Issue Relating to Escalation Provisions Under Shipbuilding Contracts Warrants Action

PSAD-79-79: Published: Apr 19, 1979. Publicly Released: Apr 19, 1979.

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Construction of a naval ship takes several years. Since construction would be a great risk to shipbuilders if they were not protected from cost increases over which they have little control, shipbuilders are protected by special contract clauses which provide for escalation payments. Because of the recent high inflation rate in the shipbuilding industry and the long construction period needed to complete the ships, the amount of escalation payments are substantial. Under some current shipbuilding contracts the Navy is paying shipbuilders for escalation on costs subject to inflation. Action is needed to prevent such excessive and unwarranted payment under proposed contracts.

Not all of the contractor's costs increase with inflation and some increase slower than others. Regulations state that escalation payments should not be made on costs not affected by fluctuations in the economy, such subcontracted items which may be fixed or certain overhead charges such as depreciation. The percentage of overhead costs on which overhead escalation is computed should not be standard but should vary with the differences among shipyards. The prior Navy practice of providing a standard percent of escalation coverage on different shipbuilders, without determining the actual percentage of costs affected by inflation for each shipbuilder, conflicts with the purpose of allowing escalation payments.

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