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Apogee Consulting Inc

Little Things Lead to Big Changes for DCAA

Nick Sanders
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In chaos theory, it’s known as sensitive dependence on initial conditions, or, more popularly, as “the butterfly effect.” Basically, it stands for the theory that a hurricane can be caused by the flapping of a butterfly’s wings a thousand miles away, several weeks before. Looking at a recent DOD Inspector General audit report on the investigation of a hotline report made by a DCAA auditor, we might be able to discern that same effect in action.

We’re talking about DOD IG audit report number D-2011-6-011, entitled, “Report on Hotline Allegation Regarding Lack of Agency Guidance on the Currency of Audit Testing at the Defense Contract Audit Agency,” dated September 21, 2011. You can find a copy of the DOD IG’s report here.

An unnamed DCAA auditor in the Eastern Region began evaluating Northrop Grumman Navel Shipyard’s Earned Value Management System (EVMS) in December, 2008. The auditor’s 90-page audit report had 17 findings. To support his conclusions, the auditor reviewed Contract Performance Reports (CPRs) dated September 21, 2008 “that were available at the time the audit started,” according to the DOD IG report. The audit was completed in August, 2009, and the report was then submitted for supervisory review, which was completed in November, 2009. The report was then forwarded to the Easter Region’s Technical Programs Division, for review by a Technical Specialist.

And that’s when the trouble started.

According to the DOD IG report—

On November 9, 2009, the Eastern Regional Technical Programs Specialist telephoned the supervisory auditor and told him that she would like the auditor to perform ‘current’” testing on more recent Contract Performance Reports. The auditor stated that he selected the most current Contract Performance Reports available at the start of the audit. At that time, no written guidance or policy related to a 6-, 9-, or 12-month testing policy existed. However, the data tested was no longer current by the time the audit was completed. To be sufficient and current, evidence supporting the audit opinion should be reasonably current as of the date of the audit report.

The Eastern Regional Technical Programs Specialist was concerned with the ‘age’ of the Contract Performance Reports and related transaction testing performed by the auditor. [Which, by the time of the review, were more than a year old.] … the specialist stated that it is the Eastern Regional Director’s position based upon discussions held in DCAA Executive Steering Committee meetings that the data tested should be within a six- to nine-month period prior to the issuance of the audit report.

On November 17, 2009, a Program Manager from Headquarters … said that the testing should be updated if it is more than 12 months old. On November 18, 2009, the Eastern Regional Director decided that the testing should be updated for transactions that were tested and are older than nine months. … the Eastern Regional Director directed the auditor to perform additional testing and determine if the original deficiencies were still at issue. Subsequently the Regional Audit Manager advised the Resident Auditor that the opinion stated in the audit report cannot be based on testing performed on contractor Contract Performance Report data from September 2008.

So, in essence, the fact that the audit took more than nine months to complete meant that the evidence used to support the auditor’s conclusions was too dated and no longer acceptable. The auditor was told to get back into the field and continue testing. Those of us who have experienced audits lasting two or more years might look at this direction and think, “Isn’t this just creating a perpetual audit environment where audits never end because the supporting data becomes stale before management signs-off?”

Yes. Yes, it is.

And that’s what the DCAA auditor alleged when he called the DOD IG hotline and reported his management. As the GAO audit report stated—

The complainant alleged that DCAA lacks any written guidance or agency-wide policy regarding the ‘currency’ of audit testing which is causing audit reports on contractor business system reviews to be delayed as a result of retesting.

The DOD IG substantiated the auditor’s allegation that DCAA lacked agency-wide guidance, which contributed to auditor uncertainty regarding when evidentiary data was too old   The IG recommended that DCAA develop such guidance. However, the IG also agreed that, in this instance, the data was too old and that the auditor was properly directed to perform additional testing.

As the IG stated in its report—

The auditor should have tested a representative selection of transactions across the year and not just transactions from reports issued on just one day. We observed that for very large projects such as this, the data tested will never be current unless such audits are scoped and resourced adequately. This particular audit only had two auditors assigned. Cost Performance Reports are submitted monthly for the nuclear aircraft carrier and are submitted quarterly for the nuclear submarine. The data tested by the auditor was not current and did not consist of sufficient appropriate evidence to provide a reasonable basis for the audit conclusion.

The IG stated that the rule that should have been applied to the situation to be as follows—

GAGAS 6.04b requires the auditor to obtain sufficient and appropriate evidence to provide a reasonable basis for the conclusion that is expressed in the report. The evidence provided in the report is more helpful if it is current.

The IG noted that prior GAO reports had criticized DCAA for GAGAS violations. The IG recommended that DCAA implement policy guidance to address the gap and ensure GAGAS compliance. The IG audit report included the following statement—

We recommend that DCAA Headquarters develop written agency-wide policy and guidance on the need to test current data to support opinions on the contractor’s internal controls and business systems. The policy and guidance should include criteria when the auditor should expand testing and perform additional work.

On behalf of DCAA, Patrick Fitzgerald concurred with the IG’s recommendation. The DOD IG report stated that DCAA committed to undertake the following steps—

By November 2011, DCAA will issue guidance, which will include the requirement for auditors to (i) perform sufficient testing of data that is relevant to the audit objectives, including the period or point in time covered by the report, (ii) perform testing of data generated by the system throughout the period under audit, and (iii) issue timely audit reports. For audits of contractor business systems, DCAA will perform compliance attestation engagements and report on the contractor’s compliance during a period of time or as of a point in time, consistent with the applicable attestation reporting standards (AT 601.55b) in AICPA’s Statements on Standards for Attestation Engagements. Circumstances where auditors would need to expand testing to obtain sufficient evidence for the conclusions expressed in the report should be limited since the transactions being evaluated in the audit will coincide with the defined period covered by the audit. DCAA agrees with the guidance in GAGAS A8.02g, that the evidence provided in the report is more helpful if it is current and, therefore, timely issuance of the report is an important reporting goal for auditors.

Importantly, the above paragraph states that DCAA plans to issue guidance in the very near future that will provide a policy statement regarding the issuance of timely audit reports. Obviously, that’s the first step to addressing the concern about “perpetual audits”. For our part, we applaud any actions taken by DCAA to get audit reports out quicker than the current system permits.

So to our readers, keep an eye out for the promised November 2011 Memorandum for Regional Directors (MRD) implementing the promised policy guidance. We think it will be quite important.

And also notice how a single phone call to the DOD IG hotline by a concerned auditor led to potentially big changes at the DCAA. That’s the butterfly effect in action.

 

What is the Contract Value of an ID/IQ Type Contract?

Nick Sanders
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The Federal Acquisition Streamlining Act of 1994 (FASA), signed into law by then President Bill Clinton, created opportunities for the Federal government to enter into multiple award ID/IQ contracts (called in the legislation “task or delivery order contracts”. Almost immediately, questions arose as to how such contracts should be valued for purposes of compliance with Truth-in-Negotiation Act (TINA) and Cost Accounting Standards (CAS). To our knowledge, while the contract valuation issue may have been addressed by the FAR Councils in some dicta-like rule-making comments, no regulatory policy-making entity has squarely addressed the issue in the form of a regulation, and thus it has never been officially answered—at least, to our satisfaction. Moreover, as we shall explore, to the limited extent the FAR Councils did address the issue with respect to TINA and CAS applicability, they reached opposite conclusions. In other words, the FAR Councils advocated a position for TINA contract valuation purposes that was diametrically opposed to their position for CAS contract valuation purposes. Such a situation, of course, is (logically speaking) utter rubbish—and indicates the superficiality of the analyses behind the Councils’ positions.

Why is this even an issue?

TINA applies to negotiated contract actions valued in excess of a certain value (currently $700,000), unless an exemption applies. If your contract action is valued at less than the TINA threshold, then that action is not subject to TINA and you are not submitting “certified cost or pricing data” and you are not at risk of an allegation of “defective pricing”. Similarly, CAS applies to negotiated contracts valued at $700,000, unless an exemption applies. (There used to be ten CAS exemptions; now there are nine.) If your contract action is valued at less than $700,000, then it is exempt from CAS and you are not at risk of a CAS noncompliance with respect to that contract action. Moreover, in the world of CAS, there is an important threshold at $50 Million in contract value (whether from a single contract award or aggregated from multiple awards); if you are below that number then you are free from some burdensome CAS requirements (such as submitting and maintaining a CASB Form DS-1 “Disclosure Statement”); but if you are above that number then you’re in the deep end of the pool. So, you see, it’s quite important to know the correct value of your contract in order to determine compliance requirements and to identify risks associated with non-compliance.

Accurate contract valuation, at the time of award, is essentially impossible for ID/IQ contract types.

The very nature of the ID/IQ type means that neither the Government nor the contractor knows the final contract value until after the performance period (which is different than the ordering period) expires. Each ID/IQ contract award has a minimum order value as well as a maximum order value, but within those parameters the final contract value is unknowable at the outset. The contractor has a best-case and worst-case assessment of what it thinks the aggregate order value will be, and the Government has an independent estimate of what it thinks the aggregate order value will be—but nobody knows until all the orders have been placed—and performed. So, since nobody knows, how do such contracts get valued for purposes of TINA and/or CAS compliance?

Dealing with TINA and CAS aren’t the only issues presented by ID/IQ contract types. “Don Acquisition” over at WIFCON noted that the Limitation on Subcontracting clause (52.219-14) is subject to the same lack of clarity, with GAO opining (in 1997) that the clause was applicable at the “whole contract” level but not at the task/delivery order level—but never discussing why that would be so. Further, “Don Acquisition” also noted that there is potential confusion with other clauses. He wrote—

What about the clause at FAR 52.232-20, Limitation of Cost? Do the notification requirements apply at 75% of the estimated cost of the task or delivery order, or at 75% of the estimated cost of the indefinite delivery contract? What about the clause at FAR 52.216-8, Fixed Fee? Does the $100,000 fee withholding limitation apply to each task or delivery order, or to the whole IDIQ contract? The questions are endless. Contracting officers have answers to these questions, but they are not all the same. Without a clear set of rules, it’s hard to argue that anybody is wrong.

“Don Acquisition” also discussed the disparate treatment to TINA and CAS given by the FAR Councils in their promulgating comments associated with recent rulemaking. According to “Don Acquisition,” in the comments to FAR Case 2008-012, the Councils asserted—

In the case of IDIQ contracts, it is commonly understood that it is the estimated total value of orders for the specified period at the time of contract award, as well as the individual value of any subsequent discrete orders, to which the TINA thresholds apply.

“Don Acquisition” agreed with that position, but disputed that it was “commonly understood.” He wrote—

‘It is commonly understood…’ is the equivalent to saying ‘Well, everybody knows…’ which is not an answer that I would accept from a student nor is it one that the public should be accepting from the FAR Councils. Further, the FAR Councils' use of ‘commonly understood’ raises the question: Commonly understood by whom? Based on my experience, ‘commonly debated’ would be a more apt description. …

If it's ‘commonly understood’ that TINA applies to task and delivery orders, why isn't there a standard FAR clause for use in task and delivery order contracts that compels the submission of cost or pricing with a task or delivery order proposal when applicable? There's a standard FAR provision at FAR 52.215-20, Requirements for Cost or Pricing Data or Information Other Than Cost or Pricing Data (Oct 1997), that can be used to compel offerors to submit cost or pricing data when submitting offers for a basic IDIQ contract. There's also a standard FAR clause at FAR 52.215-21, Requirements for Cost or Pricing Data or Information Other Than Cost or Pricing Data—Modifications (Oct 1997), that compels submission of cost or pricing data when pricing contract modifications (if applicable). Where is ‘Requirements for Cost or Pricing Data or Information Other Than Cost or Pricing Data—Task and Delivery Orders’? Why not have offerors agree to submit cost or pricing data (if applicable) with subsequent task and delivery order proposals?

Delving deeper, “Don Acquisition” noted that the FAR Councils reached the exact opposite conclusion with respect to CAS applicability. He found the FAR Councils’ logic behind that position to be (in our words) insupportable. He wrote—

[The FAR Councils wrote that] ‘As for the issue of CAS-covered versus non-CAS-covered tasks, a contract cannot contain both CAS-covered and non-CAS-covered tasks. In order for CAS-coverage to differ between tasks, each task would have to be a separate contract. In such cases, the definition of affected CAS-covered contracts would exclude the non-CAS covered tasks from the computation of the cost-impact.’ …

Thus, a determination of CAS applicability is made only when placing the basic IDIQ contract. If an IDIQ contract is subject to CAS, all orders under the contract are subject to CAS. If an IDIQ contract is not subject to CAS, none of the orders under the contract are subject to CAS.

So, according to the FAR Councils, a contracting officer must determine applicability of TINA when awarding a basic IDIQ contract and issuing any subsequent orders, but need only determine the applicability of CAS once—when awarding a basic IDIQ contract.

This raises another yet another question—how is a CO supposed to know this? …

By asserting that CAS determinations are not made at the task or delivery order level, the FAR Councils must be using a definition of ‘contract’ that is different than what appears at FAR 2.101. What definition are they using and why does that definition exclude task and delivery orders? I don't get it.

Of course “Don Acquisition” is absolutely spot-on when he calls out the FAR Councils for their specious logic. In order to value a contract, one first needs to define what a contract is. And the FAR does that—in the Definitions Subsection at 2.101. That’s the definition that must be used by Administrative Contracting Officers, auditors, lawyers, and even contractors. So when “Don Acquisition” says the FAR Councils are ignoring the FAR’s own definition of “contract” when they publish their comments, that’s a pretty powerful indictment.

In fact, it’s a violation of the FAR.

See FAR 1.108(a). (“Words and terms. Definitions in Part 2 apply to the entire regulation unless specifically defined in another part, subpart, section, provision, or clause. Words or terms defined in a specific part, subpart, section, provision, or clause have that meaning when used in that part, subpart, section, provision, or clause. Undefined words retain their common dictionary meaning.”)

So when the “Don Acquisition” asserts that the FAR Councils are ignoring the definition of “contract” found at FAR 2.101 in order to reach their conclusions regarding the applicability of CAS to ID/IQ type contracts, he’s really saying that they are violating their own regulatory conventions in order to do so.

To which we can only say, “Nice.” (Note use of sarcastic tone of voice.)

Subsequently, “Don Acquisition” noted that the DAR Council, in its promulgating comments with respect to DFARS Case 2010-D004, “unequivocally stated that the definition of “contract” included task and delivery orders. The DAR Council opined—

In accordance with FAR 2.101, a contract includes all types of commitments that obligate the Government to an expenditure of appropriated funds. Task orders and delivery orders obligate funding, and if they utilize funds appropriated or otherwise made available by the DoD Appropriations Act for Fiscal Year 2010 that are in excess of $1 million, the section 8116 restriction would apply.

So now we have the FAR Councils asserting that the term “contract” definitely encompasses a task or delivery order—but only with respect to evaluating whether a TINA exemption is applicable. We have the DAR Council clearly stating that the term “contract” definitely encompasses a task or delivery order with respect to mandatory arbitration. But so far nobody has taken the next logical step—which would be to find that the term “contract” encompasses a task or delivery order for purposes of applying CAS.

For its part, DCAA has asserted the CAS can only be determined at the contract level, and an ID/IQ contract value is equal to the ID/IQ ceiling amount, even though a contractor may never see that level of task or delivery order awards. In support of the agency’s position, DCAA auditors normally point to FAR 1.108(c), which states—

Dollar thresholds. Unless otherwise specified, a specific dollar threshold for the purpose of applicability is the final anticipated dollar value of the action, including the dollar value of all options. If the action establishes a maximum quantity of supplies or services to be acquired or establishes a ceiling price or establishes the final price to be based on future events, the final anticipated dollar value must be the highest final priced alternative to the Government, including the dollar value of all options.

When the above FAR convention is applied to priced options, we concur. When it is applied to unpriced—and, indeed, never proposed and never awarded—task or delivery orders, then we must respectfully disagree.

First, and as previously noted, “contract value” must apply to a “contract” and that term is already defined in FAR 2.101. Moreover, in analogous contexts the FAR Councils and the DAR Council have clearly agreed that the term “contract” clearly encompasses a task or delivery order.

Second, the term “ceiling price” may not be the same as an ID/IQ contract’s maximum order value. In fact, it is much more likely to apply to a fixed-price incentive (firm target) contract rather than a multiple-award task/delivery order contract.

Third, we need to remember that statute reserved to the CAS Board the exclusive right to interpret CAS. While it is true that the rule-makers incorporated the CAS regulations and Standards into FAR Part 99 (unwisely, in our view), that action did not—and could not—grant authority to the FAR Councils to interpret CAS regulations.

Only the CAS Board can define “contract value” with respect to CAS—and so far they have declined to do so.

So to point at a FAR convention and use that to support a position regarding CAS coverage and applicability is, in our view, somewhat like skating on thin ice. Someday some Judge is going to run through the logic we just ran through, and DCAA’s position that felt so solid is going to melt like ice on a Canadian lake in the summer sun.

In fact, one Judge just issued a warning that such a day may be coming sooner that DCAA and the FAR Councils may think, incidentally answering one of “Don Acquisition’s” rhetorical questions posed above.

Armed Services Board of Appeal (ASBCA) Administrative Judge Peacock, issuing an opinion for the Court on cross-motions for summary judgment in the matter of WestWind Technologies, Inc. (ASBCA No. 57436, July 21, 2011), addressed the matter of how fee retainage should work on Cost-Plus Fixed-Fee (CPFF) task orders under an ID/IQ type contract.

According to the opinion, between 2001 and 2004, WestWind performed 31 individual task orders under its contract with the U.S. Army (Rock Island Contracting Center). “Each task order was priced on a cost-plus-fixed-fee basis and paid with funds from one of two individual paying activity codes …” WestWind received a second ID/IQ contract from the same contracting authority, under which it performed 87 individual task orders during the period 2005 through 2007.

In accordance with the terms of paragraph (b) of each of the base contracts' Fixed Fee clause, when making payment to the contractor, the contracting officer withheld 15% of the negotiated fixed fee (up to $100,000) in each task order issued against both base contracts. … By letter dated 7 July 2010, WestWind submitted a certified claim, in the amount of $367,273.14, in which the contractor alleged that the government was withholding in excess of the amount authorized under FAR 52.216-8(b).

WestWind told its Contracting Officer—

FAR 52.216-8(b), which you cited in the referenced correspondence, allows the government to withhold the lesser of 15% of the fixed fee portion of the contract or $100,000. In this case, the government has withheld a portion of the fixed-free [sic] under the two contracts at issue, which exceeds $100,000 as to each contract. Under the clear language of FAR 52.216-8(b), the maximum amount of withholding as to each contract is $100,000. Furthermore, WTI is entitled to 75% of the $100,000 withheld on each contract, based upon its satisfaction of the requirements for same found in FAR 52-216-8(b). You acknowledged WTI's entitlement to 75% of the fee withheld in your letters referenced above. Therefore, the total holdback on each contract should, at this point, be no more than $25,000 per contract. Based on the clear language of the FAR, the government is improperly withholding at least $367,273.14 of fixed fee, which WTI should be allowed to invoice immediately.

Judge Peacock wrote that the clause in question applied to individual task orders and not to the contract as a whole. He wrote—

The question before us is whether the limitation that the ‘reserve shall not exceed 15 percent of the total fixed fee or $100,000, whichever is less’ applies to the contract as a whole or to the individual orders issued under it. We construe the quoted language as applying to the individual orders as a matter of textual analysis.

Paragraph (a) says that the government shall pay, for performance of ‘this contract,’ the ‘fixed fee specified in the Schedule.’ The contract schedule does not specify any fixed fee, so the reference ‘specified in the Schedule’ must be to the fixed fee specified in the schedule of each of the individual orders.

Similarly, the first clause of the first sentence of paragraph (b) refers to payment of the fixed fee being made as ‘specified in the Schedule.’ Again, the reference must be to the fixed fee specified in the schedule of each of the individual orders. The second clause of that sentence refers in tum to ‘payment of 85 percent of the fixed fee.’ The words '’the fixed fee’ relate back to the fixed fee described in the first clause, namely the fixed fee in each of the individual orders. That is the fee as to which payment of 85 percent must be made. The second sentence then says: ‘This reserve shall not exceed 15 percent of the total fixed fee or $100,000, whichever is less.’ Considering that 15 percent represents the remainder after 85 percent is paid, ‘fixed fee’ again refers to the fixed fee in each of the individual orders. The word '’total'’', in context, refers to the total of the fixed fee due under each individual order. The third sentence states ‘The Contracting Officer shall release 75 percent of all fee withholds under this contract after receipt of the certified final indirect cost rate proposal covering the year of physical completion of this contract.. ..’ This sentence suggests that there may be multiple withholds under the contract, consistent with the interpretation that the government may withhold 15 percent or $100,000, whichever is less, under each individual order. The sentence then states explicitly, in contrast to the prior two sentences, that 75 percent of all of the withholds under '’this contract’ shall be released. We conclude, therefore that the proper interpretation of the Fixed Fee clause is that the government may withhold 15 percent of the fixed fee or $100,000, whichever is less, on each individual order until such time as the contracting officer receives the certified final indirect cost rate proposal, as more particularly specified in the clause, at which time it must release 75 percent of all fee withholds under the contract.

While not a happy outcome for WestWind Technologies, the ASBCA decision does provide an answer to “Don Acquisition’s” question and clarifies for other Government contractors how the fee retainage works on CPFF task or delivery orders under an ID/IQ type contract. Moreover—and more importantly from our point of view—it is yet another nail in the coffin of the FAR Council’s dubious interpretation of how contract value is to be determined on an ID/IQ type contract for purposes of applying CAS requirements.

It is time for the CAS Board to address this issue. In the meantime, it is past time for the FAR Councils to admit their mistakes in logic and admit that CAS should be applied to individual task or delivery orders within an ID/IQ type contract. If those bodies fail to act, then the Courts will have to do it for them, sooner or later.

  

 

CAS Board to Contingency Contractors: We Don’t Care

Nick Sanders
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On August 10, 2011, the CAS Board published a final rule that eliminated the “(b)(14) overseas exemption” from the list of CAS exemptions.  Formerly, there were ten (10) CAS exemptions found at 48 C.F.R. 9903.201-1.  Effective October 11, 2011, there will be only nine.

Here’s the deal:
  1. Your contract is subject to Cost Accounting Standards (CAS) unless it is exempted by one of the 10 (now 9) exemptions.
  2. The eliminated exemption addressed “Contracts and subcontracts to be executed and performed entirely outside the United States, its territories, and possessions.”  In other words, such contracts and subcontracts were not subject to any of the CAS regulations or Standards (other than those found in the FAR Part 31 Cost Principles)—but now they will be.
  3. Another CAS exemption—the (b)(4) exemption—may still apply.  But that exemption is not a blanket exemption and subjects contractors to compliance requirements associated with CAS 401 and 402.
Is this a big deal?  Maybe not for you or even for most Government contractors.  But there are many contractors—prominent amongst them the LOGCAP and other “contingency contractors”—who issue quite a few subcontracts to foreign entities that have absolutely no clue about CAS or FAR or even U.S. GAAP.  Those contractors are now going to have to explain about consistency in cost accounting practices, and while we don’t know for sure, we think that’s going to be problematic for them.

Since these contractors are going to face new compliance requirements, we worry that it’s going to take longer to put them onto contract.  We think it’s going to be harder for the prime contractors to conduct cost and/or price analysis.  We think DCAA is going to have even more workload than it currently does.  We wonder what these foreign businesses will think about CAS, and the concepts of cost accounting practices and consistency.  In a nutshell, we think the elimination is ill-advised.

The CAS Board cited three fundamental reasons for eliminating the (b)(14) exemption.  They were—
  1. The statutory basis for the exemption no longer exists.
  2. There is no accounting basis for the exemption since geographic location is “not germane” to CAS.
  3. The CAS Board felt the availability of the (b)(4) exemption would mitigate any hardships.
The CAS Board received a paltry five (5) public comments on its proposed rule.  Some of the comments raised concerns similar to those noted above.  But the CAS Board appeared to cavalierly dismiss those concerns.

For example—

Comment: One respondent noted that there is an obvious accounting basis for retaining the (b)(14) overseas exemption, specifically, the differences between the fundamental accounting principles between U.S. GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards).

Response: The CAS Board does not believe differences between GAAP and IFRS are relevant to the question of extending the (b)(14) overseas exemption.

Here’s another—

Comment: A respondent observed that the (b)(14) overseas exemption has not been identified as a cause for overseas subcontracting challenges in recent testimonies. On June 29, 2010, Stuart W. Bowen, Jr., Special Inspector General for Iraq Reconstruction, testified before the House Subcommittee on National Security and Foreign Affairs, and identified many subcontracting issues. However, he did not mention the (b)(14) overseas exemption from CAS as a cause for any of the issues, nor did he recommend the imposition of CAS coverage on foreign concern subcontracts as a potential solution. In the July 26, 2010 hearing on war zone subcontracting before the Commission on Wartime Contracting (CWC), none of the witnesses cited the (b)(14) overseas exemption from CAS as contributing to the subcontracting challenges identified during the hearings, nor did any witness recommend the imposition of CAS coverage as a solution to overseas subcontracting problems. None of the CWC commissioners spoke of, or inquired about, subcontractor CAS coverage or CAS compliance during opening statements or witness testimony.

Response: The CAS Board does not accept this reasoning for retaining the (b)(14) overseas exemption.

When we look at the CAS Board’s responses to the few comments it received, our impression is that they are telling the contractors, “We hear you.  We just don’t care.”

 

Contractor Learns Importance of Having DCAA-Approved Cost Accounting System the Hard Way

Nick Sanders
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NOTE TO READERS: The Apogee Consulting, Inc. website is likely to be updated only sporadically over the next several weeks. This situation arises from the happy problem that we are SWAMPED WITH WORK and cannot break away to update this site as we might wish. We ask your patience and promise to post articles as often as we can.

We expect that you already know FAR Part 16 requires that a Contracting Officer must only award a cost-reimbursement type contract to a contractor that has an “adequate” accounting system. Generally speaking, the Standard Form (SF) 1408 documents the Government’s review of the accounting system. Generally speaking, DCAA auditors conduct that review and DCAA’s pre-award audit program looks at the same things the SF 1408 does. Generally speaking, the cognizant Contracting Officer uses the SF 1408 and/or the DCAA audit report to make the formal determination regarding system adequacy.

You don’t have an “adequate” accounting system? Then you don’t get a cost-reimbursement type contract award. Generally speaking.

We have written about this issue before, notably here and here. In fact, those two posts prompted us to write a full article on one poor small disadvantaged business that was denied award based on an unreasonable basis (according to the GAO decision)..

Recently, we came across a recent GAO bid protest decision that caught our attention. We think it’s worth sharing with our readers.

Sygnetics is a Service Disabled Veteran-Owned Small Business (SDVOSB) located in Michigan. It has a history of winning Government contracts, and its client list includes both Government agencies and prime contractors. We couldn’t tell from its website, but some of those contracts may have some cost-reimbursement components to them. In any case, the company (apparently) knows what it’s doing in the Government contracting arena.

At least, until it came to a DCAA audit of Sygnetics’ accounting system. At that point, things seemed to fall apart for the SDVOSB.

In April, 2009, the U.S. Army issued an RFP for “personnel support services”. According to the GAO, “The RFP anticipated awards of multiple indefinite-quantity/indefinite-quality (ID/IQ) cost-reimbursement contracts, with base periods of 1 year with four 1-year options.” Moreover, “the RFP required offerors to have a [cost accounting system] CAS that was approved by the Defense Contract Audit Agency (DCAA) within the last 2 years.”

Let’s stop for a moment to ponder that last statement. Since when does DCAA “approve” any contractor’s business systems? “Never,” we hear you chorusing back to us. And, like a Greek chorus should, you foreshadow one of Sygnetics’ biggest problems—it had to have DCAA “approve” its system and it had to make its auditors happy in order to get that approval.

According to the GAO decision, DCAA came in to audit Sygnetics and, in November 2009, found its “cost accounting system” to be inadequate. In the words of the decision, “DCAA advised that Sygnetics’ most recent audit … concluded that the company did not have an approved CAS.” (Remember that “CAS” means “cost accounting system”—not Cost Accounting Standards—to the Army and to the GAO adjudicators.) Again, let’s ponder what that particular sentence might actually mean. Might it mean that DCAA auditors found that Sygnetics did not have an accounting system that had been officially approved by the cognizant Contracting Officer? (Which would make some sense because perhaps Sygnetics had never had its system reviewed before the current audit.) Or might the sentence mean that DCAA concluded that Sygnetics’ accounting system was inadequate and recommended that it not be approved? Or might it mean that DCAA tried Sygnetics and convicted the company of having an inadequate accounting system, and that the Contracting Officer had nothing to do with that decision?

We’re not really sure, but we think it might mean the third interpretation. But let’s move on.

The Army received 16 proposals, and used the fact that Sygnetics had an unapproved accounting system to remove the company from the competitive range. The Army then made award to 14 of the bidders—but not to Sygnetics.

Sygnetics protested that, “that DCAA had not updated its November 2009 audit findings to reflect responses provided by the protester to DCAA in December 2009, and that the CO was required, under the terms of the RFP, to seek such an update from DCAA.” The Army agreed to send DCAA back in to reaudit Sygnetics. In the reaudit—

DCAA advised Sygnetics that it viewed the deficiencies identified in Sygnetics November 2009 audit to have been addressed. … DCAA further advised, however, that it had identified six additional deficiencies, which rendered Sygnetics’ CAS unacceptable: (1) lack of adequate procedures for segregating and eliminating unallowable costs from claimed costs; (2) inadequate procedures to support the proper classification of costs; (3) allocation of general and administrative (G&A) expenses over a total cost input base that did not result in an equitable allocation; (4) costs billed in non-compliance with contract terms; (5) untimely notification under the limitations of funds clause; and (6) costs billed not in accordance with the allowable cost and payment clause.

Well, there you go, then. Sygnetics fixed everything DCAA found the first time, so it came back and found more things that, in DCAA’s view, rendered the company’s accounting system inadequate.

For its part, Sygnetics concurred with five of the six new findings and agreed to fix them immediately. With respect to the sixth finding (that of “allocation of general and administrative (G&A) expenses over a total cost input base that did not result in an equitable allocation”, the company balked. It told DCAA “that its CAS complied with the FAR, and that, in light of the size of Sygnetics’ business, the protester should not be required to use a separate indirect rate for subcontractor labor.”

Again, Sygnetics was not awarded a contract. Again, the company filed a protest.

We’re going to skip over a lot of legal verbiage and quote some stuff we found to be of interest.

Here’s an important part of the GAO’s decision:

In any event, to the extent that Sygnetics argues that the information it provided to the Army demonstrates that its CAS was acceptable, we do not agree. While Sygnetics argues that the January 20, 2011, audit report indicates that it had addressed all of the deficiencies identified by DCAA, the audit report in fact stated that Sygnetics disagreed with the G&A finding; for this reason, the report stated that DCAA did not consider this issue to have been addressed. … The report also stated that while Sygnetics had agreed to correct five of the deficiencies, DCAA recommended future monitoring of the protester’s responses to these deficiencies. … For these reasons, the DCAA concluded that, notwithstanding Sygnetics’ responses, “the six current conditions listed above are outstanding, and, as a result, the accounting system is considered inadequate.”

Importantly, notice in the above where DCAA’s recommendation of “future monitoring” was sufficient to sway both the Army Contracting Officer and the GAO adjudicators that Sygnetic’s accounting system remained inadequate. In other words, lack of a positive finding was construed as a negative finding. This interpretation, of course, makes no sense.

Here’s another bit.

With regard to the G&A allocation deficiency, the protester does not explain why DCAA’s concern was incorrect, or how it has otherwise addressed this deficiency. DCAA expressed concern in its initial report and exit interview that Sygnetics’ CAS applied G&A rates in a manner that did not reflect an “equitable distribution of indirect costs.” … DCAA recommended that the protester “allocate G&A expenses over a base that is representative of benefits realized in accordance with FAR [§] 31.203,” and that “Sygnetics should be properly tracking and classifying labor spent directly managing specific subcontracts as direct in accordance with FAR [§] 31.202.” Id. While Sygnetics argued to DCAA that “setting up a separate indirect rate for subcontractor labor will not result in a more accurate allocation of costs,” so that no corrective action was required, … the DCAA disagreed and reiterated the recommendation that the protester “revise their allocation practices to result in an equitable distribution ofindirect costs to cost objectives.” On this record, we conclude that the Army reasonably relied on DCAA’s advice that the protester’s CAS was not acceptable, in light of Sygnetics’ failure to acknowledge or correct this evaluated deficiency.

Wow. There’s a big bucketful of fail right there in that paragraph. How many errors can you find?

  1. In any allegation of inequitable cost allocation, the burden is on the Government to show the allocation in inequitable, and not on the contractor to show why it is. GAO reversed the burden of proof.
  2. FAR 31.203 does not require that G&A expenses be allocated on a base that is “representative of benefits realized.” What is does say

      The contractor shall accumulate indirect costs by logical cost groupings with due consideration of the reasons for incurring such costs. The contractor shall determine each grouping so as to permit use of an allocation base that is common to all cost objectives to which the grouping is to be allocated. The base selected shall allocate the grouping on the basis of the benefits accruing to intermediate and final cost objectives. When substantially the same results can be achieved through less precise methods, the number and composition of cost groupings should be governed by practical considerations and should not unduly complicate the allocation.

      In other words, the FAR provision is permissive, not restrictive.

  3. DCAA believes that Sygnetics should charge certain indirect functions (e.g., “labor spent directly managing specific subcontracts”) as direct functions. There is no requirement in FAR or CAS that a contractor must adhere to DCAA’s view of how it should manage its business.
  4. Sygnetics correctly pointed out that, according to FAR 31.203 itself, if a separate rate did not materially affect contract costs, then it was not required to establish that rate. DCAA disagreed with that position and the GAO adjudicators accepted DCAA’s disagreement on its face, without evaluating whether it was correct. (Note for GAO: DCAA was wrong.)

In our view, this was not the best GAO protest decision we’ve ever seen. We’ve pointed out several errors and we are disappointed that nobody else called-out GAO on this one. Sygnetics, a SDVOSB, deserved better treatment.

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DCAA, SAQs, and IRRs

Nick Sanders
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As many of us have learned (to our continued frustration and chagrin) over the past couple of years, DCAA has continued to struggle to get its act together.  It has, as America’s premier contract audit agency, fallen far short of the goals of providing high, quality, timely and useful audit reports.  Unwilling or unable to rely on the audit reports produced by its auditors—the very auditors it is responsible for training—it has implemented multiple layers of management review in what perhaps has been a vain attempt to force audit quality downwards.

In our view the agency’s efforts have resulted in little measurable progress towards its goals.  Instead, the reviews have delayed issuance of critical audit reports (frequently for indefinite periods), and led to the publicly reported phenomenon of “papering” working paper files to as to avoid any review “gigs,” while in reality such “papering” adds nothing of substance.

See, for example, this article in which we discussed a DOD Inspector General independent assessment of the quality of DCAA’s audit of The Aerospace Corporation.  We told readers of the many DOD IG findings, including this one—

DCAA did not adequately document the internal controls tested for the cash management and special tests and provisions requirements, the criteria used for activities allowed or unallowed and allowable costs/cost principles compliance testing, and the coordination of the scope of audit work performed by the DCAA Field Detachment office. In addition, the audit file contained a voluminous amount of work papers, many of which simply duplicated the same information. Although we acknowledge that the auditors believed that they were providing a good audit trail, we found the format and content of the working papers lacked clarity and contributed to instances of inconsistencies between working papers and the lack of required information in other working papers.


The result of DCAA’s new management philosophy, as we all now know far too well, is a dramatic (some might say precipitous) drop in agency productivity.  (We told you about that unfortunate trend here.)  Following our article, the Project on Government Oversight (POGO) told a Senate Subcommittee that, in GFY 2010, DCAA had actually cancelled more audits that it had completed.

It’s become apparent to most of us that the more DCAA tries to dig itself out of the hole created by its past and current leadership, the deeper that hole becomes ….  Now we have two new DCAA management initiatives to report.  These are two new efforts to force audit quality downwards in lieu of alternate approaches, such as (a) training auditors and providing them with adequate guidance and supervision, and/or (b) creating a workforce where quality is actually embedded into the agency culture.  (Just to name two….)

The first initiative is that each FAO (Field Audit Office) will now have a new position, the Special Assistant for Quality (SAQ), who reports directly to the FAO Manager.  DCAA has always had a SAQ at the Headquarters level; what’s new here is deploying SAQs at the FAO level.  Now, to our knowledge DCAA has not yet publicly released a MRD (Memorandum for Regional Directors) discussing the qualifications and role/responsibilities of the FAO SAQ.  But from what we’ve experienced first-hand, the SAQ must review and sign-off on all FAO audit reports, to provide assurance that the working papers meet quality standards.

The thing is, the SAQ position is a full-time role.  Consequently, DCAA (once again) is moving an experienced senior auditor from a Supervisory Auditor or Technical Specialist role and into a management position that does not directly affect the performance of audit procedures.  We’ve commented on this unfortunate trend before, and this latest news does nothing to change our mind.  We continue to maintain that DCAA’s recent reorganizational efforts have created a vacuum that has sucked senior auditors upwards, leaving a void where experienced Supervisory Auditors and Tech Specialists used to be.  This trend, of course, has exacerbated the agency’s audit quality problems.

Moreover, we would assert that the last thing DCAA needs right now is yet another layer of management review.  The agency is already experiencing prolonged delays is issuing audit reports.  (We’ve personally experienced durations in excess of one year as audit reports sit on Branch Managers’ and/or Regional Audit Managers’ desks awaiting review and sign-off.)  Does DCAA really need another “review/question/follow-up/resubmit” loop?  We would assert the answer to that question is a clear “no.”

The second new initiative is discussed in a Memorandum for Regional Directors (MRD) dated July 26, 2011.  This MRD (11-PPS-012(R)) is entitled “Audit Guidance on Independent Reference Reviews.”  These new Independent Reference Reviews (IRRs) have a rather unique meaning to the audit agency.  As the MRD states—

Referencing is a process in which an experienced auditor, who is independent of the audit, verifies all significant facts, figures, and dates are correctly reported; that the findings are adequately supported by evidence in the audit documentation; and that the conclusions and recommendations flow logically from the evidence.


Effective with the issuance of the MRD, audit reports associated with certain assignments (as delineated in the MRD) must undergo an IRR prior to issuance of the report.  Actually, the MRD states that the IRR will take place between the supervisory review and the issuance of the audit report.  How the independent reviewer performs the IRR is documented in DCAA Instruction 7642.1, which is included as an attachment to the MRD.  IRRs can only be performed by audit staff ranked GS-13 or higher.  As the MRD states—

The IRR auditor must possess the knowledge and experience necessary to complete an effective review. The selection of the IRR auditor should be based on the potential reviewer’s independence, objectivity, experience, and analytical ability. The IRR auditor must be someone not directly associated with the work on which the working papers and report are based, and must not be under the direct supervision of the cognizant supervisory auditor.


We looked, and assignments subject to IRR include—
  • Incurred cost audits where auditable dollar value is $100 million or more.
  • Internal control audits.
  • Earned Value Management System reviews.
  • All CAS-related audits (except perhaps for Disclosure Statement adequacy reviews).
  • Forward pricing assignments, including audits of Forward Pricing Rate Proposals.
  • Post-award (“defective pricing”) audits.
As one might expect, there’s a process related to the IRR that includes resolution of issues raised by the review, and even a process for documenting “unresolved deficiencies” and forwarding them to the FAO Manager for resolution.  But there’s more—

If the issues cannot be resolved at the FAO manager level, then the FAO manager will forward the workpapers, audit report, and the Independent Reference Review Checklist and Certification to the Regional or Detachment Audit Manager (RAM/DAM) for resolution. Discussions of issues should include all parties. If the issues cannot be resolved at the RAM/DAM level, then the Regional or Detachment Audit Manager (RAM/DAM) will forward the workpapers, audit report, and the Independent Reference Review Checklist and Certification to the Deputy Regional Director for resolution. The resolution should be clearly documented on the Independent Reference Review Unresolved Deficiency List.


Appendix 1 to Enclosure 3 of the MRD contains a “Independent Reference Review Checklist.” Appendix 4 to Enclosure 3 of the MRD contains an “Independent Reference Review Certification” that is to be executed by the IR Reviewer. We trust you are getting the picture ….

We have discussed these changes with current DCAA auditors, and we’ve learned that, originally, these two initiatives were separate.  By that we mean that the FAO SAQ performed quality reviews and another, independent, GS-13 performed the IRRs.  But such duplicative quality reviews were seen as being overly, well, duplicative, and thus the two initiatives were merged such that the FAO SAQ performs all necessary IRRs for the Branch.  Thus, instead of two new quality reviews, there is really only one new quality review.

That last bit might be seen as a silver lining in the dark cloud of DCAA audit reviews.

To wrap this up, we continue to wail and moan and gnash teeth at the long-delayed reports that continue (in our view) to miss the quality mark.  But we don’t think these new initiatives—which continue an unfortunate trend of imposing quality downwards instead of fostering it at the lower levels of the organization—are the right approach.  It is quite certain that they won’t do anything to speed up issuance of audit reports.
 
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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.