WASHINGTON - The Army's primary support contractor in Iraq is being warned by Pentagon auditors to cut its work force there or face nearly $200 million in penalties for keeping thousands too many on the payroll.

In this May 20, 2009, file photo, KBR, Inc. President and Chief Executive Officer William Utt answers questions during an interview with The Associated Press in Washington. (AP Photo/J. David Ake) The Houston-based KBR Inc., responsible for everything from mail and laundry to housing and meals, has increased employee levels while U.S. troops steadily leave the country after more than six years of war, the audit says. As a result, the U.S. government is paying far more in labor costs in Iraq than it should as military resources are shifted to Afghanistan.

"Each day that passes without taking action results in continued overstaffing and inefficiency," the report from the Defense Contract Audit Agency says.

The Oct. 26 audit, obtained by The Associated Press, opens a window into a behind-the-scenes battle over KBR's billing and management practices. The company provides crucial battlefield services under a $33.8 billion, 10-year deal signed in 2001.

There have been serious disagreements between KBR and defense auditors, who have challenged billions of dollars in charges as questionable. And KBR's critics, many of them Democrats on Capitol Hill, have accused the company of gouging the government during a time of war instead of being a responsible steward of public money.

The report from the audit agency, the military's first line against waste and fraud, is sure to reinvigorate KBR's detractors. The audit also reveals a confrontational approach that a congressional oversight committee has said the agency uses too sparingly when dealing with contractors.

Last week, director April Stephenson was forced out of her job following unflattering reviews of the agency's performance. Stephenson, whose last day as director is Friday, is scheduled to appear Monday at a hearing held by the independent Commission on Wartime Contracting on the management of contractors in Iraq and Afghanistan.

KBR officials reviewed the audit before it was finalized and their responses are included in the 26-page report. They disagree with many conclusions, saying the company has planned to cut employee levels in Iraq. But these efforts have been slowed while KBR waited for formal guidance from the military on the drawdown, they said.

In an e-mailed statement, KBR spokeswoman Heather Browne said the company is reviewing the final audit and is closely engaged in the military's drawdown planning. She said the company's work in Iraq "is being conducted in the ever-changing environment of a war-zone which brings its own daily challenges and priority tasks."

But KBR's planning consists of a series of "disjointed processes" and weak accounting procedures when a detailed, forward-looking strategy is needed for dealing with a reduction in forces announced nearly a year ago, the report says. A small company might be excused for such a shortcoming, it says, but KBR should not be.

"A large corporation with nearly 17,000 direct-hire employees in Iraq can not effectively communicate a consistent strategy at all levels of management without a formal written plan," the audit states.

KBR had 17,034 employees in Iraq in January 2008, when there were about 160,000 American forces there to quell a growing insurgency, the audit says. Yet as of Sept. 1, there were 17,095 KBR employees in Iraq even though troop levels had dropped to about 130,000, bases had closed and the services KBR provides were being scaled back.

Current plans call for the number of U.S. troops in Iraq to fall to 50,000 by August 2010. All American forces are scheduled to be out of the country by December 2011.

Although KBR already should have made significant reductions, the report proposes giving KBR until Jan. 1 to put in place a plan that would trim 2,857 employees identified in the audit as excess. Each full-time KBR employee earns about $8,425 a month in pay and benefits, the audit says, so the employee cuts will produce nearly $193 million in savings between the first of January and the end of August, the audit says.

The auditors say if KBR does not make the recommended changes or take even more aggressive steps, the agency will challenge future costs for the excess staff as being "unreasonable," which means the company may not be paid by the government.

The final call, however, on whether to implement the audit's recommendation and withhold any payments rests with the contract managers at Army Sustainment Command in Rock Island, Ill.

The command said Friday it has not completed its analysis of the audit. Lee Thompson, a senior command official, is scheduled to testify at the contracting hearing Monday.