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Apogee Consulting Inc

Accounting for Offsets – New Proposed DFARS Rule

Nick Sanders
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We note, for the record, that the interim DFARS rule we wrote about here has been reissued as a proposed rule. This is interesting. In our experience the vast majority of interim rules proceed directly to a final rule. Indeed, the issuance of an interim rule (i.e., one promulgated without the “benefit” of public input) is typically justified based on some type of urgency. (As this one was.)

Apparently that urgency has decreased since promulgation of the interim rule, and now there is time to walk back into the normal rulemaking process.

Accordingly, you will have an opportunity to provide your comments on the proposed rule, in addition to comments already submitted on the interim rule. If you don’t sell internationally you likely won’t care; but if you do then you probably will care about the rule quite a bit. We suspect you’ll like it.

The proposed rule would make it easier for contracting officers to find that the costs of “indirect offsets” are fair and reasonable. The DFARS would be revised to state (in part)—

Indirect offset costs are deemed reasonable for purposes of FAR parts 15 and 31 with no further analysis necessary on the part of the contracting officer, provided that the U.S. defense contractor submits to the contracting officer a signed offset agreement or other documentation showing that the FMS customer has made the provision of an indirect offset a condition of the FMS acquisition. FMS customers are placed on notice through the LOA that indirect offset costs are deemed reasonable without any further analysis by the contracting officer.

It also exempts contractors from having to provide certified cost or pricing data with respect to indirect offsets. (If you don’t know what an indirect offset is, you can check out our earlier article on this topic. Or you can read the proposed rule, because it now defines the term with some specificity.)

As we noted in our previous article, offsets are hard to account for. This proposed rule won’t make it any easier, but it will reduce the burden contractors will face when trying to price and negotiate them.

 

 

DOD Attacks IRAD

Nick Sanders
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We already wrote about the final DFARS rule that conditions the allowability of contractors’ Independent Research & Development (IR&D or IRAD) costs on having “informal technical exchanges” with unspecified DOD officials prior to incurring those costs. At the same time, a proposed DFARS rule change was issued that would also impact contractors’ IRAD projects. The proposed rule, if finalized as drafted, would dramatically affect how Source Selection Teams evaluate offerors’ prices during a competition.

The proposed rule is simple. But the impacts are not simple at all. The proposed rule states (in part)—

If the Offeror, in the performance of any contract resulting from this solicitation, intends to use IR&D to meet the contract requirements, the Offeror's proposal shall include documentation in its price proposal to support this proposed approach.

For evaluation purposes only, the Contracting Officer will adjust the Offeror's total evaluated cost or price to include the amount that such future IR&D investments reduce the price of the proposal.

We must (once again) tell you we saw this one coming long ago, and warned our readers about it. When the DAR Council issued its Advanced Noticed of Proposed Rule Making (ANPRM) we commented as follows—

… the value of any related future IR&D projects is an estimated value. It is subject to change based on the financial fortunes of the company and the whims of management. … If a contractor puts those notional values into its proposal, does that make those estimates certified cost or pricing data? If those notional values are certified cost or pricing data, then if the contractor spends less than ‘promised’—is that somehow defective pricing? (Well, no. Because cost or pricing data are facts, not estimates. But you wait and see how many auditors assert those notional IR&D project values are actually cost or pricing data. You heard it here first.)

Additionally, if this proposed methodology is implemented we’ll all have to deal with the fact that IRAD projects are allocated to final cost objectives using the same base as is used to allocate G&A expense. (It’s commonly held that IR&D and B&P costs are part of G&A. That’s not strictly true. But it’s close enough for government work.) Thus, the value of any IRAD projects, for price evaluation purposes, is not the value of the IRAD projects—the value for price evaluation purposes is in fact the value of the IRAD projects that ends up being allocated to the awarded contract after it is awarded.

To figure out the correct value of the IR&D projects, for price evaluation purposes, you will need to know not only the value of the related IR&D projects, but also the percentage of the G&A allocation base that the proposed contract will end up being, after award. That means not only knowing the contract value of the proposed contract, but also knowing the contract values of all the other contracts that will comprise the cost input base used for G&A expense allocation.

In the future. Perhaps years in the future. For the entire period of performance of the contract for which the contractor is submitting its proposal. …

This is a bad idea and you should tell the DoD that it’s a bad idea.

And you should tell the policy makers and rule-makers why it is a bad idea.

The proposed rule ignores much of the cost accounting challenges associated with implementing it. Essentially, it says “we don’t care what the impact to the estimated contract price will really be. Instead we’ll simply add the gross IRAD project expenditure amount to the submitted cost estimate.” Thus, the proposed approach inflates the true cost of the IRAD project expenditure amount with respect to the individual proposal being offered.

Interestingly, the ANPRM notified us of a public meeting to be held March 3, 2106, to accept public input. The proposed rulemaking notification acknowledges that the meeting was held. And yet there is nothing in the background section of the proposed rulemaking notification that discusses the input received. It is almost as if the DAR Council wants to ignore any input. Indeed, since the proposed rule is almost exactly what was described in the ANPRM, it seems fairly obvious that the DAR Council did ignore any negative comments received at the public meeting.

If that’s the way the DAR Council considers input, we have to ask why they bother to go to the time and expense of holding such meetings. Seems like a big waste of taxpayer dollars.

Readers will have another opportunity to be ignored by the DAR Council, because comments are being solicited as part of the rulemaking process. Feel free to submit your comments so that they can be ignored, as has been the case with similar IRAD initiatives.

Why has the DAR Council consistently ignored negative input on these topics?

Well, we’ve recently called out one reason: Better Buying Power 3.0. It calls for these IRAD initiatives. Therefore the DAR Council must implement them. As we recently wrote—

… because BBP 3.0 called for this, it must be correct and its benefits must outweigh the costs. Forget public input. Forget an objective analysis of initiative. Just do it, because it must be done. This kind of magical thinking is reminiscent of religious cults. Please pass the Kool-aid.

All snark aside, we have to realize that the DAR Council is made up of individuals. It might be fair to characterize those individuals as career bureaucrats; you don’t get to that level without dedicating your professional life to the goal. And those career bureaucrats report up a chain of command, and many of them report into OUSD (AT&L). In fact, the Chair of the DAR Council is the Deputy Director, Defense Procurement and Acquisition Policy (DPAP), which reports into OUSD (AT&L). So it should be obvious why an important OUSD (AT&L) initiative such as BBP is going to be rammed through the rulemaking process, regardless of any public input received.

It’s an inherent conflict of interest, and one that works to the disadvantage of most contractors. (Yes, we’re saying the system is rigged.)

In another sense, the way the DAR Council has treated public input on these topics is a symptom of a bigger problem, which is that DoD wants to take contractors’ intellectual property. We wrote about this conspiracy theory right here. We think that article established the ulterior motive for this seeming war on contractors’ IRAD spending. We wrote—

This is not about leveling the playing field by reducing ‘games’ that some contractors can play—tactics that are perfectly permissible under the Federal Circuit’s interpretation of CAS 402 and 420 in the ATK Thiokol decision. No. Instead, this is about obtaining contractors’ intellectual property rights via subterfuge, in the guise of adjusting price evaluations. It’s about taking away the ‘independent’ in IRAD and thereby weakening contractor protections of their IP rights. As we think we’ve shown, the Pentagon has a long history of trying to obtain those IP rights, and the latest DFARS ANPRM fits perfectly into those historical efforts.

If you were to go read that “conspiracy theory” article, you would see that we are not alone in asserting there’s something else going on here. We quote several other—perhaps more respected—sources that make essentially the same argument. Perhaps there might be something to it?

In any case, here we are. DoD is moving forward on its BBP 3.0 plans to better deal with contractors’ IRAD expenditures. You will have an opportunity to go on record with your concerns and objections. They will be ignored. Then, years from now, you can point out that you were right and they should have listened to you.

That’s what we will be doing.

 

 

DoD Tells Lockheed Martin What the F-35 Should Cost, and Means It

Nick Sanders
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It’s been a while since we weighed-in on the DoD’s “should-cost” initiative. Frankly, there hasn’t been much to write about recently. We expressed our early concerns but since then we’ve also experienced two “should-cost” reviews – and they turned-out much better than we thought they would. Much of our passion about why “should-cost” was a wrong approach kind of melted away. (It also helped that the DoD participants seemed to lose their early zeal for the initiative as well.)

Despite saying all that, of course we did keep our eyes on “should-cost” and other related DoD initiatives. For example, we published an article on GAO’s study giving the Better Buying Power initiative a failing grade. Better Buying Power, like “should-cost” is one of those OUSD (AT&L) initiatives that sound great in a PowerPoint briefing, but that don’t work out as well as predicted in the real world outside the Pentagon.

Our point being: these initiatives permit senior leaders to give great testimony before Congress, but we should all be rightly skeptical that they will really ever amount to much. Indeed, sometimes they fail completely.

This may be one of those times.

The Hartford Courant (link above) reported that Lockheed Martin and Pentagon negotiators failed to reach agreement on the price for the next batch of F-35 aircraft. Normally when parties to a contract fail to agree, that would constitute a dispute that would require resolution. Not in this case, though.

Instead, the Pentagon used a “rarely invoked” contract clause to unilaterally establish the contract price at its last offer to Lockheed Martin.

According to the newspaper story—

That deal represented a 3.7 percent price decrease from the last batch of F-35s the Pentagon purchased, and Air Force Lt. Gen. Christopher Bogdan, the program's executive officer, hailed it as ‘a fair and reasonable deal.’

We all know that, of course, the deal must be “fair and reasonable” because the contracting officer has an affirmative duty to determine that the price is fair and reasonable. In other words, it was fair and reasonable because the government determined it to be so.

On the other hand, we might reasonably wonder whether Lockheed Martin viewed the deal in similar terms.

Twelve minutes after the Air Force announcement, Lockheed Martin issued an announcement of its own. According to the Hartford Courant story—

[Lockheed said] the contract was not ‘mutually agreed upon,’ and that the company was ‘obligated’ to produce the aircraft under ‘previously agreed to items.’ It said that it was ‘disappointed’ in the government's action and that while it would ‘continue to execute’ on the program, it would also ‘evaluate our options and path forward.’

Meanwhile, back inside the Beltway, USD (AT&L) Frank Kendall has been under fire by Congressional lawmakers who want to eliminate his position. In response, he recently touted reductions in cost growth associated with major defense programs.

We are forced to wonder how much of the reductions in cost growth came from unilaterally established prices with which the contractor was in no position to disagree.

Regardless, Mr. Kendall says he should keep his job because of BBP and “should-cost” and other initiatives that have led to improvements in the cost of major weapon systems. Even if you think he might be a bit biased (because his job is on the line) you have to give the man props for his chutzpah.

In related news, the 2016 report entitled “Performance of the Defense Acquisition System” was published and Mr. Kendall is using that report as the basis for his personal initiative to keep his job. But that’s not what interests us.

The report also discusses progress made by DCAA.

DCAA is considered to be a part of the defense acquisition system. Perhaps that’s a counter-intuitive thing to say to most of us who deal with DCAA auditors on a routine basis, or to DCMA folks who have had to pick up work formerly performed by DCAA auditors in the past, but nonetheless it’s true.

So let’s see what the official assessment is of DCAA’s performance as part of the defense acquisition system.

With respect to pre-award surveys of contractor accounting systems, the report states that it now takes DCAA an average of 58 days to issue its reports, and that it finds contractors to have acceptable accounting systems 91% of the time. (See page 137.)

With respect to incurred cost audits, the report states that DCAA has significantly reduced its backlog to only 5,700 reports awaiting audit. (Interestingly the report perpetuates the fiction that DCAA is permitted to have two years’ worth of unaudited proposals—some 11,000—as “regular inventory” as if somehow that was okay.) The report states “As part of DCAA strategic initiatives and in support of BBP 2.0, substantial progress has been made since 2011 on reducing the backlog of these audits.”

Speaking of chutzpah, we admire the attempt to give BBP credit for the reduction in audit backlog at DCAA. Readers of this blog know the reality of how the backlog was reduced, and we all know it had exactly zero to do with BBP 1.0, 2.0, 2.1, or 3.0.

But we suppose a man fighting for his job will say just about anything in order to keep it. Who would blame such a man? Not us.

 

 

UPDATE: Palantir Wins First Round Against US Army

Nick Sanders
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We have been following the fight between Palantir and the US Army with interest. We’ve written about it twice, the last time right here. It’s interesting because it vividly demonstrates how actions speak so much louder than words.

On one hand, SECDEF Carter is calling for more innovation, and he’s practically begging Silicon Valley to give the DoD some of that sweet, sweet agile development in support of the warfighters. But on the other hand, institutions such as the US Army are rejecting Silicon Valley innovations in favor of traditional DOD development contracting in accordance with DOD Instruction 5000.02, which describes a ponderous, bureaucratic lifecycle punctuated with Milestone Decisions (gates) that open to permit movement into the next phase of the program.

So, yeah. This is a big deal because it shows that commander’s intent doesn’t mean boo to the bureaucrats in the field, who keep on doing what they’ve always done, despite statutes and regulations and leadership exhortations to the contrary.

Here’s a link to a nice summary of the latest status of the Palantir fight, courtesy of DefenseNews. Palantir apparently was successful in its bid protest at the Court of Federal Claims, with the Judge verbally telling the US Army to conduct market research before choosing its acquisition strategy. As DefenseNews reported—

The judge delivered an oral ruling Monday, ordering the Army ‘to go back and look seriously at whether there are in fact commercial products that can meet its needs either without modification or with some modification, but whether there are in fact commercial products, including from Palantir, that meet its needs,’ … The court upheld Palantir’s central legal argument that the Army violated a 1994 law -- the Federal Acquisition Streamlining Act -- by not conducting the market research needed to determine if commercially available items could meet its needs with or without modification. …

The lawsuit opened up a can of worms on top of what has been a lengthy controversy over whether the Army should scrap its DCGS-A program after spending more than a decade and $3 billion to develop it and go with a commercial, off-the-shelf solution. Soldiers, in Afghanistan particularly, have repeatedly requested permission to use Palantir instead of DCGS-A, as the service continues to work out glitches and problems with its own program.

People who do acquisition for a living might boggle a bit at the notion that the US Army would proposed to spend billions of taxpayer dollars without checking first to see if there was a cheaper, commercial, solution already available. Yet here we are.

But this is not only about a failed acquisition strategy. As we wrote in our last article on the topic—

Palantir has asserted that the Army’s failure to adopt its lower-cost, better functioning product has cost casualties. If that’s true, this is more than a procurement story; it’s a story about failed leadership.

Let us be even more clear this time around.

If it is determined that the US Army did willfully obstruct Palantir and that it did willfully adopt an acquisition strategy to disadvantage Palantir and in violation of statutory and regulatory requirements, then SECDEF Carter should demand the resignation of those involved. If he permits his subordinates to ignore his strategic direction, then he will have zero credibility with Silicon Valley.

 

 

New IRAD Cost Allowability Rule

Nick Sanders
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And then this happened …

The DFARS cost principle at 231.205-18 was revised to require a contractor and a DoD official to engage in an “informal technical interchange” before the contractor spends any money on its IRAD project. The contractor must document the technical interchange in its DTIC submission. (The DTIC submission was already a requirement.) If the contractor does not hold the technical interchange prior to incurring the IRAD project cost, or does not document that technical interchange in its DTIC submission, then its IRAD costs will not be accepted as being allowable costs for purposes of billing DoD.

We told you this was coming, right here.

Actually, we told you way before that article that this was coming. In September, 2015, we wrote—

Contractors who fail to ‘brief’ the unspecified and unidentified DoD technical personnel run the risk that their IR&D expenditures will be determined to be unallowable.

Among the myriad problems associated with this proposed approach is the sheer volume of individual IR&D projects that will need to be ‘briefed’ via technical interchange. Some of the larger contractors have literally hundreds of such projects going on at any given time. For those large contractors, the current requirement to input their project information into DTIC has become a bureaucratic process that adds no value but requires labor—labor that is charged to overhead and passed right back to the DoD buying commands via the contractors’ indirect rates. This approach, if implemented, will make things worse.

For example, who pays for the labor and materials associated with the technical interchange briefings? We don’t think it should be IR&D, because the IR&D effort could take place whether or not the briefings are made. We don’t think the effort should be charged as a direct contract cost—even though the effort would be required by the DoD contracts that contain the new requirement. But we don’t think the buying commands will want to pay for such non-value-added labor that is neither engineering nor manufacturing. Instead, we suspect it will be good ol’ overhead that pays for the briefings. And so the overhead rates will go up and up, and DoD will (once again) pay more for goods and services, because it insists on micro-managing its contractors.

All the foregoing is in addition to the basic problem, which is that DoD will be slowing down contractors, who must now wait to schedule their individual briefings before starting work. So much for agility and innovation.

If you were a reader of our blog, you would have been warned more than a year ago that this was coming. You would have seen our concerns with the approach. You could have submitted your comments to the DAR Council for consideration, parroting our comments or submitting your own concerns. You could have tried to influence the final rule, since the DAR Council is required to consider public comments in the rulemaking process.

Not that any of that would have mattered.

Apparently the DAR Council was determined to issue this revision regardless of public input expressing concerns with it.

For example:

Comment: Several respondents stated that the proposed rule will adversely impact innovative ideas. Another respondent cautioned that the rule will create a barrier to innovation and entry to the marketplace.

Response: DoD believes that this rule supports and promotes innovative ideas and technologies, and will incentivize entry into the marketplace by ensuring that IR&D performers and their potential DoD customers have sufficient awareness of each other's efforts and that DoD can provide industry with feedback on the relevance of proposed and completed IR&D work.

Thus, in the views of the DAR Council, requiring a technical interchange prior to initiating an IRAD project will “incentivize entry into the [defense] marketplace.” Um, no.

Another example:

Comment: A number of respondents stated that the rule will cost taxpayers more. One respondent stated that the rule will impose an administrative burden on contractors, administrative contracting officers (ACOs), and DoD personnel. Another respondent expressed concern with the significant costs associated with planning and conducting technical interchanges and the costs accrued prior to the technical interchange.

Response: While acknowledging that this rule imposes a slight administrative burden on contractors, ACOs, and DoD personnel, such burdens are overshadowed by the net benefit of ensuring that IR&D performers and their potential DoD customers have sufficient awareness of each other's efforts and that DoD can provide industry with feedback on the relevance of proposed and completed IR&D work. Moreover, the long-term priorities outlined in Better Buying Power 3.0 are a strategic imperative for DoD.

Thus, because BBP 3.0 called for this, it must be correct and its benefits must outweigh the costs. Forget public input. Forget an objective analysis of the initiative. Just do it, because it must be done. This kind of magical thinking is reminiscent of religious cults. Please pass the Kool-aid.

Or consider this example:

Comment: A number of respondents expressed concern with DoD responsiveness to requests for technical interchanges, citing that the rule fails to outline DoD's obligations and unfairly saddles contractors with the full consequence of DoD's failure to take part in a technical interchange. One respondent is concerned that the proposed rule creates practical, time, resource, and data disclosure challenges for conducting technical interchanges, and that DoD Components will not have an adequate number of personnel designated to conduct the technical interchanges in the time mandated. Another respondent questioned the recourse contractors will have if DoD personnel refuse to engage.

Response: To assist contractors in ensuring that technical interchanges take place in a timely manner, the rule has been revised to identify the primary DoD focal point for technical interchanges as OASD R&E. Contact information for this office is available at http://www.acq.osd.mil/​rd/​contacts/​. If a Contractor experiences difficulties scheduling a technical interchange, or does not have a point of contact for the technical interchange, the contractor may contact OASD R&E.

In other words, if you have a problem scheduling the technical interchange because DoD lacks sufficient resources to support it, please feel free to send an email expressing your concerns to the Assistant Secretary of Defense, who will immediately drop whatever else was on his plate and attend to your concerns. Yeah, right. Not addressed is what happens in the next Administration, when it is a very real possibility that Congress might not confirm Presidential appointments for a very long period (if at all). To whom do contractors address their concerns if that situation should arise? Guess we are all SOL.

But of course this requirement will not impede contractor IRAD projects whatsoever. Nope. In fact, adding this requirement makes things better! Just ask the DAR Council.

This blasé indifference to the question as to whether or not DoD has sufficient resources to actually implement the rule is quite reminiscent of the DAR Council’s cavalier treatment of similar contractor concerns expressed during consideration of the Contractor Business Systems regulatory revisions. And we all know how that turned out. (Poorly.)

One final example:

Comment: Two respondents stated that the rule will require contractors to establish multiple accounting costs bases and pools.

Response: This rule does not impose new cost accounting requirements. The IR&D cost principle at Federal Acquisition Regulation (FAR) 31.205-18(b) states, ‘The requirements of 48 CFR 9904.420, Accounting for independent research and development costs and B&P costs, are incorporated in their entirety. . . .’ The cost accounting standard at 48 CFR 9904.420-40, Fundamental requirement, paragraph (a) states, ‘The basic unit for identification and accumulation of IR&D and B&P costs shall be the individual IR&D or B&P project.’

In this final example, the DAR Council’s response is seemingly based on utter ignorance of government contract cost accounting principles. Either that or the author of the DAR Council response is being deliberately obtuse and misleading. Why do we say that? Because the new rule requires the technical interchanges to take place prior to IRAD costs being incurred. Ergo, the costs of supporting the technical interchange are not IRAD costs.

All that arm-waving about CAS 420 is simply inapposite. It is wrong because the costs in question are not IRAD costs and thus they are not subject to the requirements of 31.205-18 or CAS 420. Anybody who spent more than 15 seconds thinking about the situation would never have responded in the manner the DAR Council did.

If the costs are not IRAD costs, then what are they?

Nobody knows.

Thus the basis of the concerns expressed by two commenters. Are the costs overhead? Certainly it appears that they cannot be direct costs. If they aren’t IRAD project costs then they must be vanilla G&A or overhead. But from a purely beneficial or causal relationship point of view (i.e., a CAS point of view) the costs of conducting the technical interchanges are most directly associated with the IRAD projects that form the subject of the interchanges. But they can’t be IRAD costs. Therefore we all have a quandary from a cost accounting perspective.

And this matters. It matters because some of the larger defense contractors have literally hundreds of individual IRAD projects, some large and others small (in terms of costs). The cost of supporting technical interchanges, no matter how informal, may well run into the tens (or even hundreds) of thousands of dollars. If you put that cost into G&A or overhead, it gets allocated to all active customers. If you only sell to DoD, fine. But if you sell to multiple Federal agencies, you will end up with the civilian agencies paying for this unique DoD requirement. That doesn’t sound right.

Thus, we are pointed toward some type of special pooling and allocation method, to make sure that DoD pays for its poorly thought-out requirement. That was the basis of the comments.

But the DAR Council ignored those valid concerns and so here we are.

The good news, the silver lining in this dark cloud of bureaucracy, is that the rule only applies to “major defense contractors,” and if you are not one of them you can skate on by. The majors will figure this one out, and they will figure out how to stick DoD with the bill—as they always do. The small businesses, the ones that are not positioned to handle this rule, are not subject to it. That’s the best nugget of news we can offer to our readers.

Otherwise, this rule is going to be problematic for those entities that are subject to it.

 

 
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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.