More Good Audit Guidance: More Nice Words
Our last blog article broke a long-standing streak of never having a nice word to say about DCAA. We actually complimented a piece of recent guidance issued to help drive value-added findings in audits of contractor cost proposals. This article also has nice things to say about another piece of recently issued audit guidance. Perhaps this is the start of a new streak?
The audit guidance in question is MRD 13-PAC-002(R), issued March 28, 2013. It concerns the allowability of contractor travel costs under the FAR Travel Cost Principle, 31.205-46. Ostensibly, it does not break any new ground, stating that it only “emphasizes existing Agency guidance.” Despite that somewhat innocuous statement, we suspect its intent is to minimize the issuance of inaccurate audit findings by auditors who either don’t know or don’t care that what the regulations say.
Let us quote the pertinent section of the MRD—
The Government travel regulations provide for two ceiling amounts: one for lodging and one for meals and incidental expenses. However, as provided in CAM 7-1002.3c(2), contractors are subject to only one ceiling, a total of lodging plus meals and incidental expenses. This CAM guidance is consistent with the regulatory intent that the ‘maximum per diem’ rates represent a single combined ceiling.
In other words, contractors can offset higher reimbursements in one area by lower reimbursements in another area. The only ceiling that matters for contractors is the total ceiling, and not the individual ceilings for M&IE and/or lodging, which applied only to Government personnel in travel status.
We think this piece of audit guidance will serve as a good reference for both auditors and contractors. Good job, DCAA. Good job, Donald J. McKenzie, Assistant Director, Policy and Plans.
The Strategy and Tactics of Cost Allocation Structures, Part 5
Part 1 of this series can be found here. We discussed why this is an important—nay, critical—topic for you, worthy of an investment of your time and expense.
Part 2 of this series can be found here. We discussed why you need input from a diverse group of stakeholders. You will want to solicit input from a number of diverse perspectives because your cost allocation decisions—including your decision regarding the emphasis you place on maximizing the amount of direct charges—can affect your corporate culture in perhaps unexpected ways.
Part 3 of this series can be found here. We discussed the importance of making sure the entity’s organization structure reflected how the entity was being managed. We also discussed the notion that precision is not a synonym for accuracy; and that the benefit of precise cost allocations is often not worth the price to be paid, in terms of additional administrative burdens and risks of noncompliance.
Part 4 of this series can be found here. We discussed segmentation and how certain business units are afforded flexibility in their allocation structures in the DCAA Contract Audit Manual (CAM).
In today’s article we want to discuss the little understood phenomenon of “special allocations.” We are going to focus on the practical aspects, not the theoretical aspects. If you want the theory, Karen Manos, of the firm Gibson, Dunn, has the article you want to read.
Without rehashing Ms. Manos’ article, she notes that several Cost Accounting Standards discuss the use of special allocations—including CAS 403, 410, 418, and 420. Only CAS 410 requires the use of special allocations; the other standards are less prescriptive, stating that the contractor and the Cognizant Federal Agency Official (CFAO) “may agree” to the use of special allocations. Or not. (The Standards are silent with respect to what happens if the parties do not agree.)
Let’s start at the beginning. What is a “special allocation”?
A special allocation is a corrective allocation that makes an individual cost objective (allocation recipient) whole from use of the normal allocation methodology. For example, if the normal allocation methodology is to allocate G&A expense on a total cost input base, but one contract has a disproportionately large amount of (say) direct material dollars, that contract would receive too high an allocation of G&A expense, relative to the benefits received. In another example, if the normal allocation methodology is to allocate Corporate Home Office residual expenses (which include Legal) on a headcount base, but one segment has its own Legal department and receives no benefit from the Corporate Home Office Legal function, then if the segment’s headcount was included in the allocation base, it would receive too high an allocation of Corporate HR costs, relative to the benefits received.
In other words, a special allocation is what you do when your standard cost accounting practices do not result in an equitable distribution of indirect costs.
As noted above, the only Standard that requires use of a special allocation is CAS 410. The requirement imposes a duty on CAS-covered contractors to evaluate the functions and activities in their business units’ G&A expense pools and determine whether or not certain final cost objectives are receiving a disproportionate share of allocated G&A expenses, relative to benefits received. The ASBCA confirmed in the seminal Ford Aerospace decision (ASBCA No. 23883) that each contractor covered by CAS 410 has an affirmative responsibility to choose the proper G&A expense allocation base that is best representative of total activity being managed/supported by the G&A function. Even when the appropriate base is chosen, if there are outlier contracts, a special allocation must be used to correct disproportionate expense allocations.
In establishing your cost allocation structure, including indirect cost pools and allocation bases, care must be taken to ensure that the pools are logical and homogeneous, and that the allocation bases are appropriate. (See CAS 418 for more details on homogeneity and the hierarchy of allocation bases.) Often, one or more stakeholders stops the process, essentially via filibuster, by going into a long diatribe about how their operation or their contract is different, and will be harmed by imposition of the new allocation structure. These passionate pontifications are almost always based on customer financial considerations rather than an objective analysis of costs and benefits. Nonetheless, such concerns must be taken seriously and analyzed, to see if the allocation base chosen is the best one, and whether or not there are outliers that will have to be addressed via special allocations.
To be clear, special allocations should be the exception rather than the rule. They are there to address real inequities and not to placate certain stakeholders. Government auditors look with skepticism on such “special” allocations, and Contracting Officers will expect to see a detailed Advance Agreement for their execution before you implement them. However, they are permissible. Indeed, in some circumstances they are even mandated. Thus, you need to keep them in mind when designing your cost allocation structure.
Designing your cost allocation structure is a non-trivial task, one that is worthy of your time and attention. It supports both your near-term and long-term business strategy. The wrong structure and the wrong allocation methods can be the source of enormous pain; but the right structure and the right allocation methods can be the source of competitive advantage.
We hope you’ve enjoyed this five-part series and gotten some value from it. If you’d like to explore this topic further, Apogee Consulting, Inc. is available to assist you.
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In Which We Say to DCAA: GOOD JOB
You would think that, in the more than 650 blog articles published on this website over the past four years, we would have found some complimentary things to say about the Defense Contract Audit Agency. Unfortunately, we have been unable to find very many things for which to praise the audit agency, and thus the complimentary blog articles do not exist. More often, we have been scathing in our assessments of audit guidance and the audit process and lack of quality and lack of timeliness and lack of value-add to the procurement process. It’s fair to say we have not pulled many punches with respect to the Pentagon’s premier audit agency.
Even in a recent article about the rescission of a piece of terrible audit guidance—in which we wrote, “It’s nice that DCAA has admitted a mistake”—we still felt compelled to point out that (a) it took DCAA about four years to recognize it was wrong, and (b) that the only reason that agency rescinded the problematic audit guidance was because an outsider (Shay Assad) told them to. And so even in the midst of saying “good job,” we found significant points of policy disagreement.
We’ve promised our readers that, in the unlikely event that DCAA ever warranted it, we would be among the first to offer positive words and praise. Well, readers, we can hardly believe it ourselves … but here are some positive words and praise for DCAA.
We are talking about MRD 13-PSP-003(R), entitled “Audit Guidance on Developing a Finding in a Price Proposal Audit.” It seems to be a breath of fresh air wafting out of the stinking miasma of the past four years’ of agency audit guidance.
Which is to say: we like it. A Lot.
In all honesty, we were nervous at first, initially bristling at language such as, “the audit team [will be required] to identify and obtain evidence that was not used by the contractor to develop its estimate.” We were prepared to assert that auditors would claim that the contractor’s proposal was inadequate, simply as a pretext for going fishing into the contractor’s accounting system or into other areas. We were nervous that the auditors would be encouraged to substitute their judgment for the judgment of the contractor’s personnel. Happily, that does not appear to be the case.
By way of background, certain larger defense contractors have asserted that a GAGAS-compliant audit simply cannot be performed on an estimate of future costs, especially an estimate based largely on application of technical judgment. Those contractors have complained to certain government parties that DCAA’s touting of “audit findings” in the area of price proposal audits is largely smoke and mirrors.
And as you may know, we here at Apogee Consulting, Inc., don’t think much of asserted “taxpayer savings” associated with questioned and/or unsupported costs. We discussed our point of view in some depth in this article. Our position has been that the only savings that should be reported are those that lead directly to Contracting Officer-negotiated price reductions. More specifically, questioned and unsupported costs reported on contractor proposals that never result in an awarded contract should never be claimed as taxpayer savings. The taxpayers saved nothing because the contract was never awarded.
And as you may have gathered over the past 650+ blog articles, we don’t think very highly of any audit report that does not assist the Contracting Officer in reaching an equitable negotiated settlement with the contractor. Far too often, DCAA audit findings of “unsupported” and/or “questioned” costs with respect to contractors’ estimated future costs don’t add value to the negotiation process (for various reasons) and thus the Contracting Officer is no better off than if s/he had never requested field pricing assistance in the first place.
Well, the good news is that the new audit guidance seems to be a strong attempt to push auditors into going beyond “questioned” and/or “unsupported” proposed costs and, instead, develop meaningful audit findings that would actually add value to the price negotiation process. If implemented as drafted, this could go a long way towards rectifying past problems and returning DCAA to its previous place as an integral part of the DOD contract award process.
The MRD stated—
To ensure our audits bring the greatest possible value to the acquisition process and we deliver a quality product, the audit team should plan and perform procedures to develop elements of a finding that are relevant and necessary to achieve the audit objectives. The audit procedures may disclose that the contractor’s estimate does not comply with the audit criteria (i.e., FAR Part 15) because the contractor’s estimating method or the set of underlying data used to develop the estimate were incomplete or inconsistent . In these instances, the audit team should gather the appropriate evidence and perform the necessary procedures to quantify the effect of the noncompliance and report the difference as questioned costs. On occasion, this will require the audit team to identify and obtain evidence that was not used by the contractor to develop its estimate. … The audit team should make all practical attempts to obtain the appropriate evidence and apply the necessary procedures to determine questioned costs. If the evidence obtained from the contractor together with evidence obtained from other sources does not permit reaching a definitive conclusion on the impact of the noncompliance, the audit team should then classify the costs as unsupported.
The audit guidance clearly discourages those auditors who—
… have chosen to immediately classify all proposed costs associated with significantly deficient estimates as unsupported rather than applying the necessary procedures to develop the finding that are relevant and necessary to achieve the audit objectives and quantify the impact as questioned costs.
Instead, the audit guidance directs auditors as follows—
The audit team should develop a sound position by evaluating the contractor’s cost data provided in support of its price proposal and, if necessary, other evidence available either in the contractor’s files or from other reliable third-party sources. The audit team should gain a clear understanding of the audit criteria, the contractor’s basis of estimate, and the underlying supporting data as soon as practical after receiving the proposal. Professional judgment must be used to determine if the proposal is sufficiently adequate for audit, following the guidance at CAM 9-204 (i.e., all reasonably available data has been submitted or identified). If the proposal is deemed adequate, or the proposal is inadequate but the contracting officer maintains the request for audit (see CAM 9-205d), the audit team should design procedures in order to detect noncompliance with the audit criteria (e.g., FAR 15/31). If the estimating method and/or the condition of the underlying data have caused the proposal not to meet the audit criteria, the audit team should follow the ‘Rules of Engagement’ and immediately discuss the potential noncompliance with the contractor to ensure an accurate understanding. If a noncompliance is identified, the audit team should plan and perform procedures to develop the elements of the finding that are relevant and necessary to achieve the audit objectives (2011 GAGAS 5.11).
The MRD includes a three-page FAQ attachment that provides additional reinforcing guidance. It’s very helpful and you should review it. For example—
Question 7:
A proposal we are examining includes significant direct labor hours based on engineering estimates, despite the fact that this is a follow-on contract. The contractor contends that the historical hours are not representative of future performance due to design changes directed by the request for proposal. We disagree with the estimating method, believing that historical direct labor hours should be considered. If we use the historical hours to help determine the reasonableness of the proposed hours, we would essentially be fixing the contractor’s proposal, which would require a lot of time and possibly impair our independence. Is it appropriate to classify the proposed labor hours as unsupported because the estimating method is flawed?
Answer:
No. First, you should gather evidence to evaluate the contractor’s estimating method. If the evidence indicates that historical labor hours, properly adjusted for the effect of validated design changes should have been considered in the estimate, you should use the historical labor hours to fully develop the audit finding. The audit team may disagree with an estimating method, which often requires obtaining and evaluating evidence not used by the contractor to develop its estimate. While the estimating method may not necessarily be a FAR 15 noncompliance, the audit procedures may disclose a portion of the contractor’s labor hour estimate is unreasonable (e.g., FAR 31.201-3). The audit team should also consider the need to issue a deficiency report for noncompliance with the DFARS Estimating System Requirements (e.g., DFARS 252.215-7002(d)(4)(ix)). In addition, the auditor is reminded that developing the elements of an audit finding that is relevant and necessary to achieve the audit objectives should not be considered ‘fixing’ the contractor’s proposal and does not impair auditor’s independence.
(Note: We do not necessarily agree that 31.201-3 would be applicable to an estimated cost.)
As you can see from the foregoing example, the audit guidance seems designed to direct auditors to do sufficient procedures to develop quantitative, substantive, and value-added findings. It seems designed to minimize “unsupported costs,” which are difficult for Contracting Officers to deal with in price negotiations.
We like it. We like it a lot.
Good job, DCAA! Good job, Donald J. McKenzie, Assistant Director, Policy and Plans!
We need more like this.
New DCAA Audit Guidance on Healthcare Costs Associated with Ineligible Dependents Admits Past Mistakes (Sort Of)
Oh this is a good one.
If you’ve read our stuff, you know that this so-called “issue” has never been an issue except in the minds of a couple of DOD Senior Executives and some DCAA auditors. Essentially, it’s an issue that’s been almost entirely fabricated and hyped-up to amazing levels, when in reality it’s been (at best) a minor ankle-biter that never amounted to a pittance of an immaterial impact at any major contractor ever audited.1 In our view, it has become the poster child that illustrates how a few DOD leaders, fed by misinformation from below and eager to trumpet a new assertion of contractor misbehavior, have used their power to exercise contractors for no good reason.
We discussed this issue in some depth in this article.
We explored some of DCAA’s “audit findings” related to the issue over here. We cited several examples of questionable “findings”—including one audit report wherein DCAA questioned $20 million of health and dental insurance costs “because the contractor lacks adequate documentation and internal controls to verify eligibility.” And that was just one of the bizarre ineligible dependent “findings” DCAA foisted off on Contracting Officers as a result of allegedly GAGAS-compliant audits.
Regardless of our views on this “issue,” the DAR Council believes it’s real—to the extent that it is in the middle of an attempt to revise the DFARS in order to penalize contractors for failing to spend many thousands of dollars in order to prevent the incurrence of a few hundreds of unallowable dollars (metaphorically speaking).
DCAA may have finally realized that its approach to this issue was flawed, because it just issued new audit guidance. The MRD states—
This memorandum transmits a February 17, 2012 memorandum from the Director of Defense Pricing (DDP) to the Directors of DCAA and DCMA regarding unallowable costs for ineligible dependent health care benefits. The DDP memorandum states that costs incurred for ineligible dependent health care are unallowable under FAR 31.201-3 and violate the selected cost principle at FAR 31.205-6(m); however, these unallowable costs are not expressly unallowable.
Therefore, auditors should not pursue application of penalties under FAR 42.709 to the questioned ineligible dependent health care benefit costs. Accordingly, auditors also should not cite contractors that fail to exclude these costs from Government contracts for noncompliance with CAS 405.
We are updating the guidance provided in MRD 09-PSP-016(R) and MRD 11-PAC-002(R) for the clarifying guidance provided in the DDP memorandum and will incorporate it into CAM 7-505, 7-506.6, 8-502.5, and the audit program titled Incurred Insurance Cost, CAS 416 and FAR Compliance. Accordingly, once the guidance is updated, we will cancel MRD 09-PSP016(R) and MRD 11-PAC-002(R).
Well, isn’t that special.
The audit guidance first issued in August, 2009, is being rescinded because the Director of Defense Pricing told DCAA it was wrong. Let’s be very clear on this: it’s been nearly four years since the audit guidance was issued. It’s been nearly four years that DCAA has been tormenting contractors and forcing them to support audits and to prepare CAS cost impacts for an imaginary non-compliance with CAS 405. It’s taken four years for everybody to calm down and take a deep breath and realize that they have been wasting everybody’s time.
And wasting many thousands of taxpayer dollars.
The audit agency is changing course. What should the auditors (and Contracting Officers) do with the old reports? Here’s what the MRD says—
In instances where a FAO issued a report in which it identified ineligible dependent health care benefits costs as expressly unallowable and recommended the application of penalties, the FAO will need to supplement the report or document that a supplement would not serve a useful purpose. If the FAO issued a report citing the contractor for noncompliance with CAS 405, the FAO should consider the DDP memo a subsequent event that, if known at the time the FAO issued the audit report, would have affected the audit results. When this type of event occurs, Generally Accepted Government Auditing Standards (GAGAS) require that the auditor disclose this information to the parties currently relying on or likely to rely on the audit report. The disclosure to the contracting officer should describe the nature of the subsequently acquired information and the affect it would have had on the audit report. It should advise the recipient not to rely upon the audit report. The FAO also should include adequate documentation in the working papers and the FAO’s permanent files to ensure that auditors no longer rely on the audit report.
[Emphasis added.]
So here’s the thing.
It’s nice that DCAA has admitted a mistake. It’s nice that the audit reports issued under the past four years of erroneous guidance are (in effect) being rescinded. That’s good.
DCAA was wrong. We’ve been telling our readers that DCAA has been wrong for four years. And they have finally admitted it—but only because Shay Assad told them so. Not because they recognize what the FAR says, but because a Senior Executive at DOD told them they were wrong.
Why does it take a memo from DDP to get DCAA to reassess its position? Does the audit agency not have sufficient internal resources to determine—on its own—what its audit positions should be?
More to the point, if DCAA changes its positions on regulatory compliance solely based on the direction of an outsider—somebody who’s not even a CPA—what does that say about the independence of DCAA?
Think about it.
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