WASHINGTON (Bloomberg) - Boeing Co. sought $1.9 billion in "unjustified" payments on US military contracts, according to a Pentagon audit.

Boeing's claim was based on a Labour Department index that triggers increased payments to defense contractors as economic costs increase generally. Boeing, the second-largest US defence contractor, realised the index had become slanted "in Boeing's favor" and didn't inform the military, the audit found.

Boeing sought $1.9 billion extra on three of its largest contracts - the C-17 transport, F-18 Navy fighter and AH-64 Apache helicopter, together worth $20.6 billon. The Pentagon's inspector general warned this payment constituted "windfall profit" and would be "unjustified," according to the 51-page audit obtained by Bloomberg News.

With this finding, Undersecretary for Acquisition John Young demanded settlement talks. Boeing agreed to $792.9 million as a starting point and will collect $272.3 million, the audit said.

The cost increases claimed by Chicago-based Boeing "were the result of changes indirectly influenced by Boeing actions and not the result of national economic changes," Pentagon spokesman Chris Isleib said.

Boeing spokesman John Dern said the company is receiving "substantially less than it was eligible for," yet is "pleased that this situation was resolved in a way that was satisfactory for our customers".

The Employment Index for Aircraft Manufacturing that allowed Boeing's claim was created by Boeing and other aerospace companies. It is the basis for escalator clauses in long-term aircraft contracts, triggering "adjustments to the contract price" that compensate for economic conditions beyond the control of the companies or the government, Mr. Isleib said.

Boeing reimburses the Labour Department for collecting data for the index.

The department's Bureau of Labour Statistics (BLS) does not publish the data that supports the index and did not co-operate with the Pentagon's investigation, according to the audit. The Pentagon inspector general subpoenaed data on the index from Boeing, the audit said. Boeing supplied some data, spokesman Todd Blecher said.

Gary Steinberg, spokesman for the Bureau of Labour Statistics, said he had no immediate comment when asked for details on the index.

Pentagon auditors began investigating the use of the index two years ago after "abnormal increases" in costs were noticed. They reviewed the period from 2003 to 2006 and found what Boeing already knew: "Boeing has become the dominant force in the index." Moreover, the index was reflecting "significant, unjustified increases" in Boeing costs, the audit said.

Boeing claimed as a "cost" for the index $8 billion in pension fund contributions even though only $1.1 billion was used to cover current liabilities. The remaining $6.9 billion was claimed as "pre-payment credit" for future liabilities that did not need to be paid during the 2003-2006 period, the audit said.

Boeing would also claim reimbursement for the $6.9 billion later as general overhead when the money was actually paid, the audit said. The Pentagon would "essentially pay Boeing twice for the same pension costs."

Boeing's Mr. Dern said the $8 billion in pension contributions represented "responsible management" of Boeing's "under-funded pension plan" that "had the unintended consequence of generating an issue with the index used to adjust prices".

"Neither Boeing nor the Defence Department at the time knew there was an issue because the BLS does not disclose the data in this aircraft manufacturing index," he said.

Internal communications subpoenaed by the Pentagon indicate that by August 2005 Boeing officials "recognised the index had become an ineffective and inefficient measure of economic conditions and identified potential solutions," the audit said.

One August 2006 memo prepared by Boeing's Longbow Apache Helicopter team challenged the company's use of the index, according to the audit.

"Should we disclose the known anomalies in the index data and search for a more realistic indicator with our customer?" the memo said, according to the audit.

"Contractually and legally, we may have the ability to enforce the contract clause and collect these abnormal earnings," it said.

"Ethics is really about moving beyond the acts required by law and doing the right thing. In this case, what is the right thing to do?" it said. "How would our behaviour differ and how has it differed in instances where data anomalies are not in our favour?"

The audit found that "Boeing did not take appropriate action" to inform the Pentagon or military services "because the inefficiency was in Boeing's favor and Boeing believed it could legally and contractually enforce the contract clauses".