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DCAA Issues New Guidance on Labor Testing

Nick Sanders
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Recently the Defense Contract Audit Agency (DCAA) issued several new pieces of audit guidance (called Memoranda for Regional Directors, or “MRDs”). This one caught our eye. It discusses what DCAA auditors are supposed to do when the “mandatory annual audit” of a contractor’s labor accounting and timekeeping (called a “MAAR 6” audit) was not performed timely, as is required.

As the name implies, such testing is required to be performed annually (though official DCAA guidance says they are performed “continuously”.) Unfortunately, as with many such “required” testing procedures, DCAA has fallen behind and, more often than not, several years pass before an auditor gets around to actually testing the efficacy of the contractor’s timekeeping and labor accounting system.

Failure to perform MAAR audits on a timely basis is a bad thing, since official DCAA guidance says such audits are “core requirements”. In fact, the DCAA Contract Audit Manual (CAM) states—

MAARs 6 and 13 provide for the verification of the existence of prime costs (direct labor and direct materials, respectively) as they are incurred. Therefore, they can be accomplished only during the contractor fiscal year to which they apply.

(Ref. 6-105.3, emphasis added.)

The lack of performance of “mandatory annual audits” is both a symptom and a cause of DCAA’s current inability to issue high-quality audit reports on a timely basis. It’s a symptom in the sense that DCAA has taken a more-than-rigorous approach to performing such testing procedures, turning what used to be a rather straight-forward test into a GAGAS-compliant, massively sampled, workpaper documented, complex behemoth of a project that takes an auditor months to plan, perform, and (eventually) gently escort through multiple layers of management reviews. Thus, these MAAR audits aren’t treated any differently from DCAA’s now-standard approach to performing audits: they take many more hours than they used to and, while they may be bullet-proof from a GAGAS perspective, they add little if any value to anyone. By the time a MAAR audit report has been issued, the contractor has almost certainly closed its books and moved on to another year of contract performance.

In another sense, the lack of performance of the MAAR audits is a cause of DCAA’s problems. In the old days (which some would call the days of sanity), DCAA’s audits were intended to rely on each other. For example, if the MAAR 6 audit findings indicated that the contractor had strong internal controls related to timekeeping and labor accounting, then that finding could be relied on by other DCAA auditors, and thus testing related to labor accounting could be reduced in other audits. In DCAA’s new approach to conducting audits, each audit (generally) needs to stand on its own. No audit can rely on the findings of another; and thus there is little or no ability to reduce testing—which means that audit planning and testing and workpaper documentation take longer (much longer) than they used do.

DCAA has tried to address the timing problem by integrating MAAR audit performance with performance of the 10100 “incurred cost” audits. The CAM states—

During the incurred cost risk assessment process, auditors should determine whether a required MAAR 6 or 13 has been performed. When MAAR 6 or 13 have not been accomplished on a concurrent basis, auditors should ensure other procedures are performed in conjunction with the review of labor and material costs to satisfy the overall audit objectives.

(Ref. 6-106)

The recent MRD provides details regarding those “other procedures” that auditors will need to perform, when the MAAR 6 audits were not performed timely. The other procedures include:

  • For employees still employed, physically observe employee and inquire as to start date with contractor to ensure the employee worked for the contractor in the year under audit.

  • For employees no longer employed, review employee personnel records (e.g., copies of driver license, passport, contractor badge, etc).

  • Validate payment of sampled employees to contractor bank statement, electronic funds transfer, or third party payroll processor records.

  • Review other documents the employee may have created, processed, or approved during the period under audit (e.g., travel records/employee expense reports, W-4s, leave requests).

  • Review statement of work and work orders/authorizations to ensure labor type (i.e., scientist) is required to perform the work.

  • Determine if Contracting Officer has other evidence corroborating employee existence [or that an “employee’s labor is allocable to the contract”].

The problem is, of course, that those “other procedures” listed above are really no substitute for performing timely audit procedures. The MRD acknowledges this fact. It states—

In determining the overall opinion, auditors should consider such things as audit risk, significance of claimed labor costs, and contract mix. In most cases, when we have not performed real-time testing of labor, the audit team should issue a qualified opinion, even when performing alternate procedures. If the alternate procedures do not provide sufficient appropriate evidential matter, the audit team may not be able to opine on the labor cost element resulting in a qualified or overall disclaimed opinion.

If the audit team determines that they have to disclaim an opinion, they should report significant noncompliances that can be supported by sufficient appropriate audit evidence in the appendix (i.e., Other Matters to be Reported).

Thus, a failure to perform the MAAR 6 audit timely requires auditors to perform additional planning and testing during their audit of the contractor’s claimed direct and indirect costs. This will, quite obviously, delay issuance of the audit report even more than is currently the case.

And when the audit report is issued, some four or five years later, it may carry a qualified opinion—or even a “disclaimed” opinion. What does a “disclaimed” opinion mean? According to Deltak’s GovWin web site—

A disclaimer of opinion is issued when there are scope restrictions and the departures from GAGAS requirements are so significant that the examination has not been performed in sufficient scope to enable the auditor to form an opinion.

Thus, the audit report may be useless to a Contracting Officer seeking to use it as the basis for negotiating final billing rates pursuant to the requirements of the FAR and DCMA’s guidance.

Let’s say that again.

If the MAAR audits are not performed timely, DCAA is going to take longer than “the norm” to issue its audit report and, after performance of hundreds or thousands of hours of audit procedures, may issue a report that is of limited (or no) use to the Contracting Officer.

As is so often the case with DCAA audit guidance, we lack the adequate words to express our feelings regarding this latest approach to “serving the public interest as [the] primary customer.”

 

Investing Advice

Nick Sanders
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Let’s start this off with the obvious. I am not a certified financial planner. I am not a certified investment counselor. Anything I know about investing, I’ve learned by making mistakes, not by taking classes. In fact, the last formal class I took on investing was in 1982. I learned then that the stock market was a “random walk,” and that anytime somebody told me they could predict the market’s future, they were either mistaken or lying.

To be clear: I claim no insight or insider knowledge or any expertise in this area whatsoever. So feel free to ignore my investing advice. I really have no business writing about the topic.

And yet, when I discuss investing with my friends, it seems they feel I have something to say—something of value that is worth hearing and thinking about. So, with more than a little trepidation, here is Nick Sanders’ investing advice.

First things first. Are you contributing to your employer’s 401(k) plan? Are you maxing out your annual contribution? What I mean is are you investing as much as you possibly can, and not just the four percent or six percent that will get you the company match? Currently, the IRS permits you to contribute up to $17,500 annually to your 401(k) plan—are you hitting that ceiling?

If you are over age 50, you get another $5,500 in “catch-up” contributions. Are you taking advantage of that additional amount?

Remember, you get a current year tax deduction for your 401(k) contributions. That means your taxable income is reduced by those contributions (you pay taxes on the withdrawals). My first piece of advice: take maximum advantage of the 401(k) rules. Contribute as much as you can, right up to the ceiling. If finances are tight, contribute until it hurts—at least as much as your employer will match, if not more.

Second, save some money. Have some cash on hand to cover emergencies such as auto repairs, appliance replacements, etc. How do you do this? You’ve got to live within your means. If you aren’t making well into six-figures, then don’t act as if you do. Don’t drive more car than you can afford. Remember to factor-in both auto insurance and repairs into your affordability calculations. Don’t buy a more expensive house that you can afford. Remember to factor-in homeowners insurance, repairs and property taxes into your affordability calculations. The goal is to save 10 percent of your paycheck. Sure, that’s a hard goal to reach, and some months you’ll spend more than you make, just because. But try to put money away.

Let’s talk about credit cards. Don’t. Credit cards are a trap and you can easily drown in credit card debt. I know whereof I speak. At one point I had $22,000 in credit card debt. (I’m now debt free.) Even a little bit of credit card debt is an albatross around your neck—being debt free makes you feel so much lighter and less apprehensive.

So pay off your credit cards first. Pay them off as soon as possible. Make a plan and do it now. Don’t invest a single dime in anything other than your 401(k) until you are living free of credit card debt. And never, ever, allow yourself to get behind on credit cards. To that end, cancel as many as you possibly can.

Here’s the thing: you are paying a finance company lots and lots of interest on that credit card debt. How much? Go look and calculate that number yourself. It could be hundreds of dollars per month! Now picture yourself not paying a finance company that money and, instead, investing that same amount into the stock market. Pretty soon, you’ll have several thousands of dollars’ worth of investments!

Let’s put it this way: if you are paying 18 percent interest on your credit card debt, then paying off that debt means you’ve just earned 18 percent! It’s very, very difficult to find any investment that will pay you 18 percent—so paying off your credit cards may in fact be the best investment you will ever make.

Now, assuming you’re debt free and maxing out your 401(k) and saving a few bucks here and there for a rainy day, the next step is to start investing your money. Where to invest?

Here’s a link to a very informative government website that will help you get started. But I also have some opinions, which I will share below.

CD’s pay next to nothing. If you’re lucky, you can make 1.0 percent. And that amount will be taxed. But the good news is, your principal is protected. You’ll make the promised return and you won’t have to worry about it. But the fact of the matter is that 1.0 percent (taxable) isn’t really much of a return; in fact, it’s a pathetic return. If all your money is in CD’s, then you are likely to be losing money, especially in an inflationary environment.

Ditto savings bonds, T-Bills, and money market accounts. You are making right next to nothing on those investments, and what you do make may be taxed.

Municipal bonds, especially tax-free bonds, may look attractive. But remember, the value of the bonds will decline as interest rates increase. You can make your money if you hold the bond until maturity, but if you need to sell it before maturity then you run the risk of losing money.

So pretty much it’s going to be the stock market. You will need to find some way to open an investment account and invest some money in the market. You can open an independent account where you’re in charge of where the money goes, or you can sign up with certified financial planner or some other kind of financial advisor who can guide you.

My experience has been that the best way to go is to sign up with a name-brand company and with a guide whom you trust. How do you find such a guide? The best way is to ask your friends and co-workers for recommendations. Are they happy with their advisor? If so, why? If not, why not?

One way to tell the good ones from the bad ones is to sit down and talk with several. The ones who do all the talking, telling you what you should do and what you need, are not the good ones. The good ones are those who ask a lot of questions about you and your situation and your needs. They don’t try to sell you anything; instead, they seek to match investments to your real needs—after you’ve told them.

Also: annuities. I’ve had annuities for more than a decade and I finally dumped the last one this year. As my guy pointed out, I had been trading lots of investment returns for principal protection that was both somewhat illusory and had never been needed. Even in the stock market crash of 2007 – 2010, I had never needed that protection … and so I was paying for something I didn’t need. All that money is now working for me in the stock market.

Once you’ve gotten your account opened and funded, the next question is where to put the money. Normally, the choice is between mutual funds and individual equities. There is no right answer, because your decision depends on the size of your account (i.e., how much you can diversify on your own) and your risk tolerance. Also, your time horizon matters. How much time will you give your investments to generate a return? Those factors (and others) will help you to determine whether you are going with one or more mutual funds (and which ones), or will be buying individual equities (stocks).

About mutual funds: many of them underperform their benchmark indices year after year, and charge you for the privilege. Before you invest in any mutual fund, make sure you understand the overall goal/philosophy of the fund, what its annual fees will be, and what its Top 10 holdings are. Where do you get that info? From the fund’s prospectus. Don’t invest until you’ve read the prospectus.

Stock index funds are a cheap way to go. Those funds basically mirror their benchmark index (such as the S&P 500) and they don’t charge very much in the way of annual fees.

Exchange Traded Funds (ETFs) are also fairly cheap, but perhaps more volatile than index funds.

When you buy shares of an ETF, you are buying shares of a portfolio that tracks the yield and return of its native index. The main difference between ETFs and other types of index funds is that ETFs don't try to outperform their corresponding index, but simply replicate its performance. They don't try to beat the market, they try to be the market.

I own a mix of stock index funds and sector-specific ETFs. I also own a lot of individual stocks.

I want to talk about investing in individual stocks. Most people I know are nervous about investing that way, because they think that they will lose money if the stock share price goes down. Well, maybe. And maybe not.

If you have sufficient investment funds available, investing in a broad mix of different individual stocks makes a lot of sense to me. In fact, I own 50 or 100 shares of a lot of different stocks. I’m not rich—you too can buy 100 shares of Ford right now for $1,700 or so. You can buy 100 shares of Bank of America for $1,500 or so. You can buy 100 shares of Cisco Systems for $2,400 or so. So for less than $6,000, you can have a stock portfolio that includes an American auto manufacturer, a finance company, and a technology company. That’s not too shabby, in terms of diversification.

I’ve learned a few things about stock investment recently. I say “recently” because it’s taken years and years for these concepts to percolate through my brain, so that I can now say “I get it.”

One of the things I’ve learned is that I haven’t lost any money when the stock price falls, because you never lose (or make) any money until you sell the stock. I bought 10 shares of Apple at $650/share, which seemed like a good buy at the time, as the stock fell from its high of $700/share. I then watched as the share price fell below $400/share. On paper, I had lost $2,500—but in real life I had lost nothing because I continued to hold onto the stock. Today Apple is trading at about $500/share, so I’m still down, but not as much—and it’s all still on paper.

Ideally, when your favorite company’s stock price falls, you shouldn’t think about selling: you should think about buying more. This assumes, of course, that you like the stock for the long-term, which is the correct way to look at things. Most every time I’ve tried to think short-term, I’ve ended-up losing money. Even when I’ve made short-term money, I didn’t make as much as I would have, if I’d held on for a few months longer. Plus, don’t forget that short-term gains are taxed at a higher rate than long-term gains—so it definitely pays to think long-term.

I’ve also learned that there are two ways to make money in the stock market. The first way (which is what most people think about) is price appreciation, or growth. Buy low, sell high. Buy Apple for $100, sell at $700 – make $600 per share profit! And that’s all true. Especially if you hold the stock for at least a year, in which case you get very favorable long-term capital gain tax treatment.

But the other way to make money is through income, or payment of dividends. Many stocks pay dividends to their shareholders. Also, it’s important to note the dividends may be subject to preferable tax treatment if you’ve held the stock for the right length of time. The ratio of the annual dividend pay-out to the current share price is called the yield. That’s a really important concept to get, and it’s one that I didn’t grasp until quite recently.

Let me summarize my investment philosophy this way: when I invest, I’m looking for a return on that investment. The return can come in the form of either income or growth—preferably both. But I’ll take it however I get it.

Let’s look at Apple again. Assume you bought 100 shares of Apple at $700 and it’s currently trading at $500. On paper, you’ve lost $20,000. But while you’ve been holding the stock, Apple has been paying you quarterly dividends at a rate of $3.05 per share ($12.20/year). You’re getting $305.00 each quarter from Apple, just for holding the company’s stock. That’s $1,220 per year—which is what you receive in return for not selling the company’s stock because the price has fallen. Sure, that’s much less than the $20,000 you may have “lost” on paper—but that’s real honest-to-goodness money in your pocket every three months.

Too many people don’t consider dividends when investing in the stock market. But Warren Buffet knows about dividends. His Berkshire Hathaway gets quarterly dividends of $0.14 per share from Coca Cola. Sounds like nothing much, right? But Berkshire Hathaway owns 400 million shares of Coca Cola. That’s an income stream of $56 million every three months. So dividends definitely need to be considered when calculating your return on your investments.

In my investing career, I’ve sold several stocks (and mutual funds) at a loss—generating a capital loss deduction that reduced my taxes. But often, when I look at the dividends I’ve received over the length of my ownership, I’ve actually had a positive return on those investments.

Looking at yields, some of them are quite favorable when compared to other investments (such as CD’s), especially when the tax benefits are taken into account. For example, right now Intel is trading at roughly $22.00 per share, and it’s paying a dividend of $0.90 per share each year, for a yield of just over 4 percent. Compare that to your CD that’s paying you 1.0 percent, or less—and which is fully taxable as ordinary income. Unless you think Intel is going to go bankrupt sometime in the future, why wouldn’t you own it? Do the math.

Let’s say you have $10,000 to invest. You put it in a CD paying 1.0 percent and after a year, you’ve got $10,100, less taxes on the $100 in interest you earned. But what if you took that $10,000 and bought 450 shares of Intel and held it for that same year. Maybe the stock price goes up and maybe it goes down. But over that year, Intel has paid you $405 in dividends—which may have qualified for preferential tax treatment.

Sure, you have to consider commission payments. Commissions and other investment fees can definitely eat into your returns. That’s why choosing the type of investment account you open is so important. You want to have the right account. But putting that aside, the investment returns offered by the stock market seem to make it a no-brainer, especially if you have a long-term view of your investments.

To sum up, I’m not recommending any particular investment or any particular stock. I just wanted to pass on some of my hard-won lessons learned, because some people have told me my approach makes sense to them. I hope you agree.

 

Dept. of Energy Embraces DFARS Business System Compliance Regime

Nick Sanders
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Croggle—To astound, shock, or bewilder.

We found a new word recently that comes from Science Fiction fandom. (See above.) We think it appropriately captures our mood as we learned that the Department of Energy (DOE) has adopted, apparently on a completely voluntary basis, the DFARS Business System compliance regime.

We were croggled.

In a prior article, we reacted with a mixture of wonder, bewilderment, and shock to the notion that the Office of the Inspector General of the United States Postal Service would consider the DFARS Estimating System adequacy criteria to be a set of “best practices.” Apparently, the USPS operating deficit wasn’t large enough; the USPS OIG wanted to add to the deficit by requiring USPS contractors to embrace the same adequacy criteria used by DOD contractors—criteria that have been demonstrated to add a premium of 17 to 20 percent to contractors’ pricing.

Similarly, we were croggled when we read that the DOE published an Acquisition Letter (AL) that implemented “compliance enforcement mechanisms in the form of business systems clause and related clauses that requires the contractor to have acceptable business systems that comply with system criteria.”

And as is the case with DOD contractors, “When a contractor’s business system contains identified significant deficiencies, the contracting officer will be able to withhold a percentage of payments in accordance with the applicable system clause.”

The new compliance regime—which is the subject of a proposed rule to modify the Department of Energy Acquisition Regulations (DEAR)—will not apply to Management and Operating (M&O) contractors. As the notice stated, the rule applies to “applies to DOE and NNSA for non-M&O contracts in support of Capital Assets (as prescribed in DOE Order 413.3 B or latest version) or non-capital asset projects (other than M&O).” Moreover, the rule is to be applied retroactively to existing contracts. The Acquisition Letter stated—

When the threshold and contract type are met, the contracting officer will negotiate bilaterally with the contractor who hold affected contract to incorporate the clauses of this AL into the affected contract within 90 days. The contracting officers will also incorporate the clauses of this AL into affected contracts before extending them or exercising options under them by negotiating bilaterally with the contractors.

Here’s a link to the formal Acquisition Letter, containing all the details.

Readers will note that DOE is adopting only five of the six DOD business systems—MMAS will not be applicable to DOE contractors. We were also a bit croggled at the rationale for adopting the DOD business systems compliance regime. The AL stated—

Contractor business systems and its internal controls are the first line of defense against waste, fraud, and abuse. Weak control systems increase the risk of unallowable and unreasonable cost on Government contracts. … When the contractor has acceptable business systems that comply with the terms and conditions of the contract, this will improve contract performance.

Given the DOE’s rationale, quoted above, it seems puzzling that the M&O contractors would be exempted from the new business systems compliance regime. According to the DOE itself, M&O contracts are “central to the DOE’s business model.” That same DOE document also stated, “DOE relies upon the M&O contractors for the performance of the substantial part of the agency’s mission.” So we are at a loss as to exactly why those contractors would be exempt from the new compliance requirements.

Perhaps additional rule-making, focused on M&O contractors, is planned for the future? We don’t know. But we do know that the current additional compliance requirements focus on contractors that are less essential to the DOE mission, that handle less critical projects, and that spend the smaller fraction of the DOE budget.

If you are a DOE contractor, you had better review the AL and contract language, and be prepared to comply. Expect retroactive implementation on contracts already awarded—which of course will entitle you to an equitable adjustment.

Enjoy!

 

The Christian Doctrine

Nick Sanders
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The Christian Doctrine has little to do with Christianity and much to do with lawyers, judges, and government contracting. You’ll need to be careful with your internet search terms, lest you wind up with very unexpected results! Here’s a link to a Wikipedia entry to get you started.

The Doctrine started with the case of G.L. Christian and Associates v. U.S. in 1963. The litigation originated when the Army terminated Christian’s contract, and attempted to apply the rules associated with then-standard Termination for Convenience clause to the termination settlement. For its part, Christian argued that the Army couldn’t take that approach because it had failed to include the T4C clause in Christian’s contract. The Army prevailed, with the court ruling that the contract should be read to include the T4C clause because it should have been part of the contract if the drafters had followed applicable regulations.

Though the concept has evolved over time, the Christian Doctrine basically states that a government contract will be interpreted to include certain clauses, even if those clauses have been (intentionally or unintentionally) omitted. As of 1993, the Doctrine was held to apply only to “mandatory contract clauses which express a significant or deeply-ingrained strand of public procurement policy,” and not to every clause.

The trick is to know which clauses will be read into your contract, and which ones will not. Courts have not always been consistent in their application of the Christian Doctrine to disputes between the Federal government and its contractors. Some cases have been decided via strict adherence to the Christian Doctrine and others apparently have been decided in spite of the Christian Doctrine. At this point, it’s difficult to assert with any degree of certainty whether any given FAR contract clause will be found to be read into a contract when it’s missing.

We want to discuss two recent cases involving the Christian Doctrine. One comes from the Armed Services Board of Contract Appeals (ASBCA) and the other from the U.S. Court of Federal Claims (CoFC).

Let’s start with the ASBCA case: Space Gateway Support LLC v. United States. The first thing you’ll notice, should you click the link, is that the decision is massive—weighing-in at more than 230 pages. “It must be a very complicated case,” you may well think … before you notice that almost all of the decision has very little to do with the actual case at hand. Instead, Judge Hartman provided a very detailed history lesson, with the apparent intention of supporting his finding that SGS was not entitled to profit or fee on its acquisition of equipment in its cost-reimbursement J-BOSC (“Joint Base Operations Support Services”) contract at Cape Canaveral Spaceport. Judge Hartman found that, though the contractor had been directed to acquire the equipment for the benefit of the government (and title in the equipment passed to the government), it should not be entitled to any fee/profit on the costs of the equipment.

SGS argued that it should be permitted a profit on items it acquired on behalf of the Government, because (a) the contract was not a facilities contract (which would have prohibited a profit), and (b) “it lacked notice it was being furnished ‘facilities’ by NASA because the CO did not include in its contract (which was ‘other than a facilities contract') unspecified portions of standard clauses for facilities contracts and therefore its contract should not include a prohibition against profit or fee on facilities acquired in order to conform with its belief it was not receiving ‘facilities.’”

After some 200-plus pages of the history of government contracts, Judge Hartman concluded that—

… even if we did not hold FAR 45.302-3 to be controlling on NASA's COs and the J-BOSC, we would conclude it applied to SGS's contract here because it presents a significant or deeply ingrained strand of public procurement policy. As we discussed above, we believe that well-established contract law doctrines permit us to conclude a party, such as SGS, who willingly, and without protest, enters into a government contract with imputed knowledge of the government's interpretation--as prohibiting the payment of profit or fee on cost of facilities acquired for the account of the government and use by the contractor--is bound by such interpretation and cannot subsequently claim that it thought something else was meant. … Alternatively, however, we conclude that the prohibition on profit or fee set forth in FAR 45.302-3(c) is incorporated in SGS's contract by the Christian doctrine set forth by the Court of Claims nearly 50 years ago. We recognize the so-called Christian doctrine is not tied to the intent of the contracting parties, is not invoked frequently by tribunals … and is thought by some to provide less certainty than standard contract doctrines because what comprises a ‘significant or deeply ingrained strand of public procurement policy’ may not be readily predictable. … We rely upon the doctrine here as an alternative ruling because the doctrine remains binding precedent … and this is one of those rare instances of a significant procurement policy spanning 95 years of our nation's history.

 

[Emphasis added.]

In a most unusual step, the two concurring Judges issued a separate opinion. It was once sentence long. In fact, the concurring opinion consisted of just four words. Perhaps the two Judges felt Judge Hartman had written more than sufficient verbiage in his opinion?

Looking at the next case, we turn to the matter of Bay County, Florida v. United States. This opinion by Judge Lettow at the CoFC was 11 pages long. Forget the facts of the case; here’s what Judge Lettow ruled—

The government argues that Bay County waived its potential status as an independent regulatory body by [inclusion of] FAR § 54.241-8 in the Sewage Contract — ignoring the limitation of Subsection (a) on application, viz., “[t]his clause applies to the extent that services furnished hereunder are not subject to regulation by a regulatory body.” … the government contends that the only way to give meaning to the Sewage Contract is to treat Bay County as a non-independent regulatory body. …

When a contract subject to the FAR incorporates improper terms of the FAR, the correct provisions of the FAR control. … ‘Under the so called Christian doctrine, a mandatory contract clause that expresses a significant or deeply ingrained strand of procurement policy is considered to be included in a contract by operation of law.’ … In S.J. Amoroso, as here, an improper clause was substituted for a proper clause. … As S.J. Amoroso held, ‘[a]pplication of the Christian doctrine turns not on whether the clause was intentionally or inadvertently omitted, but on whether procurement policies are being ‘avoided or evaded (deliberately or negligently) by lesser officials.’’ … (citing G.L. Christian & Assocs., 320 F.2d at 351). The proper clause was consequently given effect. …

In this instance, inclusion of the clause prescribed for unregulated utilities constitutes such an impermissible deviation. … The text of the FAR is unambiguous in its requirement for inclusion of the proper change of rate clause … The prescribed condition for inclusion of FAR § 52.241-7 is that the utility services ‘are subject to a regulatory body.’ … As established supra, Bay County qualifies as an independent regulatory body, and as such, FAR § 52.241-7 is a required term of the utility contract. Correspondingly, FAR § 52.241-8 is inappropriate. Although deviations may be authorized by the agency head for individual contract actions, such a deviation must be documented and justified in the contract file. … No such documentation or justification is present here.

Accordingly, the Christian doctrine applies and binds the contracting parties to the mandatory contractual term. … ‘Such regulations are law, binding on the contract parties’ when otherwise applicable to the contract, Dravo Corp. v. United States … and ‘need not be physically incorporated into the contract,’ First Nat’l Bank of Louisa, Ky. v. United States …. The court determines as a matter of law that the clause pertaining to independently regulated utilities, FAR § 52.241-7, is incorporated into the contract in place of the improper clause, FAR § 52.241-8, which is physically present.

[Emphasis added.]

So here are two recent cases that use the Christian Doctrine as support for their rulings. In one case, the Judge delved into the arcana of government contracting history to support the finding that the contractor was not entitled to make a profit on items it acquired on behalf of its customer, because the Christian Doctrine resolved any contract language ambiguities in favor of the historical approach to such acquisitions. In the other case, the Judge used the Christian Doctrine to substitute the correct contract clause for an inapposite clause, such that the contractor was entitled to recover its utility rates charged to an Air Force base.

The Christian Doctrine is frequently used in debates regarding what contracts “mean” and what they require of the parties. In point of fact, the Doctrine is inconsistently applied and we assert it’s unwise to rely on it when trying to parse contract language. A much better approach, we believe, is to take pains to fully understand what the contract language means—including discussing seeming ambiguities before execution—so that disputes are avoided.

As we’ve opined before, if you don’t understand your contract, you probably shouldn’t be contracting with the Federal government.

 

Government Establishes Position on CAS 412 Requests for Equitable Adjustment

Nick Sanders
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If you’ve been reading this blog for any length of time, you more than likely have read an article or two on CAS 412. CAS 412 is one of those Cost Accounting Standards that only a very few (possibly psychologically unwell) individuals enjoy delving into. And the truth is, you really don’t need to understand the intricacies of CAS 412 unless you have a defined benefit pension plan. Those many upon many contractors who have defined contribution pension plans instead of defined benefit plans really can afford to stay the heck away from CAS 412, and thus maintain lower blood pressure readings and perhaps a healthier psyche.

For those who enjoy staring into the abyss, we want to recap some of our articles on the topic, in order to establish a historical context.

In May, 2010, we wrote this article, in which we discussed the Pension Protection Act (PPA) and how that public law led to “CAS harmonization”—especially the revisions to CAS 412 and 413. Three years ago, we wrote—

The Standards dealing with defined-benefit pension plans are about to be revised, and contractors will have to change their cost accounting practices in order to comply with the revised CAS requirements.  The changes will lead to an increase in measured pension costs.  A ‘SWAG’ by a DCMA pension expert estimated a 60% increase in pension costs!  Because the cost accounting practice changes are required by the revised Standards, contractors are entitled to an equitable adjustment to contract prices.  They are going to be hitting up their customers for the increased costs.  … The DOD has known about this upcoming day of reckoning for quite some time, and has taken actions that would prevent contractors (and their government customers) from doing anything about it until the CAS Board finishes its rulemaking work.  Yes, you heard that correctly.  The Pentagon has actively prevented DOD programs from creating reserves that would cover the upcoming cost impacts.  … As a result of DOD’s willful blindness, someday soon there is going to be a reckoning, as CAS-covered contractors with defined benefit pension plans notify contracting officers of the contract price increases stemming from the new CAS rules.  DOD has no budget for the price increases and any attempt at proactive planning was effectively halted by the DPAP memo noted above.  Won’t Congress dearly love the upcoming surprises coming its way!

In March, 2012, we wrote an update article, in which we discussed reactions to the news about the costs of contractor pension plans, in which several ostensibly knowledgeable entities and individuals feigned surprise and shock over the additional pension costs stemming from the CAS 412 changes that “harmonized” CAS with the PPA.

About a month later, we discussed a Memo issued by the Honorable Shay Assad, DOD Director of Pricing. That was an important Memo for two classes of contractors: (1) those that had defined benefit pension plans whose cost measurement had been impacted by the CAS 412 and 413 revisions, and who would be submitting Requests for Equitable Adjustment (REAs) associated with their cost increases; and (2) those that had defined benefit plans whose cost measurement had been impacted by the CAS 412 and 413 revisions, but who would not be permitted to submit REAs associated with their cost increases.

Okay, with that background, you are now ready for the latest discussion point: a new Memo issued by Shay Assad, entitled “Guidance on the Cost Accounting Standards Board Equitable Adjustment Process Related to Cost Accounting Standards, December 27, 2011, ‘Final Rule to Harmonize CAS 412 and 413 with the Pension Protection Act of 2006.’”

Whew. With a title like that, you know it’s got to be good!

Notably, the latest Assad Memo states—

Contracting parties have been developing, submitting, reviewing, and negotiating cost impacts since the establishment of the CAS. For these reasons, this well-defined process will serve well in this instant case. However, it must be recognized that the actual impact of CAS Pension Harmonization on affected contracts can be significant even with relatively minor increases/decreases in the interest rate used to compute the minimum actuarial liability and minimum normal cost. Accordingly, included in the attachment [to the Memo] is guidance to ensure that the adjustment to affected contracts is equitable for both contracting parties. This would include an annual assessment and potential adjustment to the negotiated cost impact based upon looking back and comparing the impact between the forecasted and actual interest rates.

Also notably, the Memo states that the contractors who submit REAs will not be entitled to profit/fee on those REAs.

The second point is annoying but perhaps relatively minor. The first point, quoted at length above, is significant and, in our view, inapposite. So we’ll rail a bit on the first point.

The purpose of a cost impact analysis is to establish the cost impact on affected CAS-covered contracts, so that the contracting parties can negotiate a contract modification that acknowledges that cost impact. (Normally, the cost impact is supposed to be a price impact, but see the second point noted above.) The point is, it’s a single negotiation, informed by the cost impact analysis. That impact analysis is really a proposal and it’s audited, more often than not, by the DCAA—just as if it were a cost proposal for new contract work. The parties then sit down and negotiate how the price of one, or more than one, contract will be affected. (See FAR 30.6 and the CAS clause 52.230-6.)

Nowhere does the CAS or FAR anticipate that the negotiation will become an annual affair, with the contract cost impact and resulting modification being adjusted again and again, based on changes to forecasted interest rates. That’s just something created out of whole cloth in order to keep the cost impact to a minimum; it comes from the same place as the notion that a contractor shouldn’t get the profit it would have originally negotiated, had Mr. Assad not forbidden the contracting parties to consider the impact of PPA in their price negotiations.

So in our view it’s kind of an inappropriate approach to negotiating cost impacts. In fact, in our experience, it would take far longer than one year for DCAA to conduct an audit of the interest rates and for DCMA to negotiate contract modifications. Thus, in addition to our philosophical objections, we believe it’s simply unworkable in practice.

Now before you get all worked up, we also consulted other practitioners at affected contractors, at least one of whom attended in person an industry meeting with Mr. Assad to discuss this new guidance Memo. The other folks told us, “it could have been worse.” In other words, they think they can live with it.

And unless you, too, are a fully CAS-covered contractor with a defined benefit pension plan, then it’s their opinion that matters and not yours. And likely not ours, either.

 
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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.