On September 30, 2009 the Government Accountability Office (GAO) issued a report to the House of Representatives Committee on Oversight and Government Reform. The report, “CONTRACT MANAGEMENT: Extent of Federal Spending under Cost-Reimbursement Contracts Unclear and Key Controls Not Always Used” (GAO-09-921), assessed (1) the extent of agencies’ obligations under cost-type contracts, (2) the rationales given for using this contract type, (3) whether the awarding agencies had determined that the contractors’ accounting systems were adequate, and (4) contractor monitoring procedures and controls used by the agencies. GAO reviewed 92 contracts at eleven military and civilian agencies, including the Air Force, Navy, Environmental Protection Agency, Treasury Department, NASA, Department of Health and Human Services, and the National Science Foundation.  In its report, GAO found numerous issues, not the least of which was yet another allegation that DCAA was failing to support the DOD acquisition process.

 

 

The Procurement Data is Flawed

 

The first finding of the report was that “the complete picture of the government’s use of cost-reimbursement contracts is unclear,” because “we found billions of dollars reported as missing a contract type (i.e., no specific contract type was indicated) or indicating ‘other’ as the contract type” in the Federal Procurement Data System—Next Generation (FPDS-NG). Consequently, although the use of cost-type contracts apparently decreased between 2003 and 2008 (from 34 to 26 percent of total obligations), GAO found that the reported decrease was misleading.  GAO found that, in fact, use of “combination” contract types had increased over the same period—from 1 percent to almost 8 percent of obligations—and that trend distorted the FPDS-NG data.  As GAO reported:

 

We analyzed fiscal year 2008 FPDS-NG obligations coded as combination contracts and found that half of the $39 billion was obligated under contracts that had at least some cost-type actions, and about a quarter of this amount ($9 billion) went to contracts that had 50 percent or more cost-type obligations. These obligations were not recorded as cost-reimbursement in FPDS-NG.

 

As GAO proudly stated, “According to a response to a draft of this report by the Office of Federal Procurement Policy (OFPP), a change was recently approved to FPDS-NG … to be effective for all new contracts awarded in fiscal year 2010, that will eliminate ‘combination’ as a contract type.  Contracts containing more than one contract type will be coded as the contract type representing the preponderance of obligations.”

 

Unsurprisingly, GAO also found that “Contracting officials frequently did not document contract files to show why they awarded cost-reimbursement contracts. The documentation we did find, for the most part, used boilerplate language; was short, vague, and repetitive; and did not show why a cost-reimbursement contract was selected.”

 

GAO also reported that—

 

Of the 92 contract files we reviewed, we found that 28, or 30 percent, contained no documentation showing why a cost-reimbursement contract was selected for award, including in the acquisition plans. Contracting officers frequently could not provide an explanation for its absence, were unaware of the need for documentation, or stated that they inherited the contract from contracting officers who had retired or otherwise left the agency.

 

 

Contracting Officers Don’t Check the Adequacy of Contractor’s Accounting Systems

 

As GAO noted, cost-type contracts may only be used when a contractor’s accounting system is found to be adequate for determining costs applicable to the contract.  (See FAR 16.301-3.)  The contracting officer is responsible for verifying that the contractor has an adequate accounting system.  The verification step can be accomplished via various means; however, GAO reported that “For most of the contracts we reviewed, this verification was based on a DCAA opinion stemming from its review of the contractor’s accounting system and related internal control policies and procedures….” According to GAO, “Regular accounting system reviews are necessary to help ensure that changes to the contractor’s accounting practices are considered by the government and evaluated for compliance with government contract cost principles.” GAO found that 20 of the 92 contracts it reviewed had no evidence that the adequacy of the contractor’s accounting system was ever considered by the contracting officer. In addition, in seven instances the contracting officer had relied on an adequacy determination made more than four years before the contract award.  Nearly one-third of the contracts reviewed had been awarded to contractors without the required accounting system due diligence.

 

As GAO noted:

 

As an example of what can occur when the determination of adequacy is not made or the contractor’s accounting systems are not deemed adequate, in August 2007, a contractor disclosed to the Air Force that it had periodically overbilled on the Joint Strike Fighter Systems Development and Demonstration cost-reimbursement contract since its inception. The amount overbilled was about $267 million. In this case, DCAA had rendered the opinion that the contractor’s accounting system was ‘inadequate in part.’ The contractor reimbursed the Air Force for the amount overbilled and paid an additional $28 million in interest.

 

But enough of the preliminaries. Let’s get to the DCAA bashing.

 

 

DOD Relies on DCAA for Cost Monitoring, to Its Detriment

 

Per FAR 16.301-3, cost-type contracts can only be awarded if two conditions are met – (1) a finding that the contractor’s accounting system is adequate (discussed above), and (2) use of “appropriate government surveillance during performance” that provides “reasonable assurance that efficient methods and effective cost controls” are being utilized. GAO found DOD relies on contractor-provided monthly Earned Value Management (EVM) reports and EVM data to perform cost surveillance.  According to GAO, “analysis of EVM data alone does not satisfy FAR requirements for cost surveillance under cost-reimbursement contracts.”  Therefore, DOD supplements its EVM analyses with reviews of contractor systems, internal controls, and actual invoices—primarily conducted by DCAA.

 

As GAO reported—

 

The effectiveness of DOD’s cost surveillance process depends, to a large extent, on the adequacy of [ ] DCAA procedures. Our recent work has raised concerns in this regard. For example, rather than documenting the population of invoices, preparing sampling plans, and testing a random (statistical) sample, as should be done, [DCAA] auditors generally used a nonrepresentative selection of invoices in deciding the number of invoices they would review and the extent of testing they would perform to support conclusions in their work. For example, we found that for one contractor that generated $1.1 billion in annual billings to the government, the DCAA auditor only reviewed 3 invoices totaling $88,000 out of 222 invoices submitted for payment from March 2003 through February 2004, tested the first invoice selected, and performed limited testing on the remaining 2 invoices. Despite this limited testing, DCAA prepared a memorandum for the record, stating that ‘continued reliance can be placed on the contractor’s procedures for the preparation of interim vouchers (invoices)’ and ‘the contractor has met the criteria for continued participation in the direct billing program.’

 

In other words, DOD’s reliance on DCAA’s audit procedures has placed it in a vulnerable situation, where it may not have appropriate insight into how a contractor is spending government funds.  GAO provided an allegory of what happens when the government lacks appropriate insight.

 

In our review, we found an additional example of what can happen when adequate cost surveillance is not in place. NSF awarded a $1.1 billion, 10-year 5-month cost-reimbursement contract (with options) for logistic and operational support for the U.S. Antarctic Program. As discussed in a series of NSF Office of Inspector General audit reports, DCAA found that the contractor was billing indirect costs as direct costs, billing over the negotiated ceiling limitations, and not providing supporting documentation for other costs. To compound these issues, NSF had not determined that the contractor’s accounting system was adequate for determining costs applicable to its contract. In November 2007, an independent auditor reported that NSF had significant weaknesses in its contract monitoring policies and procedures, meaning that the agency did not know whether the costs it was paying the contractor were allowable and reasonable. NSF officials acknowledged the weaknesses and have begun to take corrective action.

 

Lest the contractors escape unscathed, GAO provided one final cautionary tale.

 

… in January 2009, the DOE Inspector General reported weaknesses in a contractor’s internal audit, which DOE relies on to help ensure that contractors’ costs charged to DOE are allowable under the terms of the contract.33 For fiscal year 2007, the contractor had expended and claimed over $1.4 billion. The Inspector General found that the contractor’s internal audit during fiscal year 2007 was not satisfactory in several material respects. Specifically:

• Procurements were not properly approved, but the contractor’s internal audit management permitted the contractor to provide approvals 3 years after the fact. Questioned costs associated with the procurements were omitted from the contractor’s audit report.
• The contractor’s internal audit manager encouraged the omission of information that confirmed improper labor cost allocations.
• After the completion of audit testing, the contractor’s internal audit management directed the modification of the testing attribute related to independent receipt of procured goods and services, an action that caused some of the questioned costs to be excluded from reporting.

 

In conclusion, GAO found that contracting officers aren’t always doing their job when awarding cost-type contracts.  Too many times, they don’t properly document files and they don’t check the adequacy of the contractor’s accounting system.  After award, mandatory surveillance is lacking, particularly when DCAA is involved.  And reliance on a contractor’s self-governance reviews is also misplaced.  What’s a poor Federal government to do?