Giving Auditors Real Time Access
For several years DCAA leadership has grumbled about contractors’ failure to give them online and real time access to accounting data. For example, in its GFY 2012 Report to Congress, DCAA stated—
Read-only access to the contractor’s books and records would greatly assist DCAA to effectively plan and perform all of the audit effort at a contractor location. This is especially important at contractors with highly complex Enterprise Application Integrations environments and Enterprise Resource Planning systems.
Contractors are increasingly generating and storing accounting data and records in a digital environment. Whether it’s an Electronic Timecard System, an Electronic Management Records system storing invoices/vouchers, or an automated General Ledger journal entry posting and reconciliation of accounting records within an enterprise accounting system, original accounting source data and records have become increasingly developed and available solely within electronic environments and formats. DCAA has always maintained that direct access to contractor original accounting ‘books of entry’ or source records, whether manually or electronically generated, is authorized under FAR 52.215-2 Audit and Records—Negotiation. Nonetheless, many contractors have denied DCAA the read-only access to their electronic accounting systems data. Accessing these source records is necessary for DCAA to efficiently perform its audit mission and support the Contracting Officer.
Specificity of the authority for direct and online access to contractor’s data would improve both the audit and DCAA’s ability to support the Contracting Officer. For example, direct, read-only online access would allow DCAA to respond more quickly to contracting officers because we could obtain the necessary data directly rather than having to repeatedly request the data from a contractor representative. Furthermore, the access would decrease the amount of costs and personnel resources needed by contractors to support audit requests for data. In addition, online access would advance DCAA audit efforts by allowing real time contract cost monitoring and continuous risk analysis, including the use of advanced data analytics. DCAA is continuing to determine what specific legislative proposal is necessary to ensure that DCAA has appropriate access to a contractor’s online data.
Permit us to respectfully disagree with the foregoing. We disagree with both the premise and conclusions put forth in the official report from DCAA to the U.S. Congress.
We disagree with the foundational premise that the contract clause 52.215-2 grants to DCAA auditors the right to access contractors’ electronic systems—including systems on which accounting data are stored—at their discretion and without limit. Indeed, a review of the clause language indicates that DCAA does have broad access, but certainly not unfettered access. For example, the clause grants DCAA access to the contractor’s physical plant—but only the parts of the plant “engaged in performing the contract” and only at “reasonable times.” Consequently, it seems unlikely that a court would interpret that clause as granting DCAA open access, 24 hours per day, seven days per week, into a contractor’s accounting system, to include those aspects of the accounting system unrelated to government contract costs.
Moreover, we disagree with the notion that online access to contractors’ accounting systems would permit DCAA auditors to “respond more quickly” or increase efficiency. We disagree with the implicit accusation that contractor audit liaison personnel are unresponsive to DCAA audit requests (“repeatedly request the data”). And we certainly disagree with the conclusion that, if DCAA had unfettered online real time access to contractors’ accounting systems, then those contractors could lay off their audit liaison personnel (“decrease the amount of costs and personnel resources needed by contractors to support audit requests”). We disagree with essentially every single word written by DCAA leadership to Congress.
We disagree because our experience has proven otherwise.
Now, we need to be careful here, because of client confidentiality. But following are some general statements based on our first-hand experience.
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Modern ERP accounting systems are expensive, complex, and difficult to learn. In order to learn the contractor’s individual, customized, implementation of Oracle Financials, PeopleSoft, SAP R/3 or whatever, employees often have to take multiple classes spanning many hours if not weeks of training. These multi-segment systems don’t come out of a box; nor are they birthed, like the goddess Venus, fully formed and riding in a seashell. So who’s going to train the DCAA auditors in the nuances of the contractor’s ERP? The contractor? Don’t be ridiculous. Show us that requirement in a contract clause; we are confident you will not be able to do so. (Truth be told we know of at least one contractor who’s spent tens of thousands of dollars training DCAA auditors in accessing its ERP system. The problem is that the auditor staff doesn’t stay the same, auditors forget how the system works because they only access it every so often, etc. Thus, the contractor spends more money every year retraining DCAA auditors.)
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Modern ERP accounting systems have rigorous security features, including individual roles, rotating passwords, and automatic account disablement based on too many login errors or a failure to access the system within a given time period. For example, if a registered user doesn’t access the system at least once every six or eight weeks, then the account is disabled. Thus, if an auditor doesn’t access the system every so often, then the account may be disabled and the auditor will be prevented from accessing the system thereafter, until the account is reset. In order to get the account reset, the auditor will have to call the contractor’s IT Security function. How will the auditor get the name/number of the right person to call? Don’t say the auditor should call the contractor’s audit liaison personnel, because they were laid off when DCAA was given their system access. The fact of the matter is that where DCAA auditors have been given access to contractors’ ERP systems, the contractor will subsequently spend a not-insignificant amount of time maintaining that access on behalf of the auditors. In other words, giving DCAA auditors access to the accounting system costs more money, not less.
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When DCAA auditors have been given access to contractors’ accounting systems, a new problem emerges. Suddenly, the auditors’ system reports don’t tie to the contractor’s reports, and now it is the contractor’s job to reconcile the two versions of the report. In other words, now the contractor has to diagnose the errors made by the auditor in running the report. So instead of giving DCAA access leading to a reduction in contractor audit support personnel, the reverse is actually true—the contractor has to add personnel who can review DCAA’s methodology and explain where the errors were introduced. (Yes. This presupposes the errors were on DCAA’s side. That’s not always the case; but it is the case in about 90% of the discrepancies we’ve seen.) Further, notice who is now performing the analyses and reconciliations: it is no longer the auditor and is now the auditee. Ironic, no?
DCAA leadership would like Congress and others to believe that DCAA’s inability to access contractors’ accounting systems in real time is a significant impediment that delays audits. That assertion is demonstrably wrong. Experience has shown that, the more access auditors are given, the more problems are created, the more work is generated for contractor support personnel, and the longer the audits take. Experience has shown that the most efficient way for DCAA auditors to get the accounting information they need for their audits is to simply and clearly request it from the contractor’s personnel who are trained in the system and know how to extract it.
DCMA Moves Forward Without DCAA
In another one of those “we told you this was happening and now it has come to pass” sort of things, we report today that—in the words of DCAA leadership—“DCMA policy will now encourage completion of Forward Pricing Rate Recommendations (FPRR) within 30 days of Forward Pricing Rate Proposal (FPRP) receipt and to start Forward Pricing Rate Agreement (FPRA) negotiations within 60 days.”
What does that mean?
Well, we think it means that DCMA is tired of waiting for DCAA to complete its audits before entering into negotiations with the contractors.
That’s not to say that DCAA is solely to blame for the inability of the government to enter into FPRAs. DCMA has to bear some of the blame as well, since its process for approving FPRA negotiations is bureaucratic in the extreme. But the fact of the matter is that DCAA’s insistence on “GAGAS-compliant audits,” coupled with a new focus on accomplishing MAAR testing during routine audits (such as FPRA audits), has led to a situation where DCAA is simply unable to complete its audits in time to support DCMA’s negotiations.
Consequently, DCMA has issued new policy guidance that “emphasizes that the input of all technical specialists (including DCAA) is not required to complete the process unless it is necessary to close a critical gap of information. “ Let’s repeat that for emphasis: input from DCAA is not required anymore.
We learned of this change from DCAA itself, via issuance of a new MRD.
What else did we learn from the new DCAA MRD? We also learned that DCMA thinks it can move forward without DCAA because “DCMA is growing their cost monitoring function” and “DCMA believes that the FPRP audit should confirm information acquired during the cost monitoring process.”
Interestingly, the MRD tells DCAA auditors to keep on performing those FPRA audits, even though DCMA won’t be relying on them anymore. First of all, the MRD tells DCAA auditors to support DCMA audits by communicating “known audit issues” during DCMA negotiations. (This despite those known issues not being supported by any type of GAGAS-compliant conclusions.)
Second, the MRD tells DCAA auditors to issue their report despite the fact that an FPRA has been executed, so that the DCMA contracting officer can use the report’s findings to enter into a new (we assume more favorable to the government) FPRA. We can’t speak for all contractors, but we suspect that if the government wants to rescind the just-executed FPRA and implement lower billing rates, the contractor is not going to feel as if the government negotiated in good faith.
Furthermore, by the time DCAA issues its GAGAS-compliant audit report, we bet the contractor will have already submitted a new Forward Pricing Rate Proposal (FPRP), mooting DCAA’s findings to a very large extent.
This DCAA MRD may be the beginning of the end for the entity that once was inarguably the Federal government’s premier audit agency. If DCMA will no longer be relying on DCAA for Forward Pricing Rate input, where else can they do without the auditors?
One answer to that question comes from Redstone Consulting. In the firm’s recent blog article, it reported that—
… DCMA has started hiring auditors away from DCAA to perform, among other things, CAS disclosure statement reviews. DCMA says they don't need a GAGAS compliant audit to make a determination of adequacy. They only need enough information to make an assessment. … Of course one of our other former DCAA Managers is right with his assessment after I informed him of this latest blow to DCAA’s credibility. DCAA Management probably wouldn't object. With the agency’s apparent single-minded goal of increased dollars audited with corresponding savings as evidenced in emphasized remarks in reports to Congress and other statements (i.e. $6.5 to $1 ‘ROI’), DCAA wouldn't mind getting rid of this apparent ‘non-value added’ effort. Since they don't count towards dollars audited and they don’t contribute to cost questioned or ROI, why do them?
Is this the beginning of the end for DCAA? Lord knows we’ve predicted it before. So let’s not rush into any conclusions.
But it’s tough to argue that DCMA has not made a profound change to its FPRA negotiation approach by deciding to move ahead without input from DCAA. It’s a message to DCAA leadership from its single largest customer. One wonders where DCMA found the courage to make such a fundamental change.
In completely unrelated news, we heard through sources that Mr. Charlie Williams, Jr., Director of DCMA, has announced his impending retirement effective December, 2013.
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SBIR Phase II Contractor Must Comply with CDA
We have often provided counsel to contractors who have Small Business Innovation Research (SBIR) programs, as they transition from the firm fixed-price contract type of Phase I into the cost-reimbursement contract type of Phase II. That transition requires planning and, almost always, a significant change in the way in which the business is managed. Too many small business contractors cannot make the necessary changes and, as a result, end up in a dispute with their government customers.
For one example of the foregoing, see the hard-to-believe case of PHI Applied Physical Sciences, Inc., which we discussed right here. For another example, take a look at our article on Inframat. For a third example, consider the hard lesson learned by Thomas Associates, Inc.
As we considered the challenges for a small business faced with the transition into cost-type contracting we found the entire topic to be depressing, so depressing that we wrote about the sad situation and noted that the House Armed Services Committee (HASC) had similar concerns about the environment in which small business defense contractors operated.
Now we have another example to add to the stack of sad stories: the appeal by Sperient Corporation of “DCAA’s failure to reimburse Sperient for direct and indirect costs,” which Sperient characterized as being breaches of contract. According to Judge Braden, “Sperient seeks $632,765 in damages of for indirect costs incurred in fiscal years 2007 through 2011 and $168,750 for direct costs related to the leased radar range incurred in fiscal years 2007 through 2010, for a total of $801,515.”
The issues first arose in September, 2012, when DCAA “disallowed indirect costs incurred.” Even though Sperient provided DCAA with “additional details supporting the direct costs incurred,” DCAA “took no action” and in March, 2013, Sperient filed its complaint at the U.S. Court of Federal Claims (CoFC).
“Now wait a second,” we hear you saying, “since when does DCAA get to make the final decisions in cost disallowances, and since when does a contractor get to file a complaint without going through the contracting officer?”
Indeed, the record seems to be murky, because Judge Braden did not see fit to explain DCAA’s role in the direct and indirect cost disallowances. All we know is that “The Military Departments … refused to reimburse various costs incurred by Sperient…” presumably based on the DCAA audit report or reports.
With respect to your second question, Judge Braden pondered the same issue. He concluded the CoFC lacked jurisdiction to hear Sperient’s case, because “the court has determined that the SBIR Phase II contracts in dispute are best construed as procurement contracts that require Sperient to obtain a final decision by the responsible CO, pursuant to the Contract Disputes Act.”
The thing of it is, Judge Braden acknowledged that Sperient’s arguments and precedents were “persuasive” even if ultimately not sufficient to win the argument. Sperient’s counsel, who was very knowledgeable about government contract matters, provided a strong showing that, in other (distinguishable) circumstances, a SBIR award had been found to be other than a procurement contract, and thus the procedural requirements of the Contract Disputes Act would not be applicable. Unfortunately for Sperient, however, its strong arguments did not prevail and the case was dismissed (without prejudice).
Now Sperient needs to go back to its contracting officer and get a final decision, which it must then appeal (again) before a court. Seems like a painful re-do, but if you’ve been reading our blog articles, then you know that the courts strictly construe the CDA’s requirements.
The lesson to be learned here is that it’s really not going to be possible to short-circuit the procedural requirements when you decide to take on the U.S. Government in a contracting dispute. As painfully long and expensive as the process is going to be, if you want to have your day in court, then you need to be prepared for it.
Concurrent Changes to Cost Accounting Practice
This is one of those times when several different threads weave together into a story that demands to be written, even though distractions threaten to derail us from this task. Let us begin.
If you’ve been reading many of the roughly 700 articles on this site, you know several themes have emerged over the course of the past four or so years. One of those themes has been the increase in litigation between the government and its contractors—fueled by adversarial relationships, a general unwillingness to engage in negotiations leading to a compromise, and audit methodologies infused with built-in bias toward generating as much questioned cost dollars as possible. As a result of those factors contractors are too often put into a position where they must choose between acceding to what amounts to government-imposed extortion, or else lawyering-up and litigating the issues before a tribunal.
Another long-running theme has been the failure of the FAR Councils to understand the Cost Accounting Standards (CAS), particularly with respect to quantification of cost impacts related to voluntary (“unilateral”) changes in cost accounting practice. When FAR 30.6 and associated CAS contract clauses were revised in 2005, the FAR Councils essentially adopted the DCAA positions over loud objections from affected government contractors. Unfortunately for all concerned, since then those objections have proven to have been well-founded while the DCAA positions have proven to have been ill-founded.
One of the things that the rule-makers got wrong was the treatment of concurrent changes to cost accounting practice—where the contractor makes multiple changes at the same time, whose individual impacts offset each other. This plays into the interpretation of the phrase “in the aggregate” as it is used in CAS regulations. It also plays into the failure of the FAR Councils, DCMA, and DCAA to understand the difference between the statutory goal of “protect[ing] the Government from payment, in the aggregate, of increased costs” stemming from voluntary changes to cost accounting practice, and the current policy goal of recovering increased costs stemming from such changes.
With that background in mind, consider the following guidance from the CAS regulations–
A contract price adjustment undertaken under section 1502(f)(2) of this title shall be made, where applicable, on relevant contracts between the Federal Government and the contractor that are subject to the cost accounting standards so as to protect the Federal Government from payment, in the aggregate, of increased costs, as defined by the Cost Accounting Standards Board. The Federal Government may not recover costs greater than the aggregate increased cost to the Federal Government, as defined by the Board, on the relevant contracts subject to the price adjustment unless the contractor made a change in its cost accounting practices of which it was aware or should have been aware at the time of the price negotiation and which it failed to disclose to the Federal Government.
Which brings us to a recent decision by the Armed Services Board of Contract Appeals (ASBCA) regarding voluntary changes to cost accounting practice made at two segments of The Boeing Company. The decision came close to being a landmark decision, but missed because it only addressed a part of the controversy. Let’s discuss.
On January 1, 2005, Boeing initiated three voluntary (“unilateral”) changes in cost accounting practice, moving from one CAS-compliance practice to another at its Philadelphia segment. According to Judge Freeman, the impacts associated with each of those changes were as follows—
Change No. 1 $ (790.000) Decreased costs to the Government
Change No. 2 $ (289,000) Decreased costs to the Government
Change No. 3 $1,477,000 Increased costs to the Government
Net impact all changes $ 398,000 Increased costs to the Government
On the same date, Boeing initiated six voluntary (“unilateral”) changes in cost accounting practice at its El Segundo segment. The impacts associated with each of those changes were as follows—
Change No. 1 $(3,724.000) Decreased costs to the Government
Change No. 2 $(1,916,000) Decreased costs to the Government
Change No. 3 $(1,293,000) Decreased costs to the Government
Change No. 4 $ (260,000) Decreased costs to the Government
Change No. 5 $ 1,136,000 Increased costs to the Government
Change No. 6 $ 206,000 Increased costs to the Government
Net impact all changes $(5,851,000) Decreased costs to the Government
A key tactic in the government’s (flawed) approach to analyzing cost impacts from concurrent changes is to ignore decreased costs to the government and focus only on changes that lead to increased costs—thus accepting the lower costs that will be passed on to it, while concurrently demanding repayment of the increased costs. (Apparently government policy makers do not regard this approach as generating a windfall. LOL.)
Because of the (flawed) approach, the parties could not resolve Boeing’s cost impacts and the dispute was still unresolved more than 5 years later. With literally days to go before the CDA Statute of Limitations was to expire, the cognizant contracting officers issued Final Decisions in which it was determined that Boeing owed the Government $1,477,000 for the single Philadelphia segment change and $1,341,840 for the two El Segundo changes (plus interest). As per policy, changes that led to decreased costs were ignored by the contracting officers. Need we say that Boeing appealed the COFDs?
Since Boeing disclosed and implemented its changes to cost accounting practice prior to the FAR Councils’ (flawed) CAS administration revisions, Judge Freeman decided the dispute based on the pre-2005 CAS and FAR language—which was silent on concurrent changes. For its part, Boeing argued that the phrase “in the aggregate” had to mean that all changes to cost accounting practices made at the same time had to be netted against each other. The Government argued that “FAR 30.606(a)(3) is to the contrary and dispositive of these appeals is without merit.” (Sic.) The Government argued that the 2005 FAR revisions merely clarified the previous statutory interpretation. The Judge rejected both parties’ interpretations.
Judge Freeman found a way to decide the dispute without interpreting the disputed language, which is why the decision falls short of being a landmark decision. In point of fact, many contractors have been subject to the Government’s “cherry picking” approach to quantifying cost impacts from concurrent changes to cost accounting practice and everybody desperately needed a bright line decision. Judge Freeman declined to provide that bright line.
Instead, Judge Freeman decided the dispute based on existing government guidance in effect at the time, which included DCMC (Defense Contract Management Command, now Defense Contract Management Agency) guidance to contracting officers and DCAA audit guidance. Judge Freeman wrote—
On this record of the ‘guidance’ and established practice of the government agencies primarily responsible for enforcing the cost accounting standards statute and regulations, we conclude that Boeing could properly combine the 1 January 2005 cost accounting practice changes at each segment for purposes of computing the aggregate cost impact to the government of the changes at that segment.
So that disposed of concurrent changes prior to the 2005 FAR revisions, but left unanswered the question of how to handle such changes after the revisions—i.e., did the FAR Councils have the authority to interpret CAS and, if they did have that authority, did they do so correctly?
(We note for the record that Judge Freeman declined to take judicial notice of the “interim” guidance of the DOD CAS Working Group. This was the body with authority to interpret CAS for the various entities within the Department of Defense, though the body was disbanded long ago. Looking at the guidance of WG 76-8, the Working Group wrote—
The combining, for offset purposes, of several accounting changes within a segment as long as they have the same effective date should also serve to reduce the number of necessary contract price changes. Although individual treatment of voluntary changes could maximize the potential for downward price adjustments, the government’s interests are adequately protected if no overall price increase is paid by the United States.
It’s too bad the FAR Councils ignored those words when, in 2005, it decided to adopt DCAA’s ill-founded positions without much in the way of critical thought. Now both parties are stuck with those ill-founded positions, which necessitate litigation and an appeal for a judicial interpretation based on equity and common sense.
The Boeing decision addresses and solves one facet of the problem, but other facets remain to be solved in future litigation. In the meantime, we expect the Government to file an appeal of Judge Freeman’s decision, because … well, because they can.
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