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perienced in accounting to make recommendations as to methods of cost inspection. These recommendations were promptly submitted. After consideration of the various plans proposed, the Compensation Board formulated general instructions under which cost inspection has since proceeded.

In addition to the indispensable aid of the officers of the regular Pay Corps, the Compensation Board has received the selfsacrificing assistance of a group of professional accountants and financiers-able and accomplished officers commissioned in the Pay Corps Naval Reserve Force and assigned to duty with the Compensation Board. Officers of the Bureaus of Steam Engineering, Construction and Repair, Yards and Docks, and Supplies and Accounts, as well as the jurists of the office of the solicitor for the Navy Department, have also furnished invaluable help.

III

Prior to March 22, 1917, vessels built for the navy at civilian shipyards were built on a fixed-price basis. A torpedo-boat destroyer, exclusive of armor and armament, used to cost the navy from $550,000 to $900,000. A battleship of the first class cost the navy from $4,400,000 to $7,500,000. These prices, of course, represented expenditures made by the shipbuilder for direct labor and for direct material, plus indirect expense, plus his profit. What amount of a shipbuilder's fixed-price to the navy was profit was not known to the navy, although close estimates were made by the navy's representatives. It is not unreasonable to say that even if the shipbuilder knew pretty closely what expenditures he had made for direct labor and for direct material, he did not know how much of his selling price was overhead and how much was profit. The price the shipbuilder fixed to the navy was, at best, only an estimate, the estimate based on "experience" or "judgment," which, being interpreted, too often signified only a guess.

The increasing cost of raw materials and the increasing cost due to high wages paid to employees resulted in the prices named by the shipbuilders to the navy reaching a very high figure. Indications of the inevitable result of these increased prices asked by the shipbuilders from the navy were given again and again by the Navy Department. These indications were given not only in the form of tenders renewed and rejected, but, specifically, in

the form of requests from the Navy Department to shipbuilders that lower prices should be offered, if possible.

But induced by what they believed to be economic necessity, and inspired by motives of self-protection, the shipbuilders who were accustomed to construct naval vessels continued to make tenders only of prices unacceptable to the Navy Department. The Navy Department became convinced that the prices demanded by the shipbuilders were unnecessarily high-that the percentages to cover contingencies were greater than the contingencies would actually require.

It is certain that it was the duty of the Navy Department, while affording shipbuilders opportunity to earn a reasonable profit, at the same time to protect the interests of the government to the fullest extent of its powers. This duty it has performed to the

utmost.

By the act of August 29, 1917, under the heading "Increase of the Navy," it was provided,

That if, in the judgment of the Secretary of the Navy, the most rapid and economical construction of the battle cruisers authorized herein can be obtained thereby, he may contract for the construction of any or all of them upon the basis of actual cost, plus a reasonable profit to be determined by him.

As brief as the above quoted lines are, they mark the granting of a power to the government which was to result in revolutionizing the financial and accounting features of the construction of naval vessels at civilian shipyards. It is possible, even, that a revolution was begun in the whole economic situation of the shipbuilding industry. The above-quoted provisions of law were supplemented by certain vital provisions in the act of March 4, 1917, the act of October 6, 1917, and the act of July 1, 1918. It is the appropriate provisions of the respective naval appropriations bills which made possible the construction of naval vessels at private shipyards on the basis of actual cost plus an agreedupon amount of profit.

IV

During the autumn and winter of 1916 and the winter and spring of 1917, the Navy Department, and its duly authorized representatives, were engaged in endeavoring to persuade what may be called the "old-line" shipbuilders to agree to construct

naval vessels at an acceptable fixed-price. Failing this, the Navy Department endeavored to agree with the shipbuilders upon a proper cost-plus-profit basis upon which to proceed with the work of construction.

For several years, a considerable amount of ordinary buildingerection has been done in America on a cost-plus-profit basis. It is evident, however, to anyone who has knowledge of shipyard work that ordinary building-erection on a cost-plus-profit basis is a very different thing from the construction of vessels on the same basis. Without entering into details, it is believed that this will be conceded.

Since the beginning of the European war, in 1914, and in a few sporadic instances before that time, certain civilian steamship companies had had vessels constructed at civilian shipyards on a so-called cost-plus-profit basis. The word "so-called " is used advisedly, since checking of such costs, either by the shipbuilder or the steamship company, was little more than nominal. The steamship companies had no, or at least very inadequate, machinery for verifying the records of cost presented by the shipbuilders. Further, except for approximately correct records of direct labor and direct material charges, the records of cost of the shipbuilder, as presented to the steamship company for payment, were little better than estimates. In fact, such records had all the joyous freedom from restraint of an ordinary fixedprice contract.

In a word, almost no precedent existed in America for the determination of costs of vessels being constructed on a cost-plusprofit basis.

It may be noted, in passing, that since the beginning of the European war, a vast amount of naval construction has been done in Great Britain on a cost-plus-profit basis. It is interesting to note, further, that such method of construction in Great Britain, on the whole, is not regarded by the British authorities as a success, so far as keeping down costs is concerned. Examination of British records in the case indicates, however, that this feeling of failure is not so much due to the fact that costs have been excessive-if, indeed, they have been-but is due to the difficulties encountered by the British authorities in satisfactorily checking the records of costs. Upon perusal of the British hearings, it is not certain, as a matter of fact, that costs have not

been satisfactorily checked; but the feeling of dissatisfaction seems rather to have arisen from the difficulty found by government representatives in making clear to the committees of parliament that costs have been adequately checked.

V

For the purposes of the present consideration, there are four practicable divisions of contracts. The differences between the four kinds are sufficiently well defined in the report of a subcommittee of the Inter-Departmental Cost Conference. This conference was composed of representatives of the Department of Commerce, of War, of Navy, of the Federal Trade Commission, the Council of National Defense, and the War Industries Board. A sub-committee of the Inter-Departmental Cost Conference drew up a report known as Remarks on Contracts (July 31, 1917). As this is a clear exposition of the advantages and disadvantages of the four different kinds of contracts, some part of the remarks is quoted.

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A. THE FIXED SUM CONTRACT

By this is meant the form of contract in which the contractor, generally in competition with other contractors, bids a fixed lump sum for the furnishing of supplies or the performance of services (other than personal) under conditions laid down by the government..

To summarize then-this form of contract has the advantage of simplicity but has the disadvantages of establishing a diversity instead of a community of interest between the government and the contractor, of demoralizing the supply and prices of raw materials, and of requiring increased time to secure competition.

B. THE COST PLUS A PERCENTAGE CONTRACT

This form of contract involves the complication and expense of requiring that the government itself determine, or at least check with considerable accuracy, the actual costs to the contractor.

It enforces upon the government the necessity of supervising the contractual relations between its main contractor and his sub-contractors, for it is to the advantage of the main contractor to make his sub-contracts cost as much as possible.

It offers every inducement for the contractor to inflate his costs, and there are an almost infinite number of ways of doing this; the temptation

for the contractor is to inflate both his actual costs in every respect, and the cost he reports to the government.

Assuming that the above objections can be met, it has the advantage of protecting the government from excessive prices without demoralizing the prices and supply of raw materials, and of saving time.

To summarize-this form of contract has the advantages of saving time and preventing demoralization of markets, but has the disadvantages of establishing a diversity instead of a community of interest between the government and the contractor, of involving the government in the expense and trouble of determining or checking contractor's costs, of supervising his relations with sub-contractors and of giving rise to contentions between the government and the contractor that may be very troublesome during the contract and for many years thereafter.

C. THE COST PLUS A LUMP SUM CONTRACT

In this form of contract the actual cost to the contractor, determined or checked by the government is paid to the contractor, plus a definite lump sum, which, in the judgment of the contracting officer, is a reasonable reimbursement to the contractor for the employment of his services, plant, and organization in producing the desired product for the government.

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Once this lump sum has been determined and accepted by the contractor, the contractor is under no inducement to inflate his actual costs, though he may still be tempted to inflate his reported costs to the government. His costs must therefore be determined or checked by the government as in "B," above. Neither is he under any inducement to keep his costs low-in short, in so far as the real costs are concerned, he occupies a neutral position.

To summarize-this form of contract has the advantages of saving time and preventing demoralization of markets. It establishes neither a diversity nor a community of interests between the government and the contractor. It involves the government in the expense and complication of determining or checking the contractor's costs, and may involve some supervision of sub-contractual relations, although not so much as in “B.” . . . . Assuming that the difficulties in determining the contractor's costs can be met, it appears to be a satisfactory form of contract.

D. THE COST PLUS A LUMP SUM WITH LIMITED PENALTY AND BONUS CONTRACT

In this form of contract a preliminary estimate is made by the contracting officer as in "C," or by the contracting officer and contractor in agreement. A lump sum consideration is fixed by the contracting officer as in "C," on the basis of the estimated cost. The contractor is informed of or agrees to the estimated cost and the lump sum consideration. If the actual cost

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