Section 809 Panel Volume 3
Two years in the making. 1,140 pages of analysis and recommendations spread across two large downloadable files. Eight pages of Executive Summary.
The Section 809 Panel’s Third Report has dropped.
But before we discuss the third volume let’s recap the story so far:
Section 809 of the 2016 National Defense Authorization Act (NDAA) (Version 2, as the first version was vetoed by then-President Obama) directed the Under Secretary of Defense (AT&L) to establish “an advisory panel on streamlining acquisition regulations.” And lo, it was done!
In May, 2017, the Section 809 Panel issued its First Interim Report, along with a Supplemental Report. We wrote about it here.
A few months later, the first Volume (of three) was issued. We wrote about Volume 1 in this article. Short version: we liked it. We liked it a lot. There were 24 recommendations in Volume 1 and they were in line with the Panel’s self-proclaimed mission to boldly go into acquisition reform. (Excuse the split infinitive.) Eleven of the 24 recommendations were directed at DCAA. We wrote, “if implemented as drafted, the recommendations in Section 2 would significantly improve contract audit and oversight in the defense acquisition environment.” Unfortunately, though several recommendations were picked up and added to draft legislation, very few made it all the through the legislative cycle and into public law.
In June, 2018, the Panel issued the second Volume. We wrote about Volume 2. We were less thrilled with Volume 2, not because of the recommendations—which were all good—but because of the format and the way the recommendations were hidden. We wrote, “Volume 1 was marked by really concrete, actionable, recommendations that were supported by lots of detail. In contrast, Volume 2 seems to be marked by a higher-level discussion and more summary recommendations. That’s not to say there is a lack of meaty, important, recommendations in Volume 2; but they are harder to find (and presumably take action upon) than they were in Volume 1.”
Which brings us to Volume 3.
Volume 3 seems to be a return to the actionable recommendations of Volume 1. It contains 58 new recommendations proffered in 13 Sections. The recommendations cover such areas as: changing how DoD looks at the marketplace (and jettisoning a lot of the FAR Part 12 through 14 framework), rejiggering budget management processes and controls, acquisition workforce training and development, limiting bid protests, limiting mandatory flowdown clauses, and creating a Center for Acquisition Innovation (CAI). Oh, and there was a section about streamlining and improving compliance, as well.
Naturally, we want to talk about Section 6, Streamlining and Improving Compliance. Section 6 had 12 recommendations, but we only want to talk about three of them.
Rec. 71: Adopt the professional practice guide to support the contract audit practice of DoD and the independent public accountants DoD may use to meet its contract audit needs, and direct DoD to establish a working group to maintain and update the guide.
Rec. 72: Replace 18 system criteria from DFARS 252.242-7006, Accounting System Administration, with an internal control audit to assess the adequacy of contractors’ accounting systems based on seven system criteria.
Rec. 73: Revise the definition of business system deficiencies to more closely align with generally accepted auditing standards.
Let’s go backwards from 73 to 71. First (or last), nobody would argue with Recommendation 73. We’ve written several pieces about the problems created when DoD (and DCMA and DCAA) accepted a definition of “significant deficiency” that deviated from the common understanding of the term as it was used by public auditors.
Second, we’ve also written about the lack of objectivity in the current 18 Accounting System criteria used to assess system adequacy. If the Section 809 Panel’s recommendation #72 is adopted, then—
…auditors will evaluate whether key internal controls are in place and operating to provide reasonable assurance of the following:
-
Direct costs and indirect costs are classified in accordance with contract terms, FAR, Cost Accounting Standards (CAS) and other regulations, as applicable.
-
Direct costs are identified and accumulated by contract in accordance with contract terms, FAR, CAS and other regulations, as applicable.
-
Methods are established to accumulate and allocate indirect costs to contracts in accordance with contract terms, FAR, CAS and other regulations, as applicable.
-
General ledger control accounts accurately reflect all transactions recorded in subsidiary ledgers and/or other information systems that either integrate or interface with the general ledger including, but not limited to, timekeeping, labor cost distribution, fixed assets, accounts payable, project costs, and inventory.
-
Adjustments to the general ledger, subsidiary ledgers, or other information systems bearing on the determination of contract costs (e.g. adjusting journal entries, reclassification journal entries, cost transfers, etc.) are done for reasons that do not violate contract terms, FAR, CAS, and other regulations, as applicable.
-
Identification and treatment of unallowable costs are accomplished in accordance with contract terms, FAR, CAS, and other regulations, as applicable.
-
Billings are prepared in accordance with contract terms, FAR, CAS, and other regulations, as applicable.
That would be nice, wouldn’t it?
Finally (or first), let’s discuss Recommendation #71. This is kind of a repeat from Volume 1, where the Panel recommended that DCAA adopt a professional practice guide (PPG) to help ensure audit consistency and quality. But in Volume 3, the Panel actually drafted the PPG and offered it for public comment. It’s pretty dang good, in our opinion. The PPG can be found starting at Page 79 of Download #2 of Volume 3. We think you should read it.
The PPG includes a deep dive into the concept of materiality. As readers may know, DCAA’s seeming lack of ability to apply materiality standards to its audits has long been a concern of many government acquisition stakeholders, including Congress, which came close to implementing hard quantitative materiality standards in draft NDAA legislation. If adopted by DCAA, the Section 809 Panel’s approach to determining materiality will go a long way to addressing those concerns.
The PPG also includes a discussion of “reasonable assurance” which, as anybody who’s had a business system audit knows, is not a concept with which DCAA or DCMA seems to have much familiarity. Basically, it implements a Six Sigma (or cost/benefit) concept that nobody can afford a perfect system of internal controls; that the best you can do is design a system that will catch most of the deviations. Or, as the PPG states—
The concept of ‘reasonable assurance’ recognizes that the cost of achieving greater assurance will, at some point, exceed the benefit of the higher assurance. This concept is acknowledged in the Federal Acquisition Regulation Guiding Principles. The concept of reasonable assurance as it relates to systems of internal control also recognizes that it is not possible to declare with absolute certainty that an error or misstatement will not occur.
(We’ll let our readers decided who explained the concept more clearly….)
Okay, let’s wrap this up. The Section 809 Panel has issued an Interim Report, a Supplemental Report, and three Volumes of Final Reports. It has made 92 Recommendations for action. It seems to have wrapped-up, though we aren't sure about that and we wouldn’t be surprised if there was a Final Final Report issued sometime in 2019 that summarized everything.
Was the Section 809 Panel a success? Or was it simply a gathering of the “old boy’s club” who identified the problems that they themselves were responsible for fixing back in the days when they were actually paid by the Federal government to manage the acquisition system?
The answers to that those questions will be found in the implementation of the recommendations. If Congress doesn’t implement them or if DoD won’t implement them or if DCAA won’t accept them, then the Section 809 Panel just wasted everybody’s time.
In that sense, the Panel’s work is absolutely not done. It needs to push and push and push to get its recommendations to the right ears.
But we will all have to wait and see, won’t we?
DCAA Audit Guidance: Inadequate Cost/Price Analysis
In September, 2017, DCAA issued audit guidance that discussed evaluations of prime contractor cost/price analyses of proposed subcontractor costs. We didn’t discuss it because it didn’t really merit discussion; at its core it was a restatement of requirements found in FAR Part 15 (at 15.404). Prime contractors that already knew about those requirements and that were complying with them were not going to have significant issues with the “new” audit guidance; so we refrained from offering comment.
Now DCAA has issued revised audit guidance and it’s worth discussing.
MRD 18-PSP-006(R), dated November 27, 2018 (but published in January, 2019) addresses “incomplete or inadequate prime contractor cost or price analyses.” The objective of the MRD is to help auditors avoid classifying proposed subcontractor costs as being “unsupported” simply because the auditors don’t like the cost/price analyses that the prime contractor performed. If the prime’s analyses are flawed, the MRD directs the auditors to attempt to perform alternate procedures; proposed subcontractor costs should be classified as “unsupported” only if those alternate procedures fail to provide sufficient evidence to support an audit conclusion.
The MRD also directs auditors who are forced to use such alternate procedures to report the dollars associated with incomplete or inadequate cost/price analyses to the CO as a “material noncompliance” with FAR requirements. Readers should note that there is no such thing as a “material noncompliance” with FAR requirements and any such finding carries with it exactly zero consequences. Though, having said that, we suppose that piling up a bunch of such reported “material noncompliances” is not going to make the next Estimating System review go any easier.
What are these alternate procedures that the auditors are supposed to perform?
-
Create a decrement based on purchase order history
-
Create a decrement based on comparisons of prior subcontractor proposals to the cost/price analyses of those proposals
-
Create a decrement based on comparisons of prior subcontractor proposals to the actual negotiated values of the subcontractors
-
Request an assist audit of the subcontractor’s proposal by the DCAA audit team with cognizance over the subcontractor
In discussing this new guidance with professional subcontractor cost/price analysis guru Dan C., Dan noted that prime contractors can use the exact same procedures in their cost/price analyses of received subcontractor proposals. In other words, if your cost/price analyses of a subcontractor proposal isn’t going well, see if any of the procedures listed above help get you where you need to go. If so, then you will have a complete and/or adequate subcontractor cost/price analysis to share with your customer (and DCAA), thus minimizing DCAA”s need to implement the alternate procedures when performing audits of your proposal. (Thanks Dan!)
|
Legal Costs Bite Small Business
Founded in 1985 and located in San Diego, California, Energy/Matter Conversion Corporation (EMC2) researches, develops, and tests a nuclear fusion reactor that uses an electric field to heat ions to fusion conditions. The company received a Cost-Plus-Fixed-Fee (CPFF) contract from the US Navy in 2009, but EMC2 also had cost-type contracts going back at least to 2000. Though small, the company was clearly not a novice to government cost-reimbursement contracting.
With all that being said, it is possible that, as is the case with many small businesses growing in the performance of government contracts, EMC2 may not have fully appreciated the ruleset that comes with cost-reimbursement contracts. You know, the whole “cost allowability” thing?
We suspect that may have been the case because, in 2012, the Navy Acquisition Integrity Office (AIO) sent a “show cause” letter to EMC2 regarding certain costs that were deemed to be unallowable. That “show cause” letter was the result of an investigation and threatened debarment of EMC2 “pursuant to FAR 9.4.” The costs at issue were incurred and billed to the Navy between 2000 and 2005. Among the questionable costs was the salary of Cortine McGowen. According to the show cause letter, Ms. McGowen had told investigators that she worked as a housekeeper at the residence of EMC2 's prior owners, instead of at EMC2's offices. If she was a personal housekeeper then her salary would have been an unallowable personal expense, and not an allowable business expense.
Let’s digress here and state, for the record, that we have seen many instances where personal and business expenses are conflated on the books. All of those instances have been small businesses—sole proprietorships—where the owner(s) did not have a strong appreciation of the difference between personal and business expenses. If you are a sole proprietor (or even an S Corp.) it can happen. The job of the accountant/bookkeeper in such circumstances is to keep the personal and business expenses separate; but if the owner doesn’t provide good direction, that job can be challenging. Mistakes can happen. We’ve seen it.
Although EMC2 disputed that the questioned costs were unallowable, within a year it had refunded $249,851 to the Navy.
Meanwhile, the company kept incurring costs and submitted proposals to establish final billing rates, as required by the contract clause 52.216-7 (“Allowable Cost and Payment”). With respect to its proposals for Fiscal Years 2010, 2011, 2012, and 2013. In each of those proposals—which we assume were properly certified—EMC2 included its legal expenses associated with supporting the investigation and crafting the legal settlement. With respect to FYs 2010 and 2011, DCAA (apparently) alleged that the legal costs were expressly unallowable, but the cognizant contracting officer waived the penalties, as permitted by FAR 42.709-5(c).
Another digression: if you are unfamiliar with expressly unallowable costs and associated penalties, we’ve written about them on this blog. Consider starting here.
When DCAA got around to auditing EMC2’s final billing rate proposals for FYs 2012 and 2013 (an audit that commenced in 2017), it once again questioned the allowability of the legal costs, pursuant to the cost principle at 31.205-47(b)(4). In January 2018, the contracting officer agreed with DCAA that the questioned legal costs were expressly unallowable and assessed a penalty of $53,614 (an amount that included interest). The contracting officer also rejected EMC2’s request for a waiver of the penalty.
EMC2 appealed the COFD to the ASBCA. EMC2 chose not to be represented by an outside attorney before the Board and, instead, proceeded pro se. The company’s President, Dr. Park, represented the company. We’ve written about this situation before.
EMC2 advanced two arguments in its appeal—(1) the questioned legal costs were not expressly unallowable, and (2) even if they were expressly unallowable, the company should be entitled to a waiver (as it apparently received for its FY 2010 and 2011 proposals). As part of its arguments, the company noted that the government “failed to inform” it that the government was disallowing the legal costs in EMC2's FY 2010 and 2011 final billing rate proposals until after it had already submitted its FY 2012 and 2013 final billing rate proposals.
The arguments were unavailing. Judge Sweet, writing for the Board, found that the costs were both expressly unallowable and that EMC2 was not entitled to a waiver of penalty and interest. With respect to EMC2’s argument that the legal costs were not expressly unallowable, he wrote—
The express provisions of the FAR specifically state that costs incurred in connection with any proceedings—including investigations—brought by the government for a violation of the law that result in disposition by compromise are unallowable if ‘the proceedings could have led to debarment.’ FAR 31.205-47(a)-(b). Here, EMC2 incurred the legal costs in connection with the DOJ and AIO investigations for a violation of the law. Moreover, EMC2 disposed of the investigations by compromise when it refunded the Navy $249,850.90 in 2013. Further, the investigations could have resulted in debarment, as the Navy informed EMC2 in the December 10, 2012 letter. Because there is no genuine issue of material fact suggesting that it was reasonable under all of the circumstances for a person in EMC2' s position to conclude that the legal costs were allowable, there is no genuine issue of material fact but that the legal costs were expressly unallowable.
(Internal citations omitted.)
A bit of commentary on the above. Of course, we are not attorneys so what do we know? But we remember a bit of controversy we reported on this site a few years ago regarding the definition of “expressly unallowable cost.” The definition used above by Judge Sweet seems to come straight out of the DCAA audit guidance. That same DCAA audit guidance was criticized by real attorneys at Crowell & Moring for a significant departure from the definition found in CAS 405.
Now, you might argue that, as a small business, EMC2 wouldn’t be subject to the requirements of CAS 405. But you’d be wrong. First, the phrase “expressly unallowable cost” is defined in the FAR (see 31.001, Definitions). Second, FAR 31.201-6 (“Accounting for Unallowable Costs”) requires that all contractors subject to the cost principles comply with the requirements of CAS 405, regardless of whether they are actually CAS-covered. 31.20106(a) states “The practices for accounting for and presentation of unallowable costs must be those described in 48 CFR 9904.405, Accounting for Unallowable Costs.” Therefore, while we are not attorneys, we suspect that, had an attorney been arguing the case, that attorney might have asserted that the Board was making an error of law. But as we previously stated, what do we know?
Back to the case at hand.
With respect to EMC2’s argument that the penalty should be waived, Judge Sweet wrote—
The government also is entitled to judgment as a matter of law on EMC2's claim that it was entitled to a penalty waiver because there is no genuine issue of material fact suggesting that EMC2 had adequate policies, training, controls, and review systems, and that it inadvertently incorporated the legal costs into [its final billing rate proposals].
As part of the decision, it was noted that “EMC2 cannot avoid the penalty by placing the burden of identifying and disallowing the legal costs on the government.”
To the argument that EMC2 was entitled to a waiver because it had updated its policies and procedures, Judge Sweet wrote—
EMC2 also asserts that it updated its accounting policies on January 26, 2017. However, EMC2 points to no evidence to support that assertion. Even if it had, that would not be a basis for a penalty waiver. In order for the penalty waiver to apply, a contractor must have policies established at the time it submitted its erroneous [final billing rate proposal]. FAR 42.709-5. Thus, even if EMC2, as it has alleged, updated its policies on January 26, 2017 this was after its submission of the 2012/2013 [proposals] on June 30, 2016 and it cannot avail itself of the penalty waiver. Indeed, by asserting that it did not update its policies to address the error until January 26, 2017, EMC2 effectively concedes that it did not have adequate policies in place at the time it submitted the 2012/2013 [proposals] on June 30, 2016.
(Internal citations omitted.)
Another digression: if you want to read about waivers and how that all works, check out this article.
Judge Sweet also disposed of EMC2’s argument that it should only pay a penalty on unallowable costs associated with the value of the compromise. In other words, since its settlement was only 55% of the amount of originally questioned costs, it should only have to pay 55% of the penalty (and interest) amount. Citing to a General Dynamics case, the Judge found EMC2’s arguments unpersuasive.
Let’s sum this story up.
A small business—what looks like a sole proprietorship—grows through receipt of cost-reimbursable government contracts. The company appears to not fully understand the accounting requirements associated with those contracts and, as a result, it makes some mistakes with respect to claiming unallowable costs as allowable costs. It gets investigated and, although it settles its legal problems, it compounds and complicates its situation by claiming the legal costs associated with its problems as allowable costs, in contravention of FAR Part 31 requirements. The company believes imposition of penalties is wrong so it appeals to the ASBCA. It represents itself before the Board. It loses on a government motion for summary judgment.
The end.
One final digression: growing companies tend to not appreciate the changing risks in their environment. We wrote about that phenomenon over here. If you are a growing small business, or a large business with a growing supply chain, we suggest you check it out.
CID Authority Centralized in DCMA CIG
Previously on Apogee Consulting, Inc.:
-
We told you about a DPAP Memo announcing the creation of six (6) Commercial Item Centers of Excellence, each “staffed with a cadre of engineers and price/cost analysts to advise” COs in how to make commercial item determinations. The six CoE’s (located in Tampa Bay, Denver, Indianapolis, Phoenix, Boston, and Philadelphia) are collectively known as the Commercial Item Group (CIG). That policy Memo clearly stated that “the responsibility for commercial item determinations remains a PCO responsibility.”
-
We reported that a final DFARS rule had been issued and that DoD had (finally) issued its Commercial Items Handbook (version 2.0). The final version—issued literally nine years after the draft had been published—came in two volumes (“Commercial Item Determination” and “Commercial Item Pricing”), and we provided a link to that new Handbook, which was now called a Guidebook.
Now we present:
On December 20, 2018, the Acting Principal Director, DoD Defense Pricing and Contracting, issued a short policy Memo that stated “effective immediately, DCMA CIG Contracting Officers will serve as determining officials for all commercial item review requests submitted to DCMA. … Determinations by the CIG will relieve buying activity Procuring Contracting Officers (PCO) from duplicating effort expended reviewing the CIG recommendations to determine whether an item meets the FAR 2.101 definition of ‘commercial item’ as well as provide consistency in the commerciality review process.”
Thus, the responsibility for commercial item determinations (CIDs) has been transferred from the DCMA PCOs to the DCMA CIG COs. (Acronym soup for the win, right?) The CIG COs will make the call on the CIDs, and that call is final.
Is this a good thing? It depends. Those of us who’ve dealt with the reluctance of DCMA PCOs to make a decision might well think it is a good thing, whereas those of us who’ve been able to sail through a local CID might not look forward to having the “pros from Dover” reviewing the commerciality supporting documentation with a fine-toothed comb. Given the “unevenness” of expertise throughout the PCO ranks, we probably tend to bias towards the “good news” side of the spectrum.
Of course, your mileage may vary.
|
