on a, total basis than the industry averages. This was also trtie foi- the Waterloo and Burlington plants in the, 1969 fiscal year, and since these plants contributed the bulk of the, renegotiable profits, the. total returns for that year were also high. The returns in fiscal 1970 were at a. more reasonable level. The Scranton and Burlington plants' returns as well as the overall returns were found to be high in the 197 1 year. 'Overall return were considered reasonable in 1972.
The Board said recognition under RBR 1460.12(b) (1) for losses sustained in 1972 and 73, on an item produced f rom. 1971-7.3, would be given in FYE 71 as special credit for the risk evidenced bv this loss ($2.7 million). In essence, a loss carryback was effected" 7zere. Favorable consideration was given also for pre-contract ordering of material. n








In fiscal 10. profits on Iixed-pIe t; ,,,otr s were w"o+sidere
hlighli in the Burlington plant at $, 1.47.000) oi 1 01.2 000 O f rn tiable sales, or 11. in view of the fact that tlhe o't ions were 1rformed in a GO()C() plant. IProfits realized b) tlie Waterloo piant at $1'4.235,000) or 1.8( of renerotiabhle sales of S2(j.S ,70U were also considered high because of the substantial I)opor)'tiol of eqIui pnmiet furnished by the Government. The New Bedford plant realize(l profits of $4514,000 on $2.-4.000 of rienegotiab)le fixed-price sales, or 1, .7'; The Board agreed with the contractor that thle high profit on a relatively small sales vohune was caused bY co-ts that properly so1101ld have been charged off in this period but were not. TIhe profits of t'he Scranton plants were considered reasonable. The Board also considered that the contractor's profits of 907,000. or 6.1 ( of reneg(otiable sales of $14,839,000 on cost-plus-incentive-fee contracts at the Burlington plant were high in view of the low risk of performing the operations in a GOCO plant under this type of contract. T here were no profit deficiencies to offset the higoh profits as had been in the case in 1967. However, pursuant to the provisions of RBR 1460.10(b) (5), credit was given to the contractor for non-recurring costs in the early stages of production at the Burlington plant which partially offset the high profits in fiscal 1968. (Start-up costs were not discussed in FYEs 67 & 68. Contractor's treatment of such start-up costs in FYE 68 at the New Bedford division was to defer such costs over the life of the contracts.)
For the 1969 year the Board considered as high the renegotiable profits from fixed-price contracts at the Burlington and Waterloo plants. The renegotiable fixed-price sales and profits of these plants were as follows:
[Dollar amounts in thousands)
Burlington Waterloo
Sales ----------------------------------------------------------- $21,599 $30, 595
Profits .....------------------------------------------------------------ 2,604 4, 063
Percent ........................------------------------------------------------------------. 12.1 13.3

These high profits were partially offset by the profit deficiency found in the New Bedlford operation which realized 2.9% on $20,S17.000 in renegotiable sales under fixed price contracts. The low profits resulted primarily from the risk associated with contractor's purchase in the prior ear of plant and equipment more than 15 years old which had not been in use for at least, 10 years. In the year under review, the contractor devoted that ) plant anti equipment to producing 155mm shells under fixed price contracts utilizing a process quite different from that which the contractor used in its Scranton plant.
VWhile the -cranton plant's renegotiable fixed-price )profits were high in 1971 at L .S98,000 on renegotia)le sales of ,417.)3.()000) or 10.4er. on
an overall basis, total reneotiab)le profits were con sidered reaonable in light of the factor consideration "ranted to 1971 under RBIL 1O. 12 (b) (1), as previously discus sed.
Overall. renegrotiable profits in fiscal year 1970 were considered reasonable because the slightly high profits of the Burlington plant were offset by the low profits earned by the New Bedford plant.







30

Renegotiable operations in fiscal 1972 resulted in modest profits or losses at all plants, and overall profits were reasonable. Loss carryback credit to FYE 71, in the Board's view, resulted in reasonable profits overall. Specific reasons for the New Bedford FYE 70 low profits were not set out. In FYE 69, credit was given for start-up costs of FYE 68, even though the contractor had deferred such costs over the life of the contracts. Specific reasons for losses/low profits in FYE 72 were not explored because the overall situation was considerably below the other years.
The contractor commented upon the Proposed Final Opinion (FYE's 68-72) on July 30, 1975. The Board responded to these comments as follows:
1. Your position that the conclusion in the Proposed Opinion is inconsistent with the prior year's clearance. Renegotiation is carried out on a fiscal year basis and a clearance in one year is not a precedent for action in a subsequent year. In addition to returns on capital and net worth, the Board considers the other statutory factors in making its determinations. (Contrary to what is stated., the Board looks toward prior year return on sales in reaching conclusions on review year operations.)
2. Your contention that Government assets should be included in the capital amount and the allocation of net worth. RBR 1460.11(b) (3) refers to sources of capital provided, but the calculations have consistently been made on the basis of capital applied by the contractor, i.e., total assets as shown on the balance sheet at cost (less provisions) adjusted for assets not essential in 'the operations of the entity. The calculations have been made on this basis in order to recognize that the contractor should receive more favorable consideration for the capital supplied by it than for capital supplied by others, as set forth in RBR 1460.11 (b)
(4). Proper comparison with published statistics can only be made by excluding assets furnished by others since these assets are not included in balance sheet figures.
3. Your position that SIC Group No. 34 is more closely related to Chamberlain's ordnance program than SIC Group No. 39. The Board has historically categorized ordnance producers, such as yourself, in SIC Group No. 39. However, the percentages for SIC Group No. 34 are generally the same or slightly lower than those for Group No. 39.
(Contractor's returns of capital and net worth still well above any grouping.) "
4. Your statement that the comparison of a contractor with the average of anl group is misleading. The Board's use of such returns is to show that, in years for which refunds are determined, such as your fiscal 1968 ,and 1969 years, the contractor's return are significantly higher than the industry averages.
5. Your position that comparable contractors were left with higher returns.
The Board's evaluations of all contractors are made under the statutory factors taking into consideration all known facts, including those pertaining only to the contractor being evaluated.
(Board relies upon return on sales of other contractors for comparative purposes. The contractor here refers to those return on sales.)
6. Your contend tion that price reductions in 1969 should be takent into considorathon. The Board was fully aware that price reductions were made in years subsequent to fiscal 1968. The Board concluded that the contractor's pricing risk was less in fiscal 1969 than in fisc-al 1968 due to its greater manufacturing experience and better knowledge of actual costs.
The Board stated that it was unable to discover in Chamberlains letter of July 30, 1975, a substantive reason in any of the points raised to warrait a change of its findings of excessive profits. It therefore rejected an offer in settlement of $1.323,348. The Board then issued unilateral orders for 1968 and 1969 in amounts of $1)600,000 and $1,000,000, respectively, and cleared 1970-72.






31

In suifliti 1, the rene~votiation of Chalinbliinls F\ E 67 and
F Y 684(S-2 reflected inconsistent and non-uniforin considlertat ion of the f.-wts, and faulty logic in support of decisions. Foi isne1l(. conl.siderat ion was given for:
-st art-uip costs from FYE 67 but no exandiflat iofl was made of ,uch cost.
(The contractor's policy appears to have been to defer such costs o)v,,- the lives of the cmit act s. Also, the contractor' had received several il lion 1 (11 )!li s for phiant reactivation and modernization. )
-losses inl subsequent years. (In effect, a loss carryhack wa,,s allowed biere although the Act and regulations do not provide for such considlerata io."
-isk de to jre-con ractmaterial ordering. Tihe regulahtions state timatu
experience reflecting losses either to the contractor or simnila rc'atft iS
sh1()11id1 e (lited when considering risk to the contractor. -No, such experiences
wve cited however.
-New JTer'sey stafe tax liability. (The Boar'd applied part of the liability as
a dir-et redu-t ion to the FYE Gq excessive profit determination even thoul-yh
the ',ettleinent did not include EYE 68.)
The Pve(-ion cleared FYE 6.9 based on a comparison to FYI' G7 ,mnd 68
wher~ th Stautor Boar~l eteru~ne excss T-0prfits of ,i .000,00.
1) e~iOli based its decision oil the overall conisolidlated return.1s whereas the Statutory Board based its doci ion on a divisional analysis; of thle contractor. The use of divisional data versus overall dlata, had
Cz,(ilo-a nt efec t the returns on capital and net worth in _FYF ('1.. The re ion adjusted returns on capital and net worth from 29.6%
fid 8.,resne)OCtively, to 50.V 7I and 129%'c respectively. b 1i sing0 (ljvisoal data.
Co) .4vThe Stall's review of assigned cases cast. doubt upon the. adeoriacv Of thie Board's, examinations of contractorVs' filincrs. The log*ic ultilized4 ILv bothi the, Reorional &- Statutory Boards is, at times, questionable in li Tht of documnented facts. Moreover, incons-istent considera tion of facts by theo reorions and by hea(Iquarters is often evident. W~e are ]eJ( to conclude that in-depth Board examination of contractors' filinls .1n data, is often lacking. (This conclusion is borne, ouit when one. coiisilers that significant, adjustments to profits frequently mtade by thle Couirt of Claims in its reviews of Board decisions.)
Our review also revealed the lack of tYuiclelines, oni the issiieS to be cons;Idered in renegotiation. as well as the lack of policy in the treatmnent of such impotant items as longr-termn debt. allocation of itrs expense, and the computation of capital and net worth. The lack of policy gulidelinies places the Board at a severe disadvantage in (lealincZ
-with contractors who have formulated their own positions on how to tret these accounting ( issues.
Our review also confirmed the conclusions made, elsewhere in tisreport coincerninic the Board's reliance on return on sales ratios andl prior* decisions. The policy of consolidating sales and profit figures
-q.7d offsetting losses 'deficient profits without seeking just ificat ion was zalso apparent.

IV. I-N-TIrtix F 11TNGS DATA S UBM IfSc;ION

Contractors are 1'equiredl to file RB1-is 1 by the first. dlay of the fifth month follow-incr the close of their fiscal years. unless they% canl show cause wh-v an extension of time to file should be granted. The Bolard

1 Standard Form of Contractor's Report for R.eiiegottation.





32

has routinely granted such extensions when the IRS has granted the contractor an extension to file a tax return. In such cases, the contractor is required to provide proof that the IRS has granted the contractor an extension.
The Board issued a General Order, dated April 15, 1975, stating that it will grant requests for extensions to file, if such requests are timely, in writing and good cause is shown. The Board will generally limit the extension to six months. Evidence of the IRS extension must be filed with the Board, and requests for more than six months must show, as one cause, that a hardship would be created if the extension were not, granted.
The Renegotiation Act provides a penalty only for non-filing. A contractor that refuses to file after repeated warnings and years after the filing requirement would not be classified as a non-filer if it suddenly submitted its RB-1 before the Board decided to conclude the case.
Kurman Ivst-uments Corp. was declared to be a recalcitrant contractor because the contractor refused to file for FYEs 66-70, even after repeated requests by the Board from 1968-70. In recalcitrant cases, the Regional Board issues unilateral orders in an amount deemed adequate to protect the interests of the Government. The cases are then reassigned to headquarters. In October 1971, headquarters began review of Kurman's unilateral orders and repeatedly attempted to obtain the filings. The filings were finally received in July, 1974. The Statutory Board thereupon rescinded the orders, deciding that there had been no willful misrepresentation by the contractor. The contractor's FYEs were cleared on the grounds that the contractor's profits were below the minimum refund.
The following discussion relates other instances of late filing by contractors, including filings of Applications for Commercial Article Exemptions and submission of data requested by the Board. Late RB-1 Filers
The following -are examples of contractors who were late in filing their RB-is:
Chamberlain Manufacturing Corp.-RB-1 for FY 70 was due 11/1/70 but the Board had not received it as of 3/23/71. On that date, the contractor, for the first time, requested and received an extension until 4/1/71. The filing was received 4/12/71.
Rohr Industries, Inc.-RB-1 for FYE 72 was due 12/1/73. The Board informed the contractor on 12/19/73 of the contractor's filing requirement and on 12/21/73 the contractor requested an extension until 1/15/74, stating that the IRS had granted an extension until then. The extension was granted. The RB-1 was received on 5/2/74.
Republic Corp.- (s1ccessor-on -interest) to Polan In distries--RB-1 for FYE 68 due 5/1/69. Board granted three extensions until 10/1/69 because the contractor stated IRS had also granted extensions. The filing was received 1/2/69. For the short year FY 1/1/69 to 2/4/69. the Board emphatically stated that it would not grant an extension past 3/1/70. The RB-1 was received 5/28/70.
Susquehanva Corp.-RB-ls for FYE 12/31/69 on a non-consolidated basis were received 5/17/71. Such filings were due 5/1/70. One subsidiary had not filed. The Board asked the contractor whether a consolidated filing had been considered, and the contractor subsequently filed on a consolidated basis. The subsidiary non-filer was not detected until the case had been assigned to the Western Region. Both the consolidated RB-1 and the RB-1 of the non-filing subsidiary were received in July. 1975.
Yincent Piro.-RB-1 for FYE 12/31/69 of this manufacturer's agent was due 5/1/70. The Board learned, from tax returns, that the agent was required to






03

Mie ail 1113-1 After re:)eat ed reolue ts liV th loB''a1. t1 (.lit rac' 'hI eW( i> ill June. 197.3. The filing was i iion~id~e. Th'e I o( n re Ii a >1 d '111h0 1r n I-') 1if) include all renegotiab~le usiiies.-. Til ,iddit j i(-)i (lat a wos noi't r'iv-Ifo on ver a year. Thle revised RB1-i -was apparently not Aile(].
In~ilco ('orp.-RB-1 for FXE 12/31 /71 wvas (110 -5/1/'72. ( Titrae-to 'vwas late in filing. apparently not having requestedl an extension no' r iiif'ormied tlw 1 8' ai-d of an IRS extensien. Subsequently it informed the Biwai'd t1 hat IRS hiad ,4-uimted an extension until 9/1:5/72 but requested :ind~ reeive(1 aii ('Ntoiisi(.f fromlit ~ B15oard until 12/31,/72. The filing was received 1/2/173. Late A pplwcat;om for Coinw-in yal A 1i ti(1c J(/I/ e ~ 0:
In order that the RB-is mTay be sobiitted in ll tiniielv fasljijoli. flhe Board requires that~ "Applications for (oimnei'cial A rtice iF1xeiiq)P tions"' be sibitted as soon after the (lose of tile coiti'avtor's i'a year as possibe u in no event later than the first. (iv of the( fifth
month following the close of that fiscal year. The Boar(] imist first act on these applications so that the contractor mnay adjust the review wia r renegotiable sales in his RB-i by the amount of sales exempt from renegotiation. The following examples of requests byv contractors to file untimely applications were recently aproved by the Board:
The Carboriinduin Co.-PYE 12/31/75. Application due on or before 5/1/71c. Board approved the contractor's request 7/13/76.
lMjchjqan Scainle.,s Tuibe Co.-FYE 10/31/72 & 743. Applications due 3/11 /73 and 74. Board approved requests 7/7/76.
~iS~miC Engineering Co.-FYE 12/31/74. Due 5/1 /75. Reqeust approved
7 /7/76.
("irrco Wire awl, Cable, Inc.-FYE 12/27/75. IDue 5/1/763. Request approved 7/7/76.
V i.sh (Iy nt~ertccli aoloy, Inc.-FYE 6/30/75. Due 11/1/75. Request approved
Bechtel International (Trp.-FYEs 12/31/72, 73 & 74. Due 5/1/73, 74. & 75. Request approved 6/29/763.
Pa6'i Jfllc'Pfl~ltiov~l~ Comiputinig Co-p.-FYIs 12/31/72, 73. & 74. Due onil172
7 4. & 75. Request to file approved on 6/29/76.
The examples show that the requests are lbein'( filed well after the clos-e of the contractors fiscal years. Conceivably, contractors are tinSureV of what impact the Board's segmentation policy announcement of 11, '17/ 75 will have in renecrotiating- those fiscal years anl realxiolis to eXlempt as many sales dollars as possible fromt renegotiation.
;..'n Rcesyoitdinq to Reqttests for Addjtioin a a
0(Tc filingr is assi!2ned to a Regional Office. a request (s) for additional dlata is miade. to clarify and suipplemient thie data t.In tlheRBi D116111n, 0o1r reviwl we noted that the Board is often more, sucecessfill inl oltainin~c data f rom the1 smaller contractors thanIT f 1o1m the larger ccntrac-tors. If Sol thle olleraItions of the smaller coiltrI a tors ar Ie pl'ol> ably !sIbjectedl to gTreater s(Tult iuv than those of th Ie lairger contractors.
We found instances; in w~lch the Boar'd requests (lta, buit the contractor ends lip dictating to the, Board the usefulness of the data. the inner in whiich it sought to lbe considered. or why it cannot be suibm1ifte(1. One reason such siti nations occur, is that "the Board has no policy on thle treatrvellt Of longf-telrm debt in computing capital and~ net worthy un-ed in renegotiable business.
Both Ioe;nq Coin pan 1/ anid RoeCZ'7PC1 internatona! Corp. voiced strong objections to providing detailed data on a, segmented basis. Boeing even tuallv came forward with far more data than Rockwell, although som-e of Boeing's data was not useful. Rockwell first in-





34

formed the Board that before submitting the data it would have to study the impact of the Board's request. Rockwell eventually provided the Board with data in a format best reflecting the contractor's position. The Board subsequently accepted this position. The situation is analogous to a case discussed in the Joint Economic Committee hearing on April 2, 1975, in which McDonnell-Douglas Corp. persuaded the Western Regional Board, to the consternation of the Western Region's Division of Accounting, to accept its method of computing capital and net worth. This method resulted in a significant decrease in the contractors' return on net worth.
One of the most common adjustments made by the Board to renegotiable profits is the reallocation of interest expense from renegotiable to non-renegotiable business. In the Boeing case, the Board increased renegotiable profits by about $15 million. Such adjustments are complicated, when, as in the Rockwell case, the contractor argues (and convinces the Board) that long-term debt, can be traced to reiiegot ia bl e/nonrenegotiable business.
The Boards' failure to formulate a consistent policy with respect to requests for data is illustrated by the following examples:
At the Board's request, Chamberlain Corp. annually submits di-,isional data. Rock1wel Internatonal, however, is asked to provide sales and gross profit data by major product groupings. Moore Bsiness Forms, Inc., a contractor with small renegotiable sales was asked to submit detailed divisional data for FYE 68-74, despite the fact that some of these years had already been cleared.
In the Boeing case, the Board requested and received the contractor's reasons for some of the reported losses. In renegotiating Susquehana 'orp., the Western Region requested justification for losses, but subsequently relieved the contractor of its obligation to provide this data. In the Western Gear Corp. case, the Board requested reasons for prior year losses and, probably due to the response, adjusted the loss carryforward downward by 14%. Conclusions
The untimely submission of RB-is and additional data )v contractors reflects the lack of penalties for late. filers, and the Board's historical reluctance to impose the Act's criminal penalties on nonfilers. The. need for civil penalties for both non-filers and later filers is clearly in evidence. The Board's approval of contractors' requests to submit untimely Applications for Commercial Article Exemptions demonstrates the Board's departure from regulations with respect to the filing requirements, and results in further delays in processing the RB-is.
On the treatment of accounting issues such as long-term debt, allocation of interest expense, and the computation of capital and net worth, the Board is severely handicapped in its dealings with contractors because it has no policy on these matters. Consequently, the contractors, rather than the Board, determine how such items should be treated even when the items are critical in the renegotiation proceedings. The staff believes that the protection of the Government's interests requires that the Board receive the raw data and decide the manner in which these issues are to be handled. The Board's difficulty in obtaining additional data suggests that civil penalties for contractors who refuse to comply with Board requests should also be considered.






35

V. WORKLOAD STAT'rST(CS/COURT OF CLAIMS ACTIONS

The Board's estimated renegotiable sales backlog of 8125 billion at 6/30/76 is up from $105 billion and $88 billion at 8/.1/75 and 2/28/75, respectively. The increase since 2/28/75 is about 421/ The breakdowns of the $125 billion at the various operations is as follows: Billion-1
Western region ------------------------------------------------------ $2 ;
Eastern region------------------------------------------------------- 15. 9
Office of Financial Analysis --------------------------------------- 7
Screening -----------------------------------------------------. 8
Total (estimated) 1---------------------------------------5. 0
The number of personnel at the end of fiscal years 1974-76 is as follows:

1974 1975 1976

ERRB I --------------------------------------------------- 50 55 52
WRRB I -.--------------------------------------------------- 29 31 29
Headquarters ..----------------------------------------------- 38 38 41
Total ----------------------------------------------- 117 124 122

1 Includes clerical personnel, whereas headquarters figures include line personnel only.

The table shows that the number of personnel has fluctuated little over the years.
The backlog at the end of each year was as follows:

1974 1975 1976

Screening .------------------------ 1,863 3,026 3, 378
ERRB..--------------------------------------------------- 733 870 795
WRRB... --------------------------------------------------- 307 438 441
Total, regions ---------------------------------------- 1,040 1,308 1,236
Office of Financial Analysis ------------------------------------- 336 411 496
Referrals .... --------------------------------------------------- 8 3 50
Over-age cases:
ERRB._ ------------------------------------------------ 160 161 189
WRRB-- ----11 12 70
Total--. ----------------- 171 173 259

SAssignment in process for over 24 mo.

The table shows that the backlog in screening increased by 1.515 or 81.3% since F/Y 74. In ERRB, the increase was 62 or 8.5% and for
WRRB, 14, or 43.6%. Total increase for the regions was 196 or 18.8%. Over-age cases increased by 29 or 18.1% at ERRB 59 or 5, at WRRB, totalling 88 or 51.5%o for both regions. Referrals-cases assigned to re(rions ) before sereenin d(ecisionll increased by 42 or 525;,. At headquarters (Financial Analysis), the increase was 160 or 47.6%.
The number of filings completed in screening has dipped sharplydown 865 or about 24%.
The number of assignments completed by the regional boards lhas increased by 168 (81.6%) at ERRB: 49 (24.4%) at WRRB: or 217' (53.3%) for both Boards. The regional boards and headquarter's Office of Financial Analysis-may be processing primarily FYE 0's,
as evidenced by the cases appealed to the Court of Claims in FYE 76.






36

The number of completed referrals and headquarter's review reassionments both decreased-referrals off 245.5% and reassignments off 4%.
In F/Y 76, the ending backlog in screening increased by 352 or 11.6%. At ERRB, it decreased 75 or 8.6%, whereas it increased at IVRRB by 3 or less than 1%. It declined by 72 for both regions.
In F!Y 76, referrals increased by 47 or 1566.7%. At headquarters review function, the increase was 85 or 20.7%. Over-age cases increased by 28 or 17.4% at ERRB; 58 or 483.3% at WRRB; and by 86 or 49.7% for both regions.
General Counsel's backlog has risen from zero to 54 cases since the beginning of F/Y 76. The accounting and analysis sections of Financial Analysis (formerly Office of Review) experienced increases in F/Y 76 backlog of 23% and 19%, respectively. Headquarters (including General Counsel) experienced an increase of 140 cases or 34.1%. Exemption operations also experienced an increase in backlog of 23 or 9.7%. The figures show that the beginning vs. ending backlog in all areas increased in F/Y 76, except that at ERRB. Workload and Status Report-FYE 76
Based on the number of accountants and renegotiators, and on assignments completed in FYE 76, ERRB accountants would have had 13.4 cases per man and renegotiators 46.8 cases per man. WRRB accountants would have had 17.9 cases per man and renegotiators 62.5 cases per man. (The assumption is made here that both accountants and renegotiators have worked on each case during the year.) ERRB accountants would have spent an average of 16.4 days per case and WRRB accountants 12.3 days per case. ERRB renegotiators would have spent an average of 4.7 days per case and WRRB renegotiators 3.5 days per case. VRRB is regarded as having the more complex cases. (In actuality, we assume that the more complex cases would take longer to process so that the time spent on less complex cases would be less than the average times.) Need for Additon7a Personnel
The Western Board has stated that based on complexity of cases in the inventory, emphasis on case completion rate and backlog reduction, five additional accountants and one additional renegotiator would be required. Chairman Broselow stated that he preferred de-emphasis of case completion rate (the goal set by headquarters) and backlog reduction to hiring additional personnel.
Chairman Johnson of the ERRB stated that no staff increase was necessary because the region had completed 374 assignments against the completion rate of 299 cases. That was done with 29 accountants and 8 renegotiators.
Court 0/ (;ow,
In F/Y 76, the Board made 46 excessive profit determinations in an amount of $40,086,556 (after State but before Federal tax credit.)
It concluded 21 by agreement and 25 by order.
In F/Y 76, the Court of Claims handled 27 cases as follows:
Dismissal/withdrawn --------------- -----------------------9
Stipulated settlements -----------------------------------------------14
Redetermined by court -----------------------------------------------4







37

In the stipulated settlenmelts, the (-m1t redl-ted th OVelall IDo 1 1dA
determinations by G1. ("' ,000 .or n(
miined by the court, the reduction was 7;.': (!7.>52 v>. <2. a 0 I). )
)Of the i9 cases filed with the cou t in F Y 76 I wer1 ce nvot or
F'YEs 60s. The miniaIninIg case was a FYE7.

'I. trOnEnT EXCESS IVE PlROF-!ITS

This chapter discusses the treatment of col actors 8n fe r'ld
determninationlls, as compared to FTC/IRS industry statistics. The basis for each set of statistics is significant in that IRS is based( upon taxable income while FTI( is based upon book incole. Our pll'pose here is to show that the Board las allowed contractors, even on the overall basis, to retain profits well above their indust rys average profits. If excessive profit determinations were based on the CollV tractors being left with the industry's return on sales, those contractors would still be realizing several times the industrV's return onil capital and net worth. While it may be argued that the statutory factors have not been applied in this exercise and that such colmputations are thereby unfair, it can conversely be argued that:
1. the factors, to some degree. have been applied because like contractors (character of iumsiness) are being compared iand the renegotiable/non-renegotiable products are not always dissimilar or unique, and
2. there is strong siwuggestion that the excessive profit determination should lie somewhere between the industry average and the Board's determinations iInce the board's primary basis is return on sales whereas the industry reflects return (on sales, capital and net worth.
The following table compares industry statistics with the selected contractors" conso atd returns after final board action.

[In percent

Profit to
Sales Capital Net worth

Clearances:
Boeing Co.:
Final Opinion ----------------------------------------- 5.0 14.6 44.7
FTC .---------------------------------------------- 3.2 3.6 10.4
IRS ----------------------------------------------- 3.9 3.4 9.0
Refund determinations:
Chamberlain Corp. (1968):
Final opinion (after refund) --------------------- 8.4 56.2 171.9
FTC ------------------------------------------------- 7.6 12.5 24.0
IRS ...----------------------------------------------- 5.8 15.2 28.4
Chamberlain Corp. (1969):
Final opinion (after refund) ..7.3 44.9 114.2
FTC_ 7.2 11.4 21.9
IRS - - - - - - - - - - - - - 5.6 12.8 19.0
Republic S11 to Polan Industries (1968):
Final opinion (after refund)_ __ ------------------------------ 14.6 53.5 320.5
FTC ---------------------------------------------- 15.3 19.8 31.5
IRS ---------------------------------------------- 10.5 16.2 27.7


The following tables reflect the results of renegotiation, ini selected cases, if the contractors were to retain thle industry's profit,'sales ratio. Note that the contractor's returns on capital and net worth are always higher than the industry average after deducting the hypothetical profits.







38


Profit to
Refund cases Sales Capital Net worth

Chamberlain Manufacturing Corp. (1968):
Actual determination, $1,600,000: After refund return on----------------- 8.4 56.2 171.9
I ndustry statistics:
FTC (hypothetical excessive profit, $2,392,000).---------------------- 7.6 12. 5 24. 0
IRS (hypothetical excessive profit, $4,186,000) ---------------------- 5.8 15.2 28.4
After refund reduction to equate to industry return on sales:
FTC ----------------------------------------------------- 7.6 50.9 155.6
IRS-----------------------------------5.9 38.8 118.6
Chamberlain Manufacturing Corp. (1969):
Actual determination, $1,000,000: After refund returns on---------7.3 44.9 114.2
Industry statistics:
FTC (hypothetical excessive profit, $,100)- ---------7.2 11.4 21.9
IRS (hypothetical excessive profit, $3,073,000) ---------------------- 5.6 12.8 19.0
After refund reduction to equate to industry return on sales:
FTC ----------------------------------------------------- 7.2 44.3 112.7
IRS ------------------------------------------------------ 5.7 34.6 90.0
Renublic Corp. S11 to Polan Industries (1968):
Actual determination, $225,000: After refund returns on---------------- 14.6 53.5 320.5
Industry statistics:
FTC (hypothetica[, extessive profit, not computed because return
higher than Board's)--------------------------------------- 15.3 19.8 31.5
IRS hypotheticall excessive profit, $400,000) ----------------------- 10.5 16.2 27.7
FTC (hypothetical excessive profit, not computed because return
higher than Board's) ------------------------------------------------------After refund reduction to equate to industry return on sales:
FTC (capital/net worth very high returns, but not computed) ----- ----------------IRS --------------------------------------------------- 10.5 36.7 219.4
Chamberlain Manufacturing Corp. (1971):
Clearance----------------------------------------------------- 8.1 46.3 131.6,
Industry statistics:
FTC (hypothetical excessive profit ,78,0)------- 6.3 9. 1 17.8
IRS (hypothetical excessive profit, $20100-----------6.0 11.4 16.0
After refund reduction to equate to industry return on sales:
FTC-----------------------------------6.4 36.0 102.4
I RS------------------------------------------------------ 6.1 34.3 97.5
Boeing Co. (1971):
Clearance------------------ ---- 5.0 14.6 44.7
Industry statistics:
FTC (hypothetical excessive profit, $14, 439,088) --------------------- 3. 2 3.6 10. 4
IRS (hypothetical excessive profit, $8,823,887) ---------------------- 3.9 3.4 9
After refund reduction to equate to industry return on sales:
FTC----------------------------------3.3 9.3 28.6
IRS------------------------------------------------------ 3.9 11.4 34.9


In hearings held before the Subcommittee on Priorities and Economy in Government of tjhe Joint Economic Committee on April 2,
1975, two members of the Committee staff testified on the renegotiation of several cases of considerable controversy. In that testimony, the
profitability of the contractors on a segmented basis was discussed and compared to industry statistics. Hypothetical excessive profits
were similarly computed, but the results were more dramatic than-L
the examples in this study because of the large size of the contractors.
The purpose of presenting that data was to show the need for examination by the Board on a segmented basis. The data reflected the very
high profits of all segments and overall which the contractor was
able to retain above the industry statistics. The data revealed how
extemely profitable the contractors were, beyond the industry, afterfinal Board action. If one assumes that the Board's decisions were
based on application of the statutory factors, one must also assume
that a great deal of consideration was given to the apparent efficiency
of those contractors beyond the industry -,,s a whole.
The staff of the Joint" Economic Committee presented one table that
reflected how much profit the contractor, omi an overall basis, was able
to retain beyond the FTC/IRS return on sales, capital and net worth.
Each computation was individually computed and stands by itself.
For instance, -McDonnell Douglas (1967) realized $808 million above
the FTC average as regards the net worth ratio. (The table follows.)








39

MCDONNELL DOUGLAS AND NORTHRUP CORP, EXCESSIVE PROFIT DETERMINATIONS-ACTUAL AND HYPOTHETICAL BASED ON INDUSTRY AVERAGES OF PROFITS ON SALES, CAPITAL AND NET WORTH [in millions of dollars]

Sales Capital Net worth


Final opinions:
1967-McDonnell Douglas:
FTC ---------------------------------------------------- 53.3 98.0 80.8
IRS------75.9 111.9 98.8
Actual----------- --------------------------------------- 5.0
1968--McDonnell Douglas:
FTC------------------------------------------ ---- 21. 4 83.3 5F. 9
IRS ----------------------------------------------------- 46.2 94.7 76.5
Actual_ ----------------------------------------- 0
1969-McDonnell Douglas:
FTC ---------------------------------------------------- 11.1 60.5 48.6
IRS--------------------------------------------------29.2 67.7 61.2
Actual ------------------------------------------------------ 0
Northrop Corp.:
FTC ---------------------------------------------------- 6.2 14.6 10.0
IRS ----------------------------------------------------- 10.7 17.4 14.9
Actual --------------------------------------------------- ----0


The staff presented another table refleetmg that even if the contractors were reduced, on an overall basis, to the FTC/IRS return on
sales, the contractors would still realize returns on capital and net
worth several times the FTC/iRS averages. [The table follows.]

MCDONNELL DOUGLAS AND NORTHROP CORP, EXCESSIVE PROFIT PETERMINATIONS-ACTUAL AND HYPOTHETICAL BASED ON INDUSTRY AVERAGES OF PROFITS ON SALES AND AFTER DETERMINATION PROFIT ON SALES, CAPITAL AND NET WORTH

Percent profit of
Amount
(millions) Sales Capital Net worth

Final opinions:
1967-McDonnell Douglas:
FTC -------------------------------------- $53.3 4.9 18.0 36.2
IRS ---------------------------------------- 75.9 3.5 12.8 25.6
Actual--------------------------------------5.0 7.8 29.4 59.0
1968-McDonnell Douglas:
FTC --------------------------------------- 26.4 6.1 20.6 38.4
IRS --------------------------------------- 46.2 4.9 16.5 30.7
Actual ------------------------------------- 0 7.6 26.2 48.7
1969-McDonnell Douglas:
FTC_-11.1 5.5 18.0 37.0
IRS ---------------------------------------- 29.2 4.3 13.8 28.3
Actual- ------------------------------------- 0 6.3 20.7 42.5
Northrop Crop.:
FTC ------------------------------------ 6.2 5.6 11.4 23.7
IRS -. ..------------------------------------ 10.7 4.3 8.7 18.1
Actual ------------------------------------ 0 7.3 15.2 31.4


The Board's written response, in part, to the staff's testimony
particularly to the above tables on hypothetical excessive profitsstated the following:

-the statutory language permits no formulae or pre-estiblished ratios to e used in determining whether profits are excessive on any given (.'Ise, anid
-the statute, in part, speaksf in terms of normal earnings, whiyh is a tern substantially different from the average earning of an industry in a particular
year.
The Board's response did not refer to its own use of ihe protit retniln
on sales as the primary criterion, nor its reliance on prior Board ael ions
with respect to the contractor and similar conti-actors. TIhe loa rd did
not define normal ea m .'S.






40

VII. OTHER .3IATTERS
This section discusses and summarizes certain important issues and observations that were mentioned only briefly in earlier sections. "Pacwkage" Renegotiaton
The Board has entered into agreements with contractors whereby the contractor will agree to a refund determination of one or more years, if the remaining years are cleared by the Board. Such arrangements were made with the following contractors: Chamberlain Corp--FYEs ---------------------------------672
Remington Arms-FYEs -----------------------------------68-72
Federal Cartridge-FYEs 6----------------------------------8-71
The consistency and uniformity of the Board s decisions in these cases is subject to question. In both the Reminngton and Federal Cartridge cases, the years cleared by the Board reflect higher returns than the returns, after refund. of the excessive profit years. Furthermore, the GOCO operation returns in the cleared years are higher than the GOCO operation returns, after refund, of the excessive profit years. (The GOCO operations were those determined by the Board to have realized the excessive profits.)
In the Chamberlain Corp. case. filings for FYE 71. on a consolidated basis and for one segment, were comparable to FYE 69 but the Board permitted risk associated with losses in subsequent years at another plant to be given special credit. Thus. FYE 71 was cleared. Yet Worth Factor
The computation of the amount of net worth and the resultant return on net worth are of the utmost concern to the large contractors. The Board. however, has no policy on' how net worth should be computed. In the McDonell Douglas cases, the Western Board accepted the contractor's method which resulted in a reduction of returns on net worth from approximately 90% to approximately 60%. The 60% range is regarded as a "safe one for renegotiation. The Western Region's Division of Accounting objected to the contractor's method and cited other more acceptable methods for computing the amount of net worth.
Our review of the Boeing and Rockwell cases reflected similar concerns about the net worth factor. In the Rockwell case, the contractor was successful in getting the Western Board to accept its methodology. Percentage of Conmpletion Ac--oouitinq
The percentage of completion method of accounting relates to contracts containing incentive provisions or providing for escalation redetermination or other revision of the contract price during or after the completion of performance of the contract. The intent of Regulation 1457.5 1 is to permit compilation of more accurate estimates of costs and profits for matching profits with contract performance. The Board accomplishes this end by moving sales into the period in which the related costs were incurred.
The reliability of the percentage of completion method and especially the adequacy of the Board's analysis and review is highly
1 See Appendix F.




41


u~icant lv iIH~eta(I )p-ofit for nfllJl -warls, iieidinv 's tI the I;oar([ hatd ex.-minled and clearedI. I hwaise of'I Ii lil it e(l 1 MWi. \VO (1](1 not, ex})lote whiether siular PsIiit iOHls have a rlisen. o r t le (le')-ve to wIech the Bloard conducts examiinaIl ioiis of t hiese co)iltr'actor1s. Ift al pea V('d tIfa ill tile Roe/P wIell caise, the Boar-d acep t ed dhe icoit ra wti-*, amoun111ts 'at face value.
A'~0/'('l1~flI/8of J?(Jw'nl 0,? Sa~eUl ot*I P1702 or Y?/~ ,, i.' /0~
o8 B(P i/S fori, tv _Yea), iDe((Oe'1nS
'I'le S1Viortcoil iig 0f uiln 2 theo ret urnis oil sales reflect ed ill p)1'i n' year settlem-ents/act ionis in itia king, review year d ecisin 5OhS Iive I ee 1 iient jonle( elsewhere in t Iiis reorot. Generally! thley calli b"e sulIll l 1 rze'l as follows:
-adequa11te rewiev undeIr ft(e statutory factors,, of corp)ora~te segineni 5 and ()f the wholole mai,,y ie sho)rtciit.
-een if ', iicli a(lelutate reviews were performed. they cml b1(1e negated 1)(,ca ui~e (,f thie reliance placed- upon those return,,.
-Wartime Zffid vPacetiie products are 1 ein- conipa red. Loglcall,. wartime lproduchS -hoiih! probably beC accordedl more consideration. Thius. such comtpaison~is are inot reasonable.
-efficienicy of the contractor may not bie recognized and rewarded.
--flair dlealinig amiong' similar contractors and( among all contractors may not
occur because each contractor's capital/net worth input and resulting retIrs muay (liffer Mnd tile Board wo-uld not recognize these differences.
--eveni if only compared to the contraCtor's own prior years, the sales vohlinie
of eachi year miust be regarded since larger volumes should result in reduced
prices and lower return.
-the Act is shortcut when all of the above occur. Quefwstonble Logic i. lar? q Per8onis
The staff's review of selectedl cases revealed that Board deiir are frequently gTrouniledl 0o faulty logic. _A_ lack of ini-depth exainnatioi was also evident in the Board's treatment, of several cases. Two examples follow:
III support of Chiamiberlain Corp.'s FYP 67 clearance the Board stately that GOCO profits were deficient, bec-ause contracts were plimanily negotiated at 8%but, returned only 83.6%4. Thie, statements illidicate tht te Bord erey -assumed that the contractor w as effieet
The statement also reveals the Board's emphasis onl at rate of prVofit (which the regulation-s prohibit) and de-emphiasis of reiie(Totia-t ion oni a fiscal year, rather thian a contract, basis. Most imnportai tlv. th1 ea apparently overlooked lie, fact that the criteria for awardiling profit' on contracts (luring procurement andI those used in (leterniiii excessive profits are completely different.
The. Board also based its clearance on the fact that, fie, coi'8(t0Vi sustained unusual risks in accepting fixed price, contracts inl G( C() plants. InI citincrT "risk" as a factor. the Board didl not, (discuss loss(-,, to thle cntractor or sililar ~ contractors as required by the. regrulations.-; In fact, (7ahbadn 1( actually pro0flted overall on such otncs
ani received several mrill jon (dollars for plant reactivation and1 iin2(ern-izationi. As is typical of Board procedures, thie cleanice !:c (capital and net, worth) were high.*
InI another recent caise, high profits of one, corporate dj vi181011 WTe attributed1 by7 the reviewer to efficiencies on charge volumiie. jPrices inl






42

thtis case had been negotiated during war years, while the work was performed over a period of war awl peacetime years. The reviewer, however, did not question whether the contractor should continue to receive the benefit of such high prices iii a peacetime economy or
-whether the efficiencies, through experience gained over the years, may D- rendering current profits excessive.
In examining another division of the company, the reviewer agreed with the contractor's reasoning that deficient profits were clue to dlecreased sales volume. He thus apparently ov-erlooked the fact that one Of the review years with lower sales volume actually reflected a higher return on sales than the years -with greater volume. (Generally as sales volume increases, the profit returns should decrease).














A PPENDI XE S



APPENDIX A

SECTION 103(E) OF THE RENEGOTIATION A T

(DEFINITION OF EXCESSIVE PROFiTS)
(EXCESSIVE PROFITS.-ThP teri "eXCOssive profits" means the portion of th(* profits derived from contracts with the Departments and suYcontracts which is determined in accordance with this title to be excessive. In determiniinig exesiv profits favorable recognition must be given to the efficiency of the contractor or subcontractor, with particular regard to at tainnent of quantity aiid quality production. reduction of costs. and economy in the use of materials, facilities, and manpower; and in addition, there shall be taken into consideration the following factors:
(1) Reasonableness of costs and profits, with particular regard to volunn
of production, normal earnings, and comparison of war and peacetime
products
(2) The net worth, with particular regard to the amount and source of
public and private capital employed:
(3) Extent of risk assumed, including the risk incident to reasonable
pricing policies:
(4) Nature and extent of contribution to the defense effort, including inventive and developmental contribution and cooperation with the Government and other contractors in supplying technical assistance:
(5) Character of business. including source and nature of materials. complexity of manufacturing technique, character and extent of subcontracting,
and rate of turn-over;
(6) Such other factors the consideration of which the public interest and
fair and equitable dealing may require, which factors shall be published in
the regulations of the Board from time to time as adopted.


APPENDIX B

SECTION 103 I) OF TIHE RENEGOTIATION ACT (RENEGOTIATION LOSS CARRYFORWARDS)
(111) RENEGOTIATION LOSS CARRYFORWARDS.(1) ALLowANC-Notwithstanding any other provision of this section, the
rene'otiftlion loss deduction for any fiscal year ending oi or after December 31. 19755. shall be allowed as an item of cost in such fiscal year, under
regulations of the Board.
(2) DEFJ NriTIONs.--For the purposes of this subsection(A) The term "renegotiation loss deduct ion" means(i) for any fiscal year ending on or after December 31. 1956. and before
January 1, 1959, the sum of the renegotiation loss carryforwards to such
fiscal year from the preceding two uival years: and
(ii) for any fiscal yea r ending after Decenber 31. 1V5 P. the sum of t
renegotiation loss carryforwards to such fiscal year from thbe preceling five fiscal years (excluding any fiscal year ending before 1)ecember 31.
19506).
(B) The term "renegotiation loss" means, for any fiscal \ yezr. the
excess, if anly, of Costs (comiputed without the application of fik subsection and the third sentence of subsection (f) paid or inceurre 'd in such fiscal year with respect to receipts or nccruals subject to the urnvisions of this title over the amount of receipts or aernals subject to the provisions of this title which were received or accrued in such fiscal
(43)







44

year, but only to the extent that such excess did not result from gross
inefficiency of the contractor or subcontractor.
(3) A-MOUNT OF CARRYFORWARDS TO 19 56, 19 57, AND 19 58.-For the purposes
of paragraph (2) (A) (i), a renegotiation loss for any fiscal year (hereinaf ter in this paragraph referred to as the 'loss year") shall be a renegotiation loss carryforward to the first fiscal year succeeding the loss year. Such renegotiation loss, after being reduced (but not below zero) by the profits derived from contracts with the Departments and subcontracts in the first fiscal year succeeding tihe loss year, shall be a renegotiation loss carryforward to the Second fiscal year succeeding the loss year. For the purposes of the preceding sentence, the profits derived from contracts with the Departments and subcontracts in the first fiscal year succeeding the loss year
shall be computed as follows:
( (A) If such first fiscal year ends on or after December 31,, 1956,
such profits shall be computed by determining the amount of the renegotiation loss deduction for such first fiscal year without regard to the
renegotiation loss for the loss year,
(B) If such first fiscal year ends before December 31, 1956, such profits
shall be computed without regard to any renegotiation loss for the loss
year or any fiscal year preceding the loss year.
(4) AMOUNT OF CARRYFORWARDS TO FISCAL YEARS ENDING AFTER 1958. For the purposes of paragraph (2) (A) (ii), a renegotiation loss for any fiscal year (hereinafter in this paragraph referred to as the "loss year") ending on or after December 31, 1956, shall be a renegotiation loss carryforward to each of the five fiscal years following the loss year. The entire amount of such loss shall be carried to the first fiscal year succeeding the loss year. The portion of such loss which shall be carried to each of the other four fiscal years shall be the excess if any, of the amount of such loss over the sum of the profits derived from contracts with the Departments and subcontracts in each of the prior fiscal years to which such loss may be carried. For the purposes of the preceding sentence, the profits derived from contracts with the Departments and subcontracts in any such prior fiscal year shall be computed by determining the amount of the renegotiation loss deduction without regard to the renegotiation loss for the loss year or for any fiscal year thereafter, and, the profits so computed shall not be considered to be less than zero.

APPEN DIX 0

ADMINISTRATIVE LETTER 7 5-15 (SEGMIENTATION ANALYSIS)

Administrative Letter 75--15
RENEGOTIATION BOARD,
Washington., D.C., N ovember 17, 1975.
To: All professional employees.
From: The Chairman.
Subject: Segmentation analysis.
Pursuant to a Resolution adopted by the Renegotiation Board on April 10, 1975, you are herewith instructed to use the following described techniques in analyzing a contractor's renegotiable business.
Scgmen at jon
The grouping of a contractor's renegotiable business by types of contracts (fixed price, cost-plus-fixed-fee, etc.) as reported on the Board's filing Form RB1, must be examined for similarity under tile statutory factors. within each such group. With regard to contract-type grouping, where here is within one or more of such contract-type groups a marked lack of uniformity, the professional personnel assigned to the case are required to consider how such contract-type groups may be segmented further so as to identify additional segments with greater similarity. For example, there may be within fixed-price renegotiable business a substantial amount of sales produced at facilities wholly or substantially owned by the contractor as well as a substantial amount produced on government-furnished facilities. Clearly, there is a marked difference between the two groups with respect to the capital employed factor. Similarly, differences may result from the character of the business; such as the use of purchased materials versus customer-furnished material. Another examples of differences in character of business would be dissimilar produCts or services.







45

Identification of the segments to be analyzed must he done with full knowledge of the nature of the particular contractor's cost accounting system and the availability of financial and other data.
The word "segment (s) means any significantly similar portion of a contractor's renegotiable business which will permit thorough analysis and the application of the statutory factors in a consistent and relevant manner. The segments so identified may be subsidiaries, product lines, prolit centers, divisions, or such other categories.
Having developed financial data by such significant segments, the remaining renegotiable business, if any, must be placed into a separate grouping which may not be similar, but by the application of reasonable judgement is an insignificant part of a contractor's renegotiable business. No further analysis of this grouping may be warranted or necessary unless this grouping shovs a loss.
Thle analysis of each identifiable significant segment by application of appropriate statutory factor (s) must result (assuming profits in each instance) is a tentative finding that the profits are low, reasonable, or high (and if considered separately would be held to be excessive.) Low Profits
Where it is found that certain valid circumstances have caused the profits of a significant segment (s) to be so low that recognition thereof is required, consideration shall be given to such low profits. The circumstances that cause such a finding as well as the favorable consideration accorded thereto, must be set forth in the appropriate Opinion, and fully justified.
If no justificable consideration can be given under the applicable statutory factors, then no credit will be given toward offsetting high profits with low profits for the purpose of making a final determination of reasonableness or excessiveness of profits.
Losses
Where a loss is generated by one or more of the segments, within the same fiscal year, the amount thereof shall be allowed as an adjustment, in effect a reduction of profits, of significant segments for which profits are considered high (and would be considered excessive if considered separately). Losses must also be examined for reasonableness to make sure they are not the result of gross inefficiency.
It is also acceptable to give consideration, in valid circumstances, for low profits as described above.
Aggregatian
Finally, wheen the foregoing analysis has been completed, all of the sales, costs, profits, and the factor considerations allowed the various significant segments must be brought together-aggregated-along with the remaining grouping, if any, and the statutory factors applied to the aggregate of the contractor's renegotiable business where such consideration has not already been given and where in the totality it may be warranted. This action cuhninates in a finding for the total entity of the presence or absence of excessive profits, and in the event of the former, the amount thereof.
Reclassification of Class B Cases
Where pursuant to these instructions, the loss of one segment is used to offset the high profits of another segment or where consideration has been given to the low profits of one or more segments, the Chairman of the regional board responsible for such a case is required to reclassify that case from "B" to "A" so that the Renegotiation Board may review such treatment. In those cases where an overall renegotiable loss exists, no reclassification will be necessary. Ttese instructions modify the Board's previous instructions dated January 14, 1975.
This Administrative Letter is applicable to all future assigned cases where segmentation is deemed appropriate in accordance with the Boards Resolution dated April 10, 1975 and this Administrative Letter.
This Administrative Letter is also applicable to all assigned cases in process at this time. However, where cases are nearing completion, and in tlhe jud _ment of the Regional Chairman and the appropriate Office Director, a segmentaition analysis would not make a material difference as to the determination of e-,-essive profits, if any, such an analysis may be omitted and a written justification for the omission shall be provided.
C. HOLMQUIST,
Cli airm an.







46

APPENDrIX- D
Administrative Letter 75-8 (Rules for Screening of Filings)
RENEGOTIATION BOARD,
Washington, D.C., February 28, 1975.
To: All employees.
From: The acting chairman.
Subject: Rules for the screening of filings at headquarters.
An Administrative Letter of essentially identical text was issued by the Chairman of the Renegotiation Board on February 22, 1973. That Administrative Letter was revoked on Mlay 13, 197-4, in anticipation of a contemplated. revision.
Th~le revision of the Administrative Letter of February 22, 1973 has been delayed for reasons not directly connected with the screening process, and will continue to be delayed for anl indeterminate amount of time. For this reason, it is deemed necessary to re-issue the Administrative Letter of February 22, 1973, with only such minor modification as may have been made necessary by the passage of time since the date of the original Letter.
The screening process is a vital part of renegotiation activities and its proper functioning is of utmost importance in carrying out the statutory mandate of the Board.
Tlhe purpose of this Administrative Letter is to define the responsibilities of Board personnel engaged in the screening process as well as to indicate the minimal requirements, as regards both data and analysis, of an effective screening process.
1. Upon receipt of a filing from the Division of Assignments, the Office of Accounting will complete line 11 of the Screening Report and will insure that the SIC number shown on line 8 is appropriate for the principal renegotiable products or services shown. In completing line 11, care will be taken that the descriptions, to the extent possible, will be in line with the terminology used by the Standard Industrial Classification Manual in use by the Board. Effective immediately the Board will use the 1972 edition of that manual. In completing line 11, as well as line 12, amounts will be shown whenever possible.
2. In completing lines 13-23, the Office of Accounting will show the figures that are to be arrived at under the law, regulations, or orders, bulletins, or other internal rules or instructions of the Board. All adjustments required to be made in the contractor's figures will be made regardless of a judgment as to the effect of such adjustment on the ultimate outcome of the case. If the adjustment is reported in the file and reflected in the figures. such adjustment nleed not be noted on the Screening Report.
3. The "brief statement" required to be put on the Screening Report by General Order No. 2, paragraph 3a (4), whenever exception is taken to the method of sales segregation or of cost allocation, will contain an explanation of the problem as well as anl eftdmate by that Office of the maximum amounts that may be involved in each potential adjustment.
4. The Office of Accounting will give on the Screening Report a very brief description of the methods of sales segregation and cost allocation used by the contractor, and the implications, if' any, of such methods for renegotiation purposes.
5. If for any one of the preceding three fiscal years the contractor's filing wasassigned to the field for ftill-scale renegotiation or a referral. the central file will be obtained and the effect of adjustments in prior years onl the current year will' be noted onl the Screening Report. If a prior year's filing is being processed in the field, the Office of Accounting will consult with the Director of the regional! division of accounting with respect to the latter's findings, and the Screening Report will so note.
6. If a loss carryforward appears to be available for the fis cal year under review, the Screening Report will indicate whether the losses involved have, or have not. been verified for carryforward purposes.
7. If thle tiles indicate that Government-furnishied facilities, equipment, material or progress and advance payments may have been available to the contractor during the fiscal year under review, the Office of Accounting will endeavor to obtain information regarding this Government asset input, and( the information will be indicated on the 'Screening Report. The possibility of claims by. or against the contractor will be similarly investigated.
8. The signature of the accountant and the initial of the Director, or Deputy Director, Office of Accounting, will lbe deemed to certify that the data on the







47

S reening Report a re tadeqtiu Ite 1undej' t I e regul Iat iolus-, rules, (,,I, I, ()I 1) instructions Covering the collection and -eihfcai on of o iii touima I ia (iiid dal 1 a P tile sci'eenill-ig lwr(c;'5 a1n(, to thle best oft Iheir knowNledge, the datIa ark, arc4 it1a ide 101' reniegol at ion plurpose'
9. Uponl receipt (4 the thung- from the Office of Accoiiiii, ljie I Di\ i'-jii (of Sc-eeilig anid lExeliilis Off ()ice of Rev-iew. will youiy 1111' 11114 )i18lll: co"I 1iixed oil huies 11, and 12 and)( thle aporitissof thle SIC iw(1r;1 an Th'le (iiNvision wil U hcii ob~il riii1d usi ry hilanci a I51a list ics, co wipmalk a' 1-4.o* a tid percent ages to be wu(ed iii e-a ti atl u thle flii g of thle colil iaci 1' ill 111e sOV( eling pnwc,'s. Sluuh ra I ios a a pr t'itages wviil, be 5hN1 I1 (Awn e>c*s'
Rej~~~o~~t,1 14ie iVWt iIhiC44uc T -~ Quiarterly Finanial I '(B i- I
"Manufacturi hg (Corporation1s, Source Bo. ,k (of St :i list ics of I IU I. EI> ori 1101o') HowNever, if filie Screenling Report aI" coni1pletel b)y the Office of ACc omit ihig >10)XV a1 loss on1 i'eiegotiable andiie~ noIl 1 excepi on ha s beeni Iakcii vIh Jl
vii hiei' to sales sergh 01or cost a 1locati 08, 1te jresolltatil 1101 hisu i'rIi 114)11 may l;e omitted.
10. For' purpose es of thle screetihig proce, indii,.,try fi, iaulci, 1 0 ai od01hel. sta tistics will lae deemed to be comparable. even I botgh they maniy relak to nlaj4 4* ind~ustry grl'(jlhl. In th ru ne of governmnental data. or ill5l)ne1i i u suelh (181. noin-goveriliniit st11i'StiCS 1max' also be iised, and ill such cases static tics relating 11Ato zipp-opriz e ia jol iimwsfi vics wil i- ain 1_e deemed compara I to.
11. No filing which shows any of the I three cr1itical profit's ratio-,- abo4ve 1 lie sta ted indlnstry' avera "es will.t, e+laredl without a ssi guimnet or re0co ill Iieiiu ed l14be cleared without assiinitent. wxitfbouit a stafeeint on the (rciIgRpi is 1t) the rifs(AIs for the acceptability (of such higher than average ratios. Sutchl >1 atenuient will make referenc(_e, to the extel I aippro)priate, to thle considerate ion giveli to dlata showli oil liles 19-213 Of the SCI'ee li1l Report as well as to the li'esence or atsence oi Go~vernmiit asset input.
12. Thie Division of Screelling tuitd Exemptions will consult the acpprol 1iate rc"'ioln whenev-er it is processing a tilig (f a contractor who has a prior yeair orI years pending in a region. Alt hough such'l consultation may result in anl advice by the regioli to ci(ear or ass4ii the tillng, suci adlvice will not be~ ulsod is the Sole basis for the Division's action or recommendIation, a-mi wvill not jus~tify tile o-mission of any steps or considlertatioll normally called for in the screening process.
13. If tile Office of Accounting takes exception to or otherwise ind~icates reservations as to the acceptability of a loss carryforward, the IDi\-iion of Sc.,reening, and Exemptions will evaluate the tiling and will take its action or make its rionjiiendlation without regard to the loss cari'vforwai'd. in this connection the Division may recommlend referral of lie case to a region for the( purpose of resolving" the issues raised by the Office of Accountig with regtal'( to thle loss earryforward.
14 If the Division (of 'Screening at1(1 Exemiptions believes that there may be excessive profits in a given case Iut s uchi excessive profl,,s do not excee(1 the appl)icale mlinimuim refund, it will refer the case- to the Director. Office of Review, and, regardless whether or not the case is pi'ocessed unldeir (elegzaed nuthorify (paragraph 4 e of G. 0. No. 2),. the Direc-tor will seek lust-rmotions fromji the Board as to the, dislpositimi of the (case. Thel( deciiol (If the 11oardl whether to
awnor to withhold without assig-iiineitt will b~e indicated as such onl the, Screening Report.
15. No assignment will be made to the regional boards without reference onl the 'Screening, Report to the relationship of tile three critical profit ratios.' to corresponding industry average andl. to the extent appropriate, to the role of data on lines 19-23 'and the presence or absence of Government asset inplut ill arriving at the decision to assign.
10. -None of the above requirements will apply in casi,;es of oontractors. whose volume of renegotiab~le sales is so low as to prlec'lude the poss-ibility of a mieanii.zful evaluation. However. if { omtpara tive data are onittied forl this rei. soni, r hi, fact, as well as the b~ask~ (f tile action taken or recomlmenidation made, will be indlicted on tile Screening1 Report.
1-7. Tile foregoing rep-resent minimum requirements of an effective screeningprocess. Over andl beyond these. any consideration that may contribute to the (lecvoon ,iq to the disposition of aI ease will lie rioted onl the Screenig Repiort, with factual supportig data as appropriate.
V. 'Whenever. undIer paragraph 4e of G. 0. N-\o. 2, Boaird approval is reuji red for thep clearance of a filinz or. under paragraph 4 d of G. 0. No. 2. Board instructions are requested with regard to the (lvqpOition of a filing, the niemno-







48

randum submitted to the Board under paragraph 4 f of G. 0. No. 2 will contain, over and beyond the information prescribed by that subsection, all the information required by this Administrative Letter to be shown on the Screening Report. Alternatively, the Screening Report itself may be submitted to the Board in lieu of the memorandum.
REX ]N. .NANTGLY, Acting Chairman.



APPENDIx E
Renegotiation Board Regulation 1471.1 and Bulletin No. 15 (Assignment of Contractor's Filings)
1471.1 When assignment is made.
After recipt of a Standard Form of Contractor's Report from a contractor, the Board will assign the case to a Regional Board for renegotiation if it determines that further proceedings in the matter are warranted. (See Part 1458 of this subchapter.) No assignment will be made when the Board can readily decide on the basis of the information contained in the Standard Form of Contractor's Report that the contractor has not realized excessive profits for the fiscal year and that no purpose would be served by making an assignment to a Regional Board. If the Board decides not to make an assignment, the Board will notify the contractor to this effect. See 1498.6(c) of this subchapter. [17 F.R. 2541, Mar. 25, 1952, as amended at 21 F.R. 7443 Sept. 28, 1956; 26 F.R. 9503, Oct. 7, 1961]
1499.2-15 Renegotiation Bulletin No. 15: Assignment or withholding of contractors' filings.
(a) Section 1471.1 of this chapter sets forth the Board's general policy governing the conditions under which, after a Standard Form of Contractor's Report has been received from a contractor, a case will be withheld from assignment to a regional board or will be assigned to such a board for further proceedings. This section provides in part as follows:
No assignment will be made when the Board can readily decide on the basis of the information contained in the Standard Form of Contractor's Report that the contractor has not realized excessive profits for the fiscal year and that no purpose -would be served by making an assignm-ient to a Regional Board.
(b) The purpose of this 1499.2-15 is to explain this general policy and the similarity in nature and effect between a withholding from assignment and a determination after assignment that no excessive profits were realized.
(c) Many filings are made with the Board by contractors whose renegotiable receipts or, accruals for the fiscal year are below the statutory minimum or "floor." These filings of the Statement of Non-Applicability are optional (see .section 105 (a) of the act) and if not questioned, are set aside; a contractor who is under the floor may not be renegotiated (see section 105 (f )). All contractors whose renegotiable sales for the fiscal year exceed the floor are required to file the Standard Form of Contractor's Report. These are either withheld from assignment or assigned to a regional board.
(d) The withholding of. a filing signifies that the Board is satisfied that the contractor did not realize any excessive profits for the fiscal year represented by such filing, and that further proceedings are unnecessary. However, the assig-nment of a filing to a regional board does not necessarily mean that a finding of ex('essivo profits will be wade for the fiscal year.
(e) A filing is not withheld unless the Board can readily decide, on the basis of tho information furnished by the contractor, that the contractor did not realize excessive profits for the fiscal year. If such a decision can be made without
asskmentof the case, and without the detailed proceedings that may follow up-in an ~~~mnit is obvious that the Government and the contractor have been spared much time. effort and expense, and yet that the interests of the Government have been protected. Contractors, therefore, in their own interest, may wish to include in their initial filings for a fiscal year information and data tending- to demonstrate that tlbeir profits are obviously not excessive.
(f) 'Whether a filing is withheld from assignment or a clearance is issued after assignment. the result is essentially the same. Both actions import that the Board is satisfied that the contractor did not realize any excessive profits for the fiscal year involved. In the one case, this conclusion is so obvious, in the







49

opinion of the Board, from the information submitted by the contractor at headquarters, that further proceedings in a regional boar(l are consider ed unnecessary; in the other, the conclusion is not arrived at until after an examnination has been made by a regional board; but in neither case is the cont rector called upon to refund any of his profits. In short, in the one case the contractor is cleared without assignment; in the other, after assignaient.
(g) When the applicable period of limitations lhais expired, the legll effect is the same in either type of case. That is, if the Doard, having withheld from assignment, fails to commence renegotiation li within 1 year after a filing for a fiscal year, or, having commenced renegotiation after assignent, fails within 2 years after commencement to make an agreenient or order determining excessive profits, then, in the absence of fraud or malfeasance or willful mnisrei)resentation of a material fact, all liabilities of the contractor for excessive profits for such fiscal year are thereupon discharged (see section 105(c)).
(h) In order to make clear the essential similarity between a clearance determination without assignment and a clearance determination after assignment, the Board has decided to employ a similar instrument to formalize an action of either type. The form of Clearance Notice Without Assignment and the forms of Clearance Notice After Assignment are set forth in 1498.6 of this chapter, October 3, 1961.

APPENDIX F
Renegotiation Board Regulation 1457.5 (Treatment of Contracts With Price Adjustment Provisions)
1457.5 Treatment of contracts with price adjustment provisions.
(a) Renegotiation status of such contracts. Certain contracts contain incentive provisions or provide for escalation, redetermination or other revision of the contract price during or after the completion of performance of the contract. Such contracts are subject to renegotiation unless otherwise exempted.
(b) Allocation of price revision to fiscal year or years affected thereby-(1) Price revision allocable solely to fiscal year under review. If the price adjustment provisions of a contract apply to the receipts or accruals of the contractor solely in the year under review, the amount of such price revision will be deemed allocable wholly to the fiscal year under review.
(2) Price revision allocable to nore than one fiscal year. If the price adjustment provisions of a contract apply to the receipts or accruals of the contractor in more than one fiscal year, and if no special agreement shall have been made with the contractor for any other method of flloeation, Ithe amount of such price revision will be allocated to each such fiscal year as follows:
(i) If the contract provides a method for such allocation, the allocation will be made in accordance therewith.
(ii) If the contract does not provide any method for such allocation, the allocation will be made in such manner as the Board shall determine to be fair and equitable.
(3) Price rerision not disclosed in rencgotiition of allocable fisc*; year. Notwithstanding any other provisions of this section, if in the renieotiation of the fiscal year under review the contractor does not d(islose to the Board eit her the occurrence or the possible future oeurrenice of a i npwaird contract price revision relating in whole or in part to such fiScal year, the amount of aIny such price increase which is otherwise allocable to such fiscal yea: nmay be alwante:d. at the election of the Bloard, to the fiscal year in which the contraet is iodificd to provide for such upward price revision.
(c) When price revision precedes renegotiation. When, pursuant to the price adjustnment provisions of a contract applicable in whole or in part to the fiscal year under review, the price payable b1)y the Governlment to thle contractor under such contract is decreased before the completion of renegotiation of th,, contractor for such fiscal year, the amot of such price decrease allom!1e to th( fiscal year under review will be treated as a reduction of the renoti ible innieo of the contractor for such fiscal year, in accordance with the provisions of seetion 1481 of the Internal Revenue Code. When, lursnant to the price adjustment provisions of a contrfct applicable in whole or in part to thle isal year un(lder review, the price payaible by the Government to thle 'Itrfl Ctor une(lr such contrc t is incresed before the comn)letion of renegot'*ation of the coiitraetor for such fiscal year, the amount of such price increase will, notwithithstanding







50

the provisions of 1459.1 (b) (1) and 1460.4 (c) (2) and (3) of this subchapter, be included in the renegotiable income of the contractor for the fiscal year under review in order properly to reflect the renegotiable income and profits of the contractor for such fiscal year.
d( Special treatnut required when renegotiation precedes price r(vision1i h h csts. i i) if it is anticipated, pursuant to the price adjustment provisi()on of a contract applicable in whole or in part to the fiscal year under review. That the price payable under such contract will be retroactively increased or decreased after the completion of renegotiation for such fiscal year. the amount of such anticipated price revision will be estimated and adjustment will be made as hereinafter provided for any portion thereof which is determined to be allocable to the fiscal year under review pursuant to the provisions of paragraph (b) of this section.
ii) In any case in which an agreement is made for the elimination of excessive profits, if a retroactive downward price revision is anticipated, the contractor will be permitted to set up a reserve to cover the refund of the portion of the estimated price revision which is allocable to the fiscal year under review and to charge the amount of such reserve against renegotiable business for such fiscal year: Provided. That if the amount of such reserve is substantial, there will be included in the renegotiation agreement a clause providing that, in the even the final downward price revision is le (iii) In any case in which an agreement is made for the elimination of excessive profits. if a retroactive upward price revision is anticipated and the estimated amount thereof is substantial. there will be included in the renegotiation agreement a clause providing that any amounts thereafter received or accrued by the contractor as a result of such price revision shall be deemed to be additional profits for the fiscal year under review to be eliminated pursuant to the act.
(iv) Whenever more than one price revision allocable in whole or in part to the fiscal year under review is pending at the time renegotiation is completed for such fiscal year. with downward price revision anticipated under some contracts and upward price revision anticipated under other contracts, the provisions of subdivisions (ii) and (iii) of this subparagraph will be applied to the aggregate net downward or upward revision so estimated.
(v) Section 105 (a) of the act provides, in part. that an agreement may include provisions with respect to the elimination of excessive profits likely to be received or accrued. No similar provision is contained in the act for the elimination by order of excessive profits likely to be received or accrued. Accordingly, in refund cases not conducted by agreement. it is not practicable to make provision for anticipated price revisions as prescribed in subdivisions (ii) and (iii) of this subparagraph. In such cases the Board will inform the procurement agency of the status of the renegotiation and will request its cooperation in effecting prompt completion of any pending price revisions allocable in whole or in part to the fiscal year under review. If necessary, in the most exceptional cases, at the request of the contractor and the procuremont aency. when excessive profits are determined by order, the Board will also determine the portion thereof. if any attributable to contracts providing for price revisions not yet completed. Notwithstanding any other provisions of bthi section, when an order is issued before the completion of any nrice revision allocable in whole or in part to the fiscal year under review, the Board may elect to allocate the amount of such price revision not to the fiscal year under review but to the fiscal year in which such price revision is completed.
(2) Other e.P( Tf. for the fiscal year under review. the contractor vrntains an over-all loss or realizov an amount of profits which is not determined to be excessive. so that the case is either withheld from Paignment or. if assigned. is concluded by the issuance of a clearance (see 1471.1 and 1473.1 of this subchapter),







51

and if at such time the receipts or accruals of the contractor for the fiscal year under review are subject to adjustment pursuant to contract price adjustment provisions applicable in whole or in part to such fiscal year, the following ruh.'s will apply: If a net upward price revision is reasonably anticipated, the amount thereof will be estimated and included in renegotiable sales for the fiscal year under review to the extent allocable to such year. If a net downward price revision is reasonably anticipated, the amount thereof will be estimated and allowed to the contractor as a reduction of renegotiable sales for the fiscal year under review to the extent allocable to such year. In either case, if the outcome of the pending price adjustment is sufficiently uncertain so that it is bhelie(ve that the contractor may realize additional profits allocable to the fiscal year under review by receiving more than the amount of an anticipated net upward revision or by not being required to pay the full allocable amount of an 'inticipated net downward revision, and if the amount of such additional profits is considered to be sufficiently substantial to affect the result of renegotirtion for the fiscal year under review, a determination will be made by the Board of the amount of additional profits which the contractor may thereby realize without incurring any liability for excessive profits for such year. This will be done only when it is considered that by the operation of such contract price adjustment provisions the contractor may realize additional profits in an amount sufficient to bring its total renegotiable profits for the fiscal year under review above the clearance level so determined. Any such case will not be withheld from assignment or closed by a notice of clearance, but will be assigned and closed by a clearance agreement containing a clause in the form set forth in 1498.2(g) (2) or (4), as the case may be, of this subchapter.
(3) Different treatment in special cases. Notwithstanding any other provisions of this section, if the price adjustment provisions of a contract apply to the receipts or accruals of the contractor in more than one fiscal yea. including the fiscal year under review, the contractor and the IBoard or Raioial Board conducting the renegotiation may enter into a special ac:'ounting or other agreement providing for the effects of the operation of such price adjust ment provisions in a manner different from that prescribed in this section.
(4) Forms of clauses for agrecincft. Forms of clauses which may be used in a renegotiation agreement to give effect to the principles stated in this paragraph are set forth in 1498.2(g) of this subchapter. These clauses contemplate the existence of several pending price revisions, with downwa rd price adjustment anticipated in some and upward price adjustment anticipated in others. and provide for disposition of the aggregate net downward ori upward ladjustment. The clauses should be appropriately modified when only a single price revision is outstanding at the time of the renegotiation agreement, or when, although several price revisions are outstanding, it is anticipated that all will be downward or all will be upward. In any case in which the contract price fl justment provisions apply to the receipts or accruals of the contrator in mino)re thalan one fiscal year, including the fiscal year under review, such clause should be modified to limit the application of such clause to that portion of the amount of such price revision which is determined to be allocable to the fiscal year under review pursuant to the provisions of paragraph (b) of this section.
(e) Subcontracts. Subcontracts containing incentive provisions or prcvi(ing for escalation, redetermination, or other revision of the contract price a re subject to renegotiation unless otherwise exempted. The principles and pmnr(edure< set forth in paragraphs (b), (c). and (d() of this section are intended to apply to such subcontracts so that the effects of the operation of the price ad(ljusl ment provisions of a subcontract shall be the same, for purposes of renegoliation. 8s those prescribed in said paragraphs (b), (c), and (4) of this section with retpeot to prime contracts. For the application of section 1481 of the Internal Revenue Code to price redetermination refunds made by subcontractors to prime contractors or higher-tier subcontractors, see Rev. Rul. 54-82 set forth in 1 99.35 of this subchapter. The forms of clauses set forth in 1498.2(g) of this subchapter will be appropriately modified when used in renegotiation agreements with subcontractors who have made such refunds.
(f) Other price adjustments. (1) Title II of the First War Powers Act. as amended, and Executive Order No. 10210 dated February 2. 1951, issued thereunder, authorize the Secretaries of Defense. Army, Navy and Air Force under certain circumstances, and among other things, to amend contracts without consideration, to correct mutual mistakes in contracts. and to formalize informal commitments. Unless otherwise exempted, amounts received or accrued by







52

a contractor pursuant to the exercise of such authority are subject to renegotiation and to the principles and procedures set forth in paragraphs (b), and (c) and
(d) of this section.
(2) Public Law 85-804, approved August 28, 1,958, provides that "the President may authorize any department or agency of the Government which exercises functions in connection with the national defense, acting in accordance with regulations prescribed by the President for the protection of the Government, to enter into contracts or into amendments or modifications of contracts heretofore or hereafter made and to make advance payments thereon, without regard to other provisions of law relating to the making, performance, amendment, or modification of contracts, whenever lie -deems that' such action would facilitate the national defense. The authority conferred by this section sliall not be utilized to obligate the United States in an amount in excess of $50,000'without approval by an official at or above the level of an Assistant Secretary or his Deputy, or an assistant head or his deputy, of such department or agency, or by a Contract Adjustment Board established therein." Unless otherwise exempted, amounts received or accrued by a contractor pursuant to the exercise of such authority under a contract with one of the Departments blamed in or pursuant to section 102(a) of the Act, as amended, are subject to the procedures set forth in paragraphs (b), (c) and (d) of this section. [18 F. R. 3366, June 12, 1953, as amended at 19 F.R. 3766, June 19, 1954; 19 F. R. 5376, Aug. 24, 1954, 19 F. R. 7434, Nov. 18, 1954; 22 F. R. 7638, Sept. 26, 1957; 23 F. R. 8515, Nov. 1, 1958; 27 F. R. 623, Jan. 20, 1962; 33 F. R. 17785, Nov. 28, 1968]

APPENDIX G
(Selected Regulations of the Renegotiation Board) 1460.1 General considerations.
In making determinations in renegotiation, the Board will proceed generally as follows:
(a) All the information necessary to a sound determination will be obtained.
(b) The contractor will be given an opportunity to develop and present whatever information is available to it which the contractor may consider pertinent to the determination.
(c) Requests for additional information and the number of meetings held with the contractor or its representatives will be kept to a minimum.
(d) Financial and factual information will be reviewed with the contractor and its agreement to the accuracy of such information will be obtained.
(e) The contractor will be given every reasonable assistance and all necessary information with respect to the technical requirements of renegotiation, the act, and the regulations in this subehapter.
(f) The facts and conclusions with respect to the contractor's business will be fully developed.
1460.2 Specific considerations.
(a) Profits 'before taxes. In renegotiation the amount of excessive profits is determined before provision for Federal taxes on income.. In determining the existence or amount of excessive profits, the effect of Federal income taxes on the retained profits will not be considered.
(b) Separate consideration of certain types of contracts. While renegotiation will be conducted with respect to the aggregate of the contractor's renegotiable business for the fiscal year, separate consideration will be given to cost-plus-afixed-fee contracts and other cost-type contracts and to contracts, whether fixed price or cost-plus-a-fixed-fee, which contain incentive provisions or provide for escalation, redetermination, or other revision of the contract price during the life of the contract. Patent royalty income will also be separately considered.
(c) Comparisons. In evaluating the contractor's performance, comparisons will be made with the prices, costs and profits of other contractors engaged in the production of the same or similar products or using the same or similar processes.
(d) Signiflcance of settlements or profits or lossesin prior years. Renegotiation settlements for prior years are not controlling precedents. Consideration will be given to profits or losses in prior years only to the extent provided elsewhere in these regulations. Except to that extent, determinations of excessive profits will be predicated on the facts and circumstances of the year under review.







53

(e) Reserves for possible renicgotiatlion refund-s. It is recognized that sound accounting principles may make it desirable for contractors to establish reserves for possible renegotiation refunds and that the amount of such reserves established in individual situations will vary widely (lep)ending upon the policy of the particular contractor concerned. Neither the existence nor the amount of such reserves is to be considered directly or indirectly in connection wNith the determination of excessive l)rotits. The Board recognizes that conservativee p)ractice may result in setting up such reserves in excess of thle anticipated liability and will not permit such a practice to prejudice the contractor in aniy way. 14,0.8 Application of statutory factors.
(a) General policy. Reasonable profits will be deterinied in every case by overall evaluation of the particular factors present aInd not by the aplication of any fixed formula with respect to rate of 1prof(it, or otherwise. Regotiation proceedings will not result in a profit based (onl tlhe principle of a i)erceetage of cost. Contractors who sell at lower prices and produce at lower costs through good management, including conservation of manpower, facilities and materials, imporved methods of p)ro(luction, close control of expenditures, and careful purchasing will receive a more favorable determination than those who do not. Such favorable or unfavorable determinationm will be reflected in the profits allowed to be retained by the contractor or subcontractor as nonexcessive. C(iaims of a contractor for favorable consideration must he supported by established facts. analyses, and appropriate comparisons. This section and the following sections of this part apply to all contractors except those whose renegotiable contracts consist only of subcontracts described in section 103(g) (3) of the act. For the application of the statutory factors to such subcontractors, see Part 1490 of this subehal)ter.
(b) Considerations affecting small con tractors. Characteristics inherent in the operation of a small company, if shown to be relevant in a particular case, are taken into consideration by the Board in applying the factors described in section 103(e) of the act. For example, under the efficiency factor, it may be shown that a small contractor, through greater flexibility, was able to schedule and complete the performance of a contract more expeditiously than his larger competitors, or that by closer personal supervision lie achieved lower costs or a better product. Under the risk factor, the small contractor undertaking rene,,gotiable production unrelated to his ordinary commercial business may be shown to have been endangered to a greater extent than larger contract ors by the possible cancellation of the Government program. Considerations of company size may also affect the application of other factors.
[17 F. R. 2529, Mar. 25, 1952, as amended at 36 F.R. 5848, Mar. 30, 1971]
1460.9 Efficiency of contractor.
(a) Stlatutory provision. Section 103 (e) of the act provides that in determining excessive profits, favorable recognition must be given to: "the efficiency of the contractor or subcontractor, with particular regard to attainment of quantity and quality prodietion, reduction of costs, and economy in the use of materials, facilities, and manpowerr;
(b) Comment. Favorable recognition must be given to the contractors efficiency in operations, with particular attention to the following:
(1) Quantity of production : for example, in relation to available physical facilities: meeting of production schedules; expansion of facilities; maximum use of avai Iable production facilities.
(2) Quality of production: for example, maintenance of standards of quality; rejection record: reported mechanical or other difliculties in the use or installation of the product.
(3) Reduction of costs: for example a derease in costs per unit of production or per unit of sales as between fical years and as compared with other contractors producing the same or similar prOdlcets when the operations are reasonably comparable: a decrease in administrative, selling, or other general a n(d controllable expenses;: a decrease in prices paid v(ildors for Ipurchased materials and subcontracted items or units. (See 1460.10 (b).)
(4) Economy in the use of materials facilities, and manpower: for example, a decrease in quantity of materials used in relintion to production and the number of employees in relation to production : rednetion of wa ste.
(5) Nature and objectives of incentive and price redeterminable contracts and ehcontraets;: with respect to such contracts or contracts, in which the contract prices are based upon estimated costs, the Board will take into consideration







54

the extent to which any differences between such estimated costs and actual costs. are the result of the efficiency of the contractor. To enable the Board to give. such consideration, the contractor may, and if requested by the Board, shall furnish on an aggregate or unit basis (i) a breakdown of the estimated costs uponi which the prices of such contracts or subcontracts were based, together with ther amounts thereof applicable to the fiscal year under review, and (I!) a corresponding breakdown of the costs actually incurred on such contracts or subcontracts or which the contractor estimates will actually be incurred thereon together witk the amounts thereof applicable to the fiscal year under review as reported in the Standard Form of Contractor's Report or other financial data filed by the coii-tractor with the Board with respect to the fiscal year under review; and the contractor shall also furnish an explanation, in such form and detail as may be appropriate, of the reasons for any variances between such breakdowns ar betNveenparticular cost elements itemized therein, with particular reference to the extent to which such variances are attributable to the performance of the contractor in the fiscal year under review or to other events occurring in such year. The Board will consider and give due regard to the views of the contracting agencies in connection with the foregoing. Insofar as the efficiency of the contractor may be appraised by analysis of the cost elements set forth in such breakdowns, the Board will observe the following principles:
(a) The Board Nvill consider separately those elements of cost which are wholly outside the control of the contractor and those which the contractor wholly orpartly controls.
(b) The fact that the realized costs are less than original estimates will not necessarily be construed to mean that the contractor has demonstrated efficiency, nor will realization of actual costs in excess of the original estimates necessarily be construed to mean that the contractor has been inefficient.
(c) If the original cost estimates include provision for any contingency whlclr has not materialized and is no longer expected to occur, the contractor will be expected to submit information indicating whether the elimination of such contingency resulted from the efficiency of the contractor or whether the circumstances were such as substantially to eliminate the risk provided against in the original cost estimates.
17 F.R. 2529, Alar. 25, 1952, as amended at 23 F.R. 2279, Apr. 8, 19581 1460.10 Reasonableness of costs and profits.
(a) Statutory provision. Section 103 (e) of the act provides that in determining excessive profits there shall be taken into consideration the following factor:
(1) Reasonableness of costs and profits, with particular regard to volume of production, normal earnings, and comparison of war and peacetime products;
(b) Comment. (1) Consideration will be given to the reasonableness or the excessiveness of costs and profits of the contractor. Comparisons will be made with the contractor's own costs and profits in previous years and with current costs and profits of other contractors. if such information is available. In comparisons, uncontrollable variations in labor, material, or other costs will be takew into account. Particular attention will be given to relative changes in control]able costs such as selling and general administrative expense. Low costs with, relation to other contractors, when clearly established and shown to be the, result of efficiency in management, are especially significant and must receive favorable consideration. Under no circumstances, except as provided in 1457.8 or 1457.9 of this subehapter, will the contractor's profits or losses -on renegotiable business in years other than the year under review be used as an accounting offset or adjustment in the determination of excessive profits for the year under review. 1
(2) Consideration for comparative purposes will be given to profits of the contractor, and of the industry, on products and services not subject to renegotiation, especially in cases in which the renegotiable business involves productsor services substantially similar to those not subject to renegotiation. In making comparisons for fiscal periods before those subject to the act, profits durlnpWorld War TI years will not be regarded as determinative. If the renegotiable business is not fundamentally different from the non -renegotiable business and if the product is sold and distributed by the contractor's normal channels and methods, the profit margin on non-renegotiable business is significant in renegotiation.
(3) Favorable consideration will be given to an increase In volume of production for defense purposes. On the other hand, when the Government's deniand has enabled the contractor to increase his sales without exceptional effort and without corresponding increases in costs, decreased unit costs result, and







55

the Government should normally get the principal benefit in more favorable prices, or in renegotiation. In many cases, the contractor may establish that factors related to the increased volume, such as developmental contribution, added risk assumed, or added investment of capital, entitle the contractor to claim a larger share of the benefit resulting from increased volume, b)ut to the extent that this is not shown, the margin of profit oii expanded renegotiable sales should be adjusted in reasonable relationship to the expanded Volume. InI,crease in volume made possible by increased subcontracting may often not inll ve any cost savings, and will involve problems discussed under other factors. See S1460.12 and 1460.14.
(4) W~hen the contractor is engaged in more than one class or type of business, the varied characteristics of thle several classes of business will be taken into consideration.
(5) The Board will give consideration to certain situations where a contractor had deficient profits on renegotiable sales in a year or years prior to that under review. Where it can be established that deficient profits in prior years resulted f rom nonrecurring costs in the early stages of production which relate to production in the year under review, the Board will take this into account in reviewing the contractor's renegotiable business in the year under review. Thus, for example, labor costs and a proper proportion of the related overhead may be high in the early stages of production because of (i) excessive defective work resulting from inexperienced labor, (ii) idle time andl sub~normal production occeasioned by testing and changing methods of production, or (iii) the cost of training employees. There may also be high material costs due to abnormal scrap losses. Further, there may be instances where deficient profits resulted in prior years from expenses incurred in the design of a product or of special tooling, in the planning of production processes and layout, or in the rearrangement of the contractor's plant, when incurred for a renegotiable contract or contracts. Circumstances such as those set forth herein which can be present under a long-term contract can also be equally present in the case of a series of two or more short-term successive contracts for the production of the same or similar items. In evaluating the extent to which matters such as these should he taken into account, the Board will consider the reasonableness of the management practices followed.
[17 F.R. 2529, Mar. 25, 1952, as amended at 21 F.R. 7440, Sept. 28, 1936; 36 F.R. 18395, Sept. 14, 1971]
1460.11 Capital employed.
(a) Statutory provision. Section 103 (e) of the act provides that in determining excessive profits there shall be taken into consideration the following factor:
(2) The net worth, with particular regard to the amount and source of public and private capital employed;
(b) Commennt. (1) The amount of net worth employed, as well as the amount and source of capital employed, will, as a general rule, be that existing at the beginning of the fiscal year. However, if significant changes, in either capital or net worth, occur during the year, they will be reflected in the determination of the amount employed during such year. In determining net worth and capital employed, the Board will consider book values, and will disregard amounts arising from revaluations.
(2) The amount of net worth employed in renegotiable business will be estimated and considered whenever a reasonable estimatV of that amount is po0ssible.
(3) Capital employed is the total of net worth, debt, and any assets furnished by the Government or customers not contained in the contractor's records. The source of capital will be established in order that a determination may be made of the extent to which capital employed in renegotiable lbusiso; came from public sources or from customers, or was furnished by the cont ractor.
(4) The relationship of profit realized on renegotiable business to the capital and net worth employed in renegotiable business will be usedI as, one- of the c-onsiderations in the final determination of what constitutes; ex('-es sive profit. A contractor who is not dependent upon Government or customer financing of ainy type is entitled to more favorable consideration than a contractor who isq largely dependent, upon these sources of capital. When a large part of the capital employed is supplied by the Government or by customer.,, the contra jctor's,- cold ribution tends to become one of management only and the profit will be considered accordingly.
[17 P.R. 2529, Mar. 25, 1952, as amended at 34 F.R. 436, Jan. 11, 1969]






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1460.12 Extent of risk assumed.
(a) Statutory provision. Section 103 (e) of the act provides that in determining excessive profits there shall be taken into consideration the following factor:
(3) Extent of risk assumed, including the risk incident to reasonable pricing policies;
(b) Comment. (1) The risks to be considered include but are not limited t(> risks incident to close pricing policies. For example, contractors in certain industries may attain maximum production only at the risk of saturating postemergency markets. Contractors may assume risks by guaranteeing delivery schedules notwitli standing possible inability to obtain needed materials or labor. Contractors may guarantee quality and performance of the product notwith-standing uncertain ties as to the quality obtainable from their plants, particularly with respect to products which may be more or less abnormal to them., In some cases a substantial degree of risk will be found in the temporary sacriflee of civilian markets to competitors, in order to accept more defense orders, orin the certainty of heavy reconversion expenses at the end of the emergency. Acceptance of contracts without escalation or similar protection may involve a risk that the cost of labor or materials may increase. Contractors who subcontract work, the performance of which they guarantee, in general assume a greater risk than contractors who retain performance entirely within their own control. In general, the Board will consider whether the contractor's performance of renegoti.;able business is free from risk. or subject to it, on the basis of actual experience and not more speculative or unlikely possibilities. The Board willgive special consideration to evidence showing risks through actual realization of losses incurred by the contractor in performing contracts in other years similar to the contracts undergoing renegotiation, and losses incurred in the same or other years, by concerns other than the contractor, especially when connected with the contractor in any way, and in performing similar contracts.
(2) The risk assumed by the contractor as a result of its pricing policy will be given particular consideration. A contractor, having initial prices calcuLited to yield a reasonable profit, who revises such initial prices downward periodically when circumstances warrant, will be given more favorable treatment under this factor than a contractor who does not follow such policy. In order that proper consideration may be given. it is suggested that contractors, when making such periodic price revisions, notify the Board of the action taken in this respect.
(3) Consideration of the pricing policy of the contractor frequently involves the question of refunds made before renegotiation under the act. As stated in Part 1462, such refunds may be made as an integral part of the repricing policy of the contractor or as prepayments of excessive profits. in either event, the effect upon the risk assumed by the particular contractor depends entirely upon the facts of each case. including the manner in which the refund is made. For example, a contractor wlRo executes a legally binding agreement to pay the Government a rebate on articles delivered during a particular period of time, has incurred a greater risk than a contractor who gives the Government a nonbinding "statement of intention" or "statement of policy" indicating that it will m-ake refunds, even though the final profit position of the two contractors at thet end of the fiscal year is the same. On the other hand, a contractor who makes a refund pursuant to such a "statement of intention" or "statement of policy" may have incurred a greater risk than one who simply makes a refund. Similarly, a contractor who makes a refund near the beginning of its current fiscal year has incurred a greater risk than one who makes a refund near the end of its fiscal year. The effect of the refund must, therefore, be weighed in the light of all pertinent facts.
1460.13 Contribution to the defense effort.
(a) Statutory provision. Section 103 (e) of the act provides that in determining excessive pTofits there shall be taken into consideration the following factor:
(4) 'Nature and extent of contribution to the defense effort, including inventive and developmental contribution and cooperation with the Government and othor contractors in supplying technical assistance.
(b) Comment. Every contractor contributes to the defense effort when be per, form,, or assists others to perform a defense contract or subcontract. or when, in connection with such a contract or subcontract, he otherwise renders a service of value to a defense program or objective. Credit will -be given under this factor, in such degree as the facts may warrant, for (1) superior performance in







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excess of contract requirements, such as completion of urgent work ahead of schedule at the request of the procuring department, or exce(,ediniig slecilic atiois in a manner beneficial to the defense effort; (2) iniigenuity in providing new uses for products or production machinery or equipment; (3) overcoming difliculties, which others have fa iled to overcome. in providing materials or services for tlhe defense effort; (4) experimental anid developmental work of high value to the defense effort; (5) new inventions. techniques, and processes of unuIsual iwrit :
(6) performance under difficult environmental or geographiA conditi;ns or hazardous working conditions; (7) cooperation with the ('overient ndt with other contractors in contributing propri(4etary dt( or in developing anld suppl ying technical assistance to alternative or competitive sources of supply ; or (bS) performance, assistance, or service considered otherwise exceptional. [38 FR 6390, Mar. 9, 1973]
1460.14 Character of business.
(a) Statutory proUis.ion. Section 103 (e) of the act provides that in determining excessive profits there shall be taken into consideration the following factor:
(5) Character of business, including source and nature of materials., cojmplexity of manufacturing technique, character and extent of subcontracting. and rate of turnover.
(2) Comment. (1) Consideration will be given to the character of the business of the contractor. The manufacturing contribution will vary with the nature of the product and the degree of skill and precision required in the work performed by the contractor. The relative complexity of the manuf acturing techiiiiqiie and the relative integration of the manufacturing process are the basic considerations in evaluating this factor.
(2) A contractor who uses customer-furnished materials generally is not entitled to as large a dollar profit as the dollar profit to which such contractors would have been entitled had it furnished the materials itself. In the latter case, the contractor would have expended effort in finding or acquiring the materials, would have assumed the risk of obsolescence, spoilage, or other loss inherent in owning such materials. Although the aggregate dollar profit allowed the contractor in the former case should not be as great as it would be if such contractor furnished its own materials, nevertheless the dollar profit allowed will usually result in a larger percentage of sales than the dollar profit which would have been purchased by the contractor and, therefore, included in its sales and costs.
(3) (i) Defense production needs and the policy of C(ongress require that subcontracting, particularly to small business concerns, be used to the maximum extent practicable. Although a contractor who subcontracts work may not renlsonably expect to be allowed as large a profit thereon as if it had done the work itself, subcontracting of the kind described in this subparagraph, especially the extent to which subcontracts are placed with small business concerns, will be given favorable consideration in the renegotiation of the contractor.
(ii) A contractor will ge given favorable treatment when. by subcontracting. it utilizes in the defense effort facilities and services, particularly of sinmall business concerns, which might otherwise have been overlooked or passed by; when it has demonstrated its efficiency and ingenuity in finding appropriate opportunities for subcontracting; when the amount of subcontracting so accomplished is substantial; when the amount or complexity of technical, engineering a(nd other assistance rendered by the contractor to the subcontractor is substantial: and when the price negotiated with the subcontractor is reasonable in view of the character of the components produced.
(iii) The portion of the renegotiable business of the contractor which is su)contracted will be a part of its total sales, and separate consideration must be given in applying to this portion the factors of risks assumed, capital employed, and reasonableness of costs and profits.
(iv) The subcontractor, of course, will receive favorable consideration ii renegotiation for the successful employment of its own facilities and production skill.
(4) The rate of turn-over will indicate the use of plant, materials. and net worth. A low rate of turn-over may indicate more complete integration in production or may be related to the type of the product and the nature of the 1n'n,facturing process. A high rate of turnover may indicate a relatively smaller manufacturing contribution or. by comiparison with other manufacturers of similar products, a relatively greater efficiency. [17 F.R. 2529, Mar. 2, 1952, as amended at 21 F.R. 7440, Sept. 2S, 1956]

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