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Welcome to Apogee Consulting, Inc.

Another Small Business Stumbles When Calculating its Rates

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It’s correct to note that Apogee Consulting, Inc., is in the business of assisting government contractors in the back-office administrivia associated with government contracts. It’s also correct to note that there is a certain amount of “we-told-you-so” in this article.

Yet, further note the maxim that every consultant in this business knows to be true: “It’s harder to sell services that prevent problems; whereas it’s much easier to sell services that fix the problems into which the contractor has got itself.” Nobody is a hero when problems are prevented; but lots of people can be heroes when confronted with preventable problems that "suddenly" need to get fixed.

If one were of a mind to peruse previous articles found on this blogsite, one might note a certain amount of repetition on the above statements, particularly with regard to small businesses that simply do not know what they don’t know. They often don’t understand the intricacies associated with their government contracts and thus fail to make accurate risk assessments. They don’t invest in their back-office controls because they don’t really understand the probabilities and consequences associated with their contract risks. They do not understand that those investments have a quantifiable return on investment, in terms of disputes avoided.

In September, I will be presenting at the Society of Corporate Compliance and Ethics (SCCE) 18th Annual Compliance & Ethics Institute. (If you are interested: link here.) The catchy title of my presentation is “Taking a Dynamic Approach to Compliance Risk Assessments for U.S. Government Contractors.” My presentation is described as follows:

  • Learn how to manage a changing risk profile as your business evolves in size and transitions from sub to prime contractor and contracts change from fixed-price to cost-reimbursable

  • Increase your organization’s ability to identify and assess risks associated with organizational and contractor evolution using revenue, contract-type and acquiring agency as key differentiators

  • Better understand Federal Acquisition Regulation contract clauses and changing non-compliance risk

So, yeah. This is a topic that’s on my mind. When you couple a small business’ inability to properly identify and assess risks with an evolving environment, you often get problems. For example, when a small business moves from FFP contracts to its first Cost-Type contract—as is often the case when a SBIR Phase 2 contract is awarded—then that small business really needs to be prepared for its new risk environment. However, such is not always the case.

With all that in mind, let’s discuss the situation faced by Falmouth Scientific, Inc., a successful small business that performed on a four-year Cost-Type SBIR contract for SPAWAR. Falmouth’s problems stared with its initial proposal, in which Falmouth failed to apply G&A expenses to its three project subcontractors. In the first year of contract performance, DCAA “informed the company that it was required to apply G&A to its subcontractors and it would have to redo the invoices it had submitted on the contract to that point. Falmouth worked with DCAA to revise its prior payment requests.” (Internal citations omitted.)

Why would DCAA tell Falmouth that it had to apply G&A to its subcontractors? It’s not particularly clear. The notion that government contractors are required to use a Total Cost Input allocation base for G&A expenses has been dead for more than 30 years. Of course, perhaps Falmouth had an accounting policy or procedure, or practice, that described its G&A expense allocation base—and perhaps that G&A expense allocation base was TCI. But there was nothing that required Falmouth to apply G&A expense to its subcontractors unless it had chosen to do so. Nonetheless, apparently Falmouth agreed with DCAA that G&A expenses should be applied to its subcontractors, because it subsequently revised its previously submitted invoices. Thus, Falmouth was committed to applying G&A on a TCI allocation base (even though, presumably, its SBIR proposal had been priced without such an application and was therefore going to burn through contract funding faster than the parties had anticipated.)

But just two years later, Falmouth and the government reached a deal that retroactively approved use of a G&A expense allocation base that excluded subcontractor costs, and also capped the allowable G&A expense rate. At that point, presumably, the past two years of invoices needed to be revised once again.

At that point, one might well wonder exactly what Falmouth’s G&A expense allocation base was. Was it Total Cost Input, or Value-Added, or perhaps even Single Element? We don’t know but we hazard a guess that Falmouth didn’t really know, either. In the first two years of contract performance the company had three separate G&A expense allocation bases, which of course meant three separate G&A expense rates. And that third rate (whatever it was) had been capped by mutual agreement. It must have been a nightmare for the Program Manager to get a handle on the budget and to comply with the Limitation of Cost and/or Limitation of Funds clauses in that SPAWAR SBIR contract.

Let’s agree that there was a big red flag that Falmouth had indirect rate calculation problems.

At some point the company hired a former DCAA auditor to assist it with its problems. The results of that hiring decision were a bit mixed, in our view.

Between 2009 and 2011, Falmouth submitted five years’ worth of proposals to establish final indirect cost rates (commonly known as “Incurred Cost Proposals”). This tells us that they didn’t submit their proposals when they were required to do so (in accordance with the 51.216-7 clause in their contract). Perhaps the company didn’t know that such a proposal was required until DCAA (or their ex-DCAA auditor consultant) told them. Evidence once again that the small business didn’t know what it didn’t know.

Further, it’s a bit unclear what G&A expense allocation base Falmouth used in those proposals, since two of them were submitted prior to the contract modification that established a G&A expense allocation base that excluded subcontractor costs. If they used an allocation base that was subsequently revised by mutual agreement, they may have been required to withdraw and resubmit their final billing rate proposals using a different G&A allocation base. Or not. We really don’t know; but if you’re thinking the whole situation sounds chaotic, you’re on the same page as we are.

Surprising nobody who has experience with the back-office administrivia associated with government contracts, “DCAA's evaluation … identified numerous problems with Falmouth's financial management of its G&A and subcontract costs. After a second iteration, DCAA's analysis concluded that Falmouth received overpayment of $118,810 for its indirect costs for the contract. … Further DCAA analysis of the allowable cost limits in Falmouth's contract reduced its allegation of overpayment to $100,611.88.” (Internal citations omitted.)

Importantly, the foregoing was communicated to the DCMA Administrative Contracting Officer (ACO) via a Memorandum and not a formal audit report that would have been subject to GAGAS. Apparently, DCAA found Falmouth’s proposals to be inadequate for audit. That finding, if it was made, would be consistent with the situation as we are picturing it, years later and miles away from Falmouth’s headquarters.

Apparently, the DCAA finding was not the result of performing audit procedures; the finding came from application of a 20 percent decrement factor to both direct and indirect costs. (This is a thing that DCAA can do, though we believe that the audit agency currently applies a 16 percent factor, which is really not significantly better.) Readers may be interested to note that when DCAA applied such a factor in an audit report subject to GAGAS, the DOD Office of Inspector General found such a factor to be a violation of GAGAS. (See this article, in which we quoted the OIG as writing, “The auditor did not obtain sufficient evidence to conclude that the subcontract costs were unsupported … [and] the field audit office applied an arbitrary and unsupported 20-percent decrement factor to calculate the questioned costs.”) But while asserting an arbitrary decrement factor is a GAGAS violation if included in an audit report, apparently it’s just fine to include such a factor in a Memo to a Contracting Officer, which is not subject to GAGAS. We’re willing to bet the small business didn’t really understand the nuances of GAGAS compliance.

Let’s talk about the DCAA assertion. $100,000 may not seem like a lot of money to a bigger business, but to a small business that’s a huge amount. Thus, the parties negotiated and, eventually, agreed that Falmouth owed the government $83,295, which was a decent reduction but still quite a lot for a small business to swallow.

The agreement that Falmouth owed $83.3K was duly executed but, apparently, Falmouth was still a bit confused about next steps. There was some back-and-forth correspondence that including the following bit:

As you know FSI is a small company and cash flow is a significant issue for us. In previous discussion [sic] between you and I when I agreed to accept the rate settlement you indicated that a long term penalty and interest free payment plan was possible in this kind of situation. This was one of the main reasons I agreed to accept the settlement and not contest it further. [Falmouth] requests that the payment be amortized over 5 years. Please call me to discuss or let me know what we need to do.

Thus, Falmouth sought to pay the $83.3K over five years, interest free. That goal was not attained.

In May, 2016, Falmouth received a Contracting Officer Final Decision (COFD) and a demand for payment in full. Falmouth reacted by undertaking the following actions: (1) submitted a deferral request, (2) submitted a request for an installment payment plan, and (3) filed an appeal with the ASBCA.

With respect to the appeal, Falmouth alleged that the dispute stemmed from a DCAA assertion that Falmouth’s accounting system was inadequate plus “untimely, inconsistent and erroneous guidance from DCAA auditors during the contract performance periods.” Okay. As we’ve stated publicly, getting guidance from DCAA regarding your contract costs is a lot like getting guidance from the IRS regarding how much taxes you owe. You certainly can rely on such guidance, but we suspect one does better by consulting tax preparation professionals. In addition, DCAA auditors are not supposed to actually provide guidance to the contractors under audit. Something about independence ….

With respect to Item #2 (the installment plan), Falmouth did receive a three-year payment plan from DFAS. Along with the payment plan came a promissory note stating “that Falmouth ‘will pay’ DFAS $83,294.88 plus interest at 1.875% and a penalty on its ‘indebtedness under’ the contract.” (Internal citations omitted.) The interest-free and penalty-free goal was not part of that installment plan. Falmouth signed the promissory note anyway.

With respect to Item #1 (the request for payment deferral), it appears that Falmouth thought that signing the promissory note was a part of the deferral request. Spoiler: it wasn’t.

With all that, the Board granted summary judgment in favor of the government. The decision did not give the government victory because Falmouth had signed the promissory note (as the government first argued), but the decision was for the government on the basis that the parties had entered into a bilateral agreement “which effectively established an agreed-upon figure owed to the government.” In other words, when Falmouth negotiated and agreed upon final rates that led to a situation where it owed the government money on its cost-type SBIR contract (based on application of the agreed-upon rates and the agreed-upon contract rate caps), and when Falmouth actually executed that agreement, at that point Falmouth had effectively agreed with the government’s position—and all the complaints about bad DCAA auditor advice were simply irrelevant.

Though the negotiations began because of the DCAA audits and were informed by them, the agreements do not rest upon them. Instead, they are a product of the negotiations of the parties as contemplated by FAR 52.216-7, which is incorporated into the contract. … Falmouth's generalized argument that there was no meeting of the minds between the parties because the rate agreements did not include the bottom-line number of the amount owed fails because the agreements specified what was required (the rates) and Falmouth well knew what the exact consequences of agreeing to those rates would be.

(Citations and footnotes omitted.)

Falmouth is a small business and it learned a hard lesson. When it signed its SBIR contract, it should have realized the back-office compliance requirements associated with cost-type contracting. But it didn’t realize what was required; we continue to believe the company simply didn’t know what it didn’t know.

A hard lesson, and also an expensive one.

Last Updated on Friday, 23 August 2019 06:17
 

DCAA Does Materiality

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I was going to write about the latest DCAA audit report and do a bunch of charts showing trends, but then DCAA issued this MRD entitled “Audit Guidance on Using Materiality in Incurred Cost Audits,” and it seemed a bit more important … so here you go.

Section 803 of the 2018 National Defense Authorization Act (NDAA) had a lot to say about DCAA, most of them in relation to the then-current backlog of “incurred cost” audits. Among the requirements imposed by that public law was the following—

Not later than October 1, 2020, the Secretary of Defense shall comply with commercially accepted standards of risk and materiality in the performance of each incurred cost audit of costs associated with a contract of the Department of Defense.

In response to that direction, DCAA issued a MRD (link in the first sentence) that, for the first time, provided auditors with direction regarding how to assess materiality. This is important because, historically, contractors have complained about the lack of materiality in DCAA audit procedures. For example, contractors have complained publicly about having to spend thousands of dollars to chase down a receipt for $53.00 (or something like that; we’re paraphrasing here). Of course, those anecdotal “thousands of dollars” were allowable overhead costs, so it was the Department of Defense that was footing the bill for the overzealous auditors’ demands.

But now DCAA has an official materiality standard. In the words of the MRD, “The use of a quantified materiality threshold is intended to facilitate a consistent approach that helps an auditor determine the nature, timing, and extent of audit procedures on those cost elements and accounts that are significant, or material, to the audit opinion.”

DCAA has provided its auditors with the following formula for calculating materiality for its incurred cost audits:

For values up to $1 billion, use the formula $5,000 x ((Total Subject Matter / $100,000) .75), which in Excel looks like: =5,000*((1,000,000/100,000)^.75). For an incurred cost proposal with an Auditable Dollar Volume (ADV) of $1 million, the materiality threshold is $28,117.

For ADV in excess of $1 billion, the MRD directs auditors to use a materiality threshold of 0.50 percent of the ADV value.

What does this mean?

First, it’s not clear. We think it means that transactions below the materiality threshold will not be subject to audit procedures. That would seem to be reasonable. On the other hand, who knows? It may well depend on each individual auditor’s approach to conducting the audit.

Second, it’s not dispositive. By that we mean that the audit guidance permits auditors to adjust the materiality threshold based on auditor judgment. In the words of the MRD—

Materiality requires the use of two separate thresholds: quantified materiality to identify significant cost elements, and adjusted materiality to identify significant accounts recorded in the significant cost elements. Adjusted materiality is less than quantified materiality and is applied to accounts within a cost element. For purposes of selecting accounts for audit testing, adjusted materiality can be stated as a reduction of the quantified materiality threshold by 20 percent to 80 percent based on auditor judgment.

So while the materiality threshold may be a nice theoretical concept, it may actually mean close to nothing when applied during an incurred cost audit.

Finally, DCAA did the minimum it was required to do. (Actually, the agency did a bit less because it was supposed to tie the materiality threshold(s) to commercial audit standards; that did not seem to happen.) The NDAA required a materiality standard for incurred cost audits, and that’s exactly what DCAA did. However, the audit agency did not impose a materiality threshold for its CAS-related audits or associated cost impact proposal audits. There is no materiality threshold for defective pricing or for MAAR audits. As was the case with “incurred cost” audits, a risk-based approach to audit procedures, using a quantified materiality standard, is needed.

Let’s hope DCAA takes this precedential approach and applies it to other areas.

 

Competition

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Hello.

After all the hectic stuff, things calmed down and I went on vacation. Now I’m back.

Thanks for your patience. It’s gratifying to see activity on this site even when the new blog posts pause for a while. (One of the benefits of having more than 1,100 articles in the archive, I guess.)

Today I want to talk about competition.

The data published by DOD have shown clearly that competition leads to better contract outcomes. (See our blog article on the 2013 Defense Acquisition Performance Report, where we reported the official conclusion that “… cost and price growth are statistically lower on competed contracts.”) Thus, people who read have known for years that competition is where it’s at. Despite that knowledge, the majority of DOD contract actions are not competitive.

There’s a reason for that counter-intuitive situation. The reason is that most contract actions are modifications to existing contracts. Something has changed—such as quantity of items to be acquired—and the contract needs to be “equitably adjusted” as a result. Those Requests for Equitable Adjustment (REAs) are not competed and thus have to be recorded in the databases as non-competitive contract actions.

Even for other (non-REA) contract actions, often there is only one known source. For example, if your IT system is based on Apple stuff, you are probably going to go back to Apple for new stuff and new licenses. You are not likely to change providers mid-stream, such that half your hardware and software is Apple-based, and the other half is Windows or Android-based. (Look, it was an example, all right? I don’t want a lot of emails telling me how it could be done or that it happens all the time. Mutter to yourself all you want; but leave me out of it.)

To impart some learning: “competition” and “price competition” are two different things, found in two different Parts of the FAR. Competition is, essentially, when the contract award opportunity is made available to more than one bidder—although there are several types or gradations of competition. (See FAR Part 6.) “Adequate price competition” is a term of art found in FAR 15.403-1(c). Adequate price competition is defined as:

  1. Two or more responsible offerors, competing independently, submit priced offers that satisfy the Government’s expressed requirement;
  2. Award will be made to the offeror whose proposal represents the best value … where price is a substantial factor in source selection; and
  3. There is no finding that the price of the otherwise successful offeror is unreasonable. Any finding that the price is unreasonable must be supported by a statement of the facts and approved at a level above the contracting officer.

But (of course) if you are modifying an existing contract, then you have neither competition nor adequate price competition, because only the price of the modification to the existing contract held by the existing contractor is being evaluated.

Recently, the FAR was revised to make it harder for DOD agencies to achieve “adequate price competition.” For civilian agencies –

… a price is also based on adequate price competition when–

 

(A) There was a reasonable expectation … that two or more responsible offerors, competing independently, would submit priced offers in response to the solicitation's expressed requirement, even though only one offer is received from a responsible offeror and if-

 

(1) Based on the offer received, the contracting officer can reasonably conclude that the offer was submitted with the expectation of competition, e.g., circumstances indicate that–

(i)  The offeror believed that at least one other offeror was capable of submitting a meaningful offer; and

(ii)  The offeror had no reason to believe that other potential offerors did not intend to submit an offer; and

 

(2) The determination that the proposed price is based on adequate price competition and is reasonable has been approved at a level above the contracting officer; or

 

(B) Price analysis clearly demonstrates that the proposed price is reasonable in comparison with current or recent prices for the same or similar items, adjusted to reflect changes in market conditions, economic conditions, quantities, or terms and conditions under contracts that resulted from adequate price competition.

On the other hand, for DOD agencies and other components subject to NDAA language, the FAR (at 15.403-1(1)(ii)), is clear that the foregoing language is no longer applicable. Instead, contracting officers and buyers at those agencies must comply only with the three “traditional” criteria listed above. If only one offer was received, then adequate price competition has not been achieved and therefore certified cost or pricing data must be obtained to support cost analysis.

We told readers this was coming. Of course, we analyzed the proposed rule as a DFARS revision and not as a FAR revision. But still … our readers had some measure of advance notice on this one.

The FAR rule revision comes a few years after the DFARS was revised. One is tempted to think DOD leaders (and law-makers) want to make it harder to award contracts where only one bid is received.

Now, in related news, let’s talk about TransDigm. We wrote about the TransDigm issue here. If you are unfamiliar with the TransDigm profit story, you might want to read that backgrounder first. If you are too lazy to click that link, suffice to say that, in the view of the DOD OIG and law-makers, TransDigm made too much profit on its sale of spare parts to DOD. Basically, TransDigm said, “Here’s my price. Take it or leave it.” And the DOD contracting officers had to take the price, because there was no other contractor with the spare parts. And even though there were no other bidders, TransDigm often refused to provide cost or pricing data, because it could. There was no other game in town.

That business approach—which was free market capitalism at its finest—didn’t sit well with auditors or with Congresspeople. There were hearings. While every Congressperson loves the free market while campaigning, many don’t seem to love it after election. TransDigm was accused of “price-gouging” (which was, in our view, inaccurate) and was “urged” to reimburse taxpayers for some $16 million in “extreme” profits reaped based on “unethical business practices.”

FederalNewsNetwork reported that, a couple of weeks after the hearings, TransDigm did agree to pay back $16.1 million. We are sure that was a reluctant business decision, perhaps driven by the fact that the DOD was one of its largest customers.

But that wasn’t the end of the story.

A couple of weeks later, the Acting Principal Director, Defense Pricing and Contracting (APD, DPC, OUSD, A&S) issued a memo aimed directly at TransDigm. The new policy was based on (unproven) allegations that TransDigm had “rigged” competitions because it was the only source for spare parts.

From the memo—

The IG report found that TransDigm is the only manufacturer of the majority of the spare parts the IG included in its review, putting TransDigm either in a sole source position or in a situation where it had the opportunity to set the market prices even for competitively awarded parts. ….

 

Therefore, for all procurement actions not yet awarded as of the date of this memorandum, unless the prices agreed upon are based on adequate price competition or are set by law or regulation, contracting officers are directed to require the submission of uncertified cost or pricing data to support prices proposed by TransDigm and its subsidiaries.

Notice what’s missing from the above. Even if the items are found to be commercial items, TransDigm must still submit uncertified cost or pricing data to support cost analysis.

Okay. TransDigm is now paying a steep price for its attempt to use market forces against the DOD. But what will that mean? We don’t know, but if it were us, we would take the costs of providing the information—and perhaps the costs of modifying our accounting system to record that information—and pass it right back to the DOD customers. Only this time, it wouldn’t be “profit”—it would be legitimate overhead, to which profit would be applied.

So … competition. Always a good thing. And when it cannot be achieved, then sometimes it can be forced.

 

Due Diligence Oopsie

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This story broke before we went on vacation and we’ve been meaning to write about it. The story concerns a risk associated with acquiring a smaller company. It’s a risk that most due diligence efforts would not identify.

Say you’re a large, well-established, company. You are acquiring a small company in the same marketspace. Naturally, as part of the due diligence efforts, you obtain a list of recent contract awards. You also obtain a list of what’s in the “pipeline”—i.e., what proposals have been submitted and are awaiting an award decision. You probably also get a list of proposals in process that will be submitted in the near future. You (presumably) have a good picture of what’s been happening, and what is likely to happen, with respect to the near-term future of the company you are acquiring.

If you are good at your job, you looked at the target’s business systems. You evaluated the accounting system and property control system. You looked at the estimating system. You looked at the purchasing system. As part of those efforts, you likely evaluated the risk that the target had material misstatements on its financial statements. You probably evaluated its anti-fraud and anti-corruption controls. You likely reached a conclusion regarding the accuracy of its cost proposal process, and the company’s ability to comply with Truthful Cost or Pricing Data requirements. In short, if you are good at due diligence you should have some idea as to whether or not you are buying contingent liabilities for which reserves need to be established at the time of acquisition.

But would you have evaluated the target company’s ability to tell the truth to potential customers? Would you have assessed its ability to comply with the False Statements Act in its interactions with government personnel?

We don’t think so. At least, we’ve never been part of such a rigorous due diligence process. In order to address those risks, you would have to start from the question: “What if much of the target company’s success wasn’t because of the quality of its product and/or services, or because it was a low-cost provider?” You would have to ask the question, “What if much of the target company’s success stemmed from its sales process, where it misrepresented its qualifications in order to win work?”

It’s possible you might ask those questions. But in our experience, those questions are almost unthinkable. In addition—even if you did ask them, how would you go about testing for them? It’s too out there, too hard. Plus, most due diligence efforts are sprints, and nobody has time for such small probability risks, even if the consequences might be significant.

What happens if the risk materializes after completion of the acquisition? What happens if the risk is materializing on the day of the acquisition?

Let’s ask IBM.

According to the Department of Justice press release (link above), on the exact day that IBM was closing its acquisition of Cúram Software Ltd (Cúram), the company (as a subcontractor) submitted a proposal to the State of Maryland for software and services. Less than a month later, “with IBM’s knowledge,” Cúram participated in a presentation to the source selection evaluators—a presentation that resulted in a contract award.

According to the DOJ, Cúram made “material misrepresentations” to the evaluators “including misrepresentations regarding the development status of the Cúram for Health Care Reform software; the existing functionality of the Cúram software to meet the State’s technical requirements, such as addressing life events and calculating tax credits under the Patient Protection and Affordable Care Act; and the integration of Cúram software with other software needed to provide a properly functioning HIX website.” Allegedly, the misrepresentations led to a contract termination after Cúram was unable to deliver on the promises it had made in its proposal and during its presentation.

Many long-time acquisition practitioners have learned not to fully trust verbiage contained in contractor proposals. We’ve heard contractor proposals called “fantasies” and evaluations termed “creative writing contests.” Maybe that’s true. But we’ve rarely heard those proposed deemed to be material misrepresentations, or violations of the False Statements Act, or of such a serious nature to have led to a situation where each contract invoice was alleged to be a violation of the False Claims Act.

What was the outcome of all this? IBM paid $14.8 million “to settle alleged violations of the False Claims Act arising from material misrepresentations to the State of Maryland during the Maryland Health Benefit Exchange (MHBE) contract award process for the development of Maryland’s Health Insurance Exchange (HIX) website and IT platform.”

Again, this is not something we’ve seen due diligence programs delve into. Accordingly, it’s tough to blame IBM for the situation. On the other hand, during each acquisition there should be a thorough evaluation of the probability that there are hidden contingent liabilities. The acquired company should not get its full payday until sufficient time has passed to reduce the likelihood that the contingent liabilities will materialize.

 

Business Systems are Back

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Recently we noted that DCAA has reinvigorated its audits of contractor business systems. We wrote “it’s becoming clear that DCAA is getting serious about performing more contractor business system audits. We continue to doubt that they will perform as many as they have promised; however, we’re pretty sure they will be performing more than they have in recent years (which is a grand total of ‘very few’).”

Government oversight of contractor business systems (“CBS” in government acronymese; “BusSys” in our vernacular) has evolved since Congress got hornswoggled by DCAA and the Commission on Wartime Contracting back in 2010 – 2011. In some respects, Congress saved contractors from a worse oversight plan, as proposed by DCAA and the DAR Council, by limiting implementation of payment withholds to the largest of defense contracts. But that small bit of grace did not overcome the reality of the final rule: it was unenforceable.

It was unenforceable because neither DCMA nor DCAA had sufficient resources to perform the necessary BusSys reviews. Congress directed, and the DAR Council promulgated, a rule that could not be enforced at the current staffing levels.

And perhaps that was the strategy. Perhaps DCAA and/or DCMA thought that their inability to perform the required audits/reviews would give them good grounds for getting additional budget for additional heads. If that was the plan, it didn’t work. Staffing levels haven’t changed all that much over the past seven years at DCAA.

In addition, Congress’ attention has been focused on the lack of DCAA audits of contractor proposals to establish final billing rates. BusSys audits have faded into the background because everybody has been looking at the incredible backlog of final billing rate proposals DCAA let build up over the same time period. Thus, DCAA was performing neither of the audits to the required levels and Congress still didn’t give the audit agency more money.

Since budgets and staffing haven’t significantly increased, other bureaucratic responses had to be enacted. Many of those responses have been documented in this blog.

With respect to the unaudited contractor proposals to establish final billing rates, DCAA implemented new procedures that led to the majority of those submissions being deemed to be acceptable without performing the required audits. You’d think somebody somewhere would be concerned about that approach, but it turned out not to be the case. Certainly, the contractors who were told their final billing rates would be accepted os submitted without audit were not going to complain.

In fairness, DCAA did some other things that accelerated their audits. They started to perform multi-year audits, where more than one (sometimes as many as three or four) proposals to establish final billing rates were audited at the same time. That helped. (Unless you were the contractor that had to staff up to support them.) Another thing DCAA did was to create “virtual Incurred Cost audit teams” at the Regional level. This helped ensure that sufficient resources and urgency were devoted to the issue.

Finally, Congress “helped” by passing a law that required DCAA to perform its audits of contractor final billing rate proposals within 12 months of receipt. (In recent years, DCAA has been taking roughly three years to audit one year’s worth of indirect cost rates.)

In sum, DCAA “risked-away” the majority of its required audits and focused on performing the remaining few more efficiently. It worked to a very great extent. Problem solved.

While DCAA was working on reducing its “incurred cost” backlog, rule-makers were working hard to make sure that the number of required BusSys reviews were being reduced.

In 2015, DOD issued Class Deviation 2015-O0017 to raise the threshold at which Earned Value Management System (EVMS) reviews were performed from $50 million to $100 million. More specifically, although the EVMS clause is required to be included in cost-type or incentive-type contracts and subcontracts valued at $20 million or more, “no EVMS surveillance activities will be routinely conducted by the [DCMA] on cost or incentive contracts and subcontracts valued from $20 million to $100 million.”

More recently (May 31, 2019), a proposed DFARS rule revision was published in the Federal Register that would, if implemented as a final rule, raise the threshold at which Contractor Purchasing System Reviews (CPSRs) are performed from $25 million to $50 million of qualifying government sales. The rationale for the proposed change was to “appropriately account for inflation, reduce burden on small contractors, and allow a more efficient and effective use of CSPR resources to review larger contractors where more taxpayer dollars are at risk.”

While the BusSys review thresholds are being raised to exempt smaller contractors from the need to be subject to them, DCAA is also preparing to perform more of them. It is important to note that, in the minds of DCAA and Congress, DCAA has solved its embarrassing backlog of unperformed “incurred cost” audits. Thus, the focus has moved to the embarrassing lack of performance of other important audits, such as CAS compliance, defective pricing, and contractor business systems.

One means of increasing the throughput of BusSys audits is to create “virtual business system review teams” at the regional level. This will help to ensure that sufficient resources and urgency are devoted to these audits.

The parallels between the focus on contractor “incurred cost” audits and contractor business system are striking. We see the same strategies being employed.

  1. Whittle-down the universe of required audits to focus on the bigger contractors.
  2. Create focused groups of resources to efficiently perform the remaining few.

We expect it will work—at least for DCAA. (We have no information about any DCMA changes; our impression is that DCMA and contractors are largely happy with how DCMA is handling its BusSys reviews.)

But how will the creation of “virtual business system review teams” impact contractors?

Obviously, feedback is limited with such a new approach—but we’ve heard from one contractor that has experienced a BusSys review from a regional team. The feedback was decidedly mixed. Again: just one data point so take that into account. But that one data point is that the regional team did not take the time to gain a deep understanding of the contractor’s operations, which created audit challenges. In order to overcome those challenges and related inefficiencies, the contractor had to get its regular auditors (who did understand its operations) together with the regional auditors to get the “outsiders” comfortable with how things worked there.

So: focused resources but also not a lot of time devoted to depth. A superficial “check-the-box” audit performed in small increments over a long time. Not what that contractor expected (or wanted) to see.

Meanwhile, for the rest of us, we’ll have to wait and see for ourselves how DCAA will be performing its BusSys audits under its new management focus.

Edited to add: Also DCAA has recently republished Contract Audit Manual Chapter 5, which covers audits of BusSys. You might want to check it out to see what has changed.

Last Updated on Monday, 17 June 2019 05:47
 

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Newsflash

Effective January 1, 2019, Nick Sanders has been named as Editor of two reference books published by LexisNexis. The first book is Matthew Bender’s Accounting for Government Contracts: The Federal Acquisition Regulation. The second book is Matthew Bender’s Accounting for Government Contracts: The Cost Accounting Standards. Nick replaces Darrell Oyer, who has edited those books for many years.