Business System Requirements - Government Property

The Department of Defense has propsed regulations that will allow it to withhold payments from contractors who have inadequate business systems; purchasing, accounting, estimating, MMAS, EVMS, and Government Property. Over the past few days, we have been discussing the characteristics of adequate systems. Today we discuss the sixth and final business system covered undet this regulation; Government Property.

Government property in the possession of contractors consists of property provided or leased to the contractor by the Government and property acquired by the contractor fromother sources where upon acquisition title passes to the Government under the terms of the contract. It includes property such as:

• plant equipment
• real property
• special test equipment
• special tooling
• facilities
• Government production and research property
• material
• nonseverable property
• agency-peculiar property
• industrial plan equipment

FAR 45.5 prescribes the minimum requirements contractors must meet in establishing and maintaining control over Government property. This business system is essentially a record keeping requirement at a very detailed level. Historically, many contractors have had extreme difficulty in meeting these standards although software solutions, bar coding, and RFID technology is making it easier to administer. The basic requirements for an adequate Government Property system include:

•  Receipts for Government property.
• Records of discrepancies incident to shipment
• Records and reports of Government property. The contractor shall establish and maintain adequate control records for all Government property, including property provided to and in the possession or control of a subcontractor.
• The name, description, and National Stock Number (if furnished by the Government or available in the property control system).
• Quantity received (or fabricated), issued, and on hand.
• Unit price (and unit of measure).
• Contract number or equivalent code designation.
• Location.
• Disposition.
• Posting reference and date of transaction.
• Records of pricing information.
• Records of material.
• Records of plant equipment.
• Special reports of plant equipment.
• Records of real property.
• Records of scrap or salvage.
• Records of related data and information.
• Records of completed products.
• Records of transportation and installation costs of plant equipment.
• Records of misdirected shipments.
• Records of property returned for rework.
• Reports of Government property - provide annually the total acquisition cost of Government property for which the contractor is accountable under each contract with each agency, including Government property at subcontractor plants and alternate locations.
• Segregation of Government property.
• Physical inventories.
• Care, maintenance, and use.
• Contractor’s maintenance program (including preventative maintenance).
• Use of Government property.
• Property in possession of subcontractors.

Business System Requirements - Earned Value Management

In 1996, DoD accepted Industry Guidelines for Earned Value Management (EVM) replacing DoD's Cost/Schedule Control System Criteria (C/SCSC) program. The industry guidelines adopted by DoD are the ANSI/EIA EVM Standards (ANSI/EIA-748-1998). The guidelines represent the framework for an integrated management system that provides for:

• Planning the timely performance of work
• Budgeting resources
• Accounting for costs and measuring actual performance against plans, and
• Replanning resources needed to complete the contract when significant deviations from plans are identified.

EVM requirements apply to contracts over $20 million but may apply to contracts under that threshold if the contracting officer determines its necessity (based on risks).

A contractor's management system must meet 32 guidelines organized into the following five major categories. Unlike the other business system posts, we will not list out all 32 guidelines but they can be accessed here:

• Organization
• Plannig, Scheduling, and Budgeting
• Accounting Considerations
• Analysis and Management Reports
• Revisions and Data Maintenance

EVM surveillance is conducted jointly by DCAA, DCMA, and representatives from the buying command (procurement office).

Business System Requirements - MMAS

We continue our series on identifying the elements that DoD believes must be present in various business systems in order for the systems' to be considered "adequate" for Government contracting purposes. Today we discuss Material Management Accounting Systems (MMAS). MMAS applies primarily to manufacturing environments. Contractors that provide labor services or engaged in construction, do not have to be concerned with this particular business system.

While contractors are required to conform to MMAS sandards on all cost reimburseable and fixed price prime contracts that exceed the simplified acquisition threshold ($100 thousand), only contractors that have had $40 million in sales under those types of contracts in the preceeding year, are subject to review by the Government.

DoD policy stipulates that all contractors must ahve an MMAS that reasonably forecasts material requirements, assures proper charging and allocation of purchased and fabricated material (baased on valid time-phased requirements), and maintains a consistent, equitable, and unbiased logic for costing of material transactions. More specifically, the MMAS must have adequate internal accounting and administrative controls to assure system and data integrity and must comply with ten specific MMAS standards. Those ten standards include:

1. Have an adequate system description including policies, procedures, and operating instructions that comply with the FAR and Defense FAR Supplement;
2. Ensure that costs of purchased and fabricated material charged or allocated to a contract are based on valid time-phased requirements as impacted by minimum/economic order quantity restrictions.
• A 98 percent bill of material accuracy and a 95 percent master production schedule accuracy are desirable as a goal in order to ensure that requirements are both valid and appropriately time-phased.
• If systems have accuracy levels below these, the Contractor shall provide adequate evidence that—
• There is no material harm to the Government due to lower accuracy levels; and
• The cost to meet the accuracy goals is excessive in relation to the impact on the Government;
3. Provide a mechanism to identify, report, and resolve system control weaknesses and manual override. Systems should identify operational exceptions such as excess/residual inventory as soon as known;
4. Provide audit trails and maintain records (manual and those in machine readable form) necessary to evaluate system logic and to verify through transaction testing that the system is operating as desired;
5. Establish and maintain adequate levels of record accuracy, and include reconciliation of recorded inventory quantities to physical inventory by part number on a periodic basis. A 95 percent accuracy level is desirable. If systems have an accuracy level below 95 percent, the Contractor shall provide adequate evidence that—
• There is no material harm to the Government due to lower accuracy levels; and
• The cost to meet the accuracy goal is excessive in relation to the impact on the Government;
6. Provide detailed descriptions of circumstances that will result in manual or system generated transfers of parts;
7. Maintain a consistent, equitable, and unbiased logic for costing of material transactions as follows:
• The Contractor shall maintain and disclose written policies describing the transfer methodology and the loan/pay-back technique.
• The costing methodology may be standard or actual cost, or any of the inventory costing methods in 48 CFR 9904.411-50(b). The Contractor shall maintain consistency across all contract and customer types, and from accounting period to accounting period for initial charging and transfer charging.
• The system should transfer parts and associated costs within the same billing period. In the few instances where this may not be appropriate, the Contractor may accomplish the material transaction using a loan/pay-back technique. The “loan/pay-back technique” means that the physical part is moved temporarily from the contract, but the cost of the part remains on the contract. The procedures for the loan/pay-back technique must be approved by the ACO. When the technique is used, the Contractor shall have controls to ensure—
• Parts are paid back expeditiously;
• Procedures and controls are in place to correct any overbilling that might occur;
• Monthly, at a minimum, identification of the borrowing contract and the date the part was borrowed; and
• The cost of the replacement part is charged to the borrowing contract;
8. Where allocations from common inventory accounts are used, have controls to ensure that—
• Reallocations and any credit due are processed no less frequently than the routine billing cycle;
• Inventories retained for requirements that are not under contract are not allocated to contracts; and
• Algorithms are maintained based on valid and current data;
9. Have adequate controls to ensure that physically commingled inventories that may include material for which costs are charged or allocated to fixed-price, cost-reimbursement, and commercial contracts do not compromise requirements of any of the standards in paragraphs (e)(1) through (8) of this clause. Government-furnished material shall not be—
• Physically commingled with other material; or
• Used on commercial work; and
10. Be subjected to periodic internal reviews to ensure compliance with established policies and procedures.

Business System Requirements - Estimating

The DoD has proposed regulations that will allow it to withhold 10 percent of each billing for each business system found to be inadequate. We have been discussing the Government's fundamental expectations of these systems. Previously, we looked at the Purchasing and Accounting Systems. Today we continue our coverage with the Estimating System. After the accounting system, we believe the estimating system is the most important business system for Government contractors. A good system will facilitate contract negotiation and award and will decrease the risk of defective pricing.


For DoD purposes, an adequate estimating system must:

1. Establish clear responsibility for preparation, review, and approval of cost estimates;
2. Provide a written description of the organization and duties of the personnel responsible for preparing, reviewing, and approving cost estimates;
3. Assure that relevant personnel have sufficient training, experience, and guidance to perform estimating tasks in accordance with the Contractor's established procedures;
4. Identify the sources of data and the estimating methods and rationale used in developing cost estimates;
5. Provide for appropriate supervision throughout the estimating process;
6. Provide for consistent application of estimating techniques;
7. Provide for detection and timely correction of errors;
8. Protect against cost duplication and omissions;
9. Provide for the use of historical experience, including historical vendor pricing information, where appropriate;
10. Require use of appropriate analytical methods;
11. Integrate information available from other management systems, where appropriate;
12. Require management review including verification that the company's estimating policies, procedures, and practices comply with this regulation;
13. Provide for internal review of and accountability for the acceptability of the estimating system, including the comparison of projected results to actual results and an analysis of any differences;
14. Provide procedures to update cost estimates in a timely manner throughout the negotiation process; and
15. Address responsibility for review and analysis of the reasonableness of subcontract prices.

How does your estimating system measure up?

Business System Requirements - Accounting

Today we continue our coverage of DoD's proposed regulations to withhold money from contractors that have inadequate business systems. The proposed regulation sets forth specific criteria on what each of six business systems must accomplish in order to be judged adequate. Today's system is the Accounting system. The accounting system is absolutely the most important of all the six business systems. The specific system requirements are essentially the same attributes, with a few modifications, as those listed in the SF Form 1408 that the Government uses as a pre-award assessment tool to determine if a prospective contractor's accounting system is adequate for Government contracting purposes.

An accounting system must comply with applicable laws and ensure the propoer recording, accumulating, and billing of costs on Government contracts, including, but not limited to providing;

1. A basic structure that defines the form and nature of the organization as well as the management functions and reporting relationships (i.e. written policies and procedures);
2. Proper segregation of direct costs from indirect costs;
3. Identification and accumulation of direct costs by contract (i.e. some form of job costing);
4. A logical and consistent method for the accumulation and allocation of indirect costs to intermediate and final cost objectives;
5. Accumulation of costs under general ledger control (automatic with most accounting software);
6. Reconciliation of subsidiary cost ledgers and cost objectives to general ledger;
7. Approval and documentation of adjusting entries (not part of SF 1408);
8. Periodic monitoring of the system, as appropriate (not part of SF 1408);
9. A timekeeping system that identifies employees' labor by intermediate or final cost objectives;
10. A labor distribution system that charges direct and indirect labor to the appropriate cost objectives;
11. Interim (at least monthly) determination of costs charged to a contract through routine posting of books of account;
12. Exclusion from costs charged to Government contracts of amounts which are not allowable in terms of FAR Part 31, Contract Cost Principles and Procedures, and other contract provisions;
13. Identification of costs by contract line item and by units (as if each unit or line item were a separate contract) if required by the contract;
14. Segregation of preproduction costs from production costs;
15. Cost accounting information as required:
• By contract clauses concerning limitation of cost (FAR 52.232-20) or limitation on payments (FAR 52.216-16); and
• To readily calculate indirect cost rates from the books of accounts;
16. Billings that can be reconciled to the cost accounts for both current and cumulative amounts claimed and comply with contract terms; and
17. Adequate, reliable data for use in pricing follow-on acquisitions.

Business System Requirements - Purchasing

Over the past few days, we've been discussing the proposed DFARS (DoD FAR Supplement) regulations that will allow the Government to withhold funds from contracts with contractors that have inadequate business systems. We discussed the six systems addressed by the regulations, the procedures from audit finding to initial determination to final determination, and the amount of the withholds (10 to 100 percent). It is readily apparent that if this reguation is implemented in any form resembling the proposal, contractors are going to be heavily incentivized to pay more attention to their business systems. Implementation will come at a cost. One commentator quipped that this is Sarbanes-Oxly for defense contractors, meaning that everyone spends lots of money to set up internal control systems and spends more money to test for compliance while unable to show any tangible benefits.

Regardless of how the final regulation fleshes out, the sections that list specific requirements for each of the six business systems will most likely remain intact. These specific requirements are not exactly new however. They've been brought in from other sources. For example, the requirements for a purchasing system are essentially those that DCMA (Defense Contract Management Agency) tests for when conducting  a CPSR (Contractor Purchasing System Reviews). Beginning today and continuing until we cover the six business systems, we will list the specific requirements that the Government will expect systems to include. We begin with the 17 requirements for an adequate purchasing system.

Purchasing systems must:

1. Have an adequate system description including policies, procedures, and operating instructions that comply with the FAR and DFARS.
2. Ensure that all applicable purchase orders and subcontracts contain all flow down clauses, including terms and conditions and any other clauses needed to carry out the requirements of the prime contract.
3. Maintain an organization plan that establishes clear lines of authority and responsibility.
4. Purchase orders are based on authorized requisitions and include complete history files.
5. Establish and maintain adequate documentation to provide a complete and accurate history of purchase transactions to support vendors selected and prices paid.
6. Apply a consistent make or buy policy that is in the best interest of the Government.
7. Use competitive sourcing to the maximum extent practicable and ensure debarred or suspended contractors are properly excluded from contract award.
8. Evaluate price, quality, delivery, technical capabilities, and financial capabilities of competing vendors.
9. Require management level justification and cost/price analysis as applicable for any sole or single source award.
10. Perform appropriate cost or price analysis and technical evaluation for each subcontractor and supplier proposal or quote.
11. Document negotiations in accordance with FAR 15.406-3.
12. Seek, take, and document appropriate purchase discounts, including cash discounts, trade discounts, quantity discounts, rebates, freight allowances, and company-wide volume discounts.
13. Ensure proper type of contract selection and prohibit issuance of cost-plus-a-percentage-of-cost subcontracts.
14. Maintain subcontract surveillance to ensure timely delivery of an acceptable product and procedures to notify the Government of potential subcontract problems that may impact delivery, quantity, or price.
15. Document and justify reasons for subcontract changes that affect cost or price.
16. Notify the Government of the award of an auditable subcontract and perform adequate audits of those subcontracts.
17. Enforce adequate policies on conflict of interest, gifts, and gratuities, including the requirements of the Anti-Kickback Act.

 

 

 

Inadequate System? How Much will the Government Withhold?

We've been discussing the proposed DFARS regulation that will allow the Government to withhold funds if contractors are found to have inadequate business systems. This proposal affects most kinds of contracts; cost-reimbursement, incentive type, time-and-materials, labor hour, fixed price with progress payments based on costs, percentage, or stage of completion, and some construction contracts.

This regulation, if enacted, will dramatically alter the trajectory of cooperation between the Government and its contractors. Some commentators are already warning that the relationship between the Pentagon and its contractors are moving in the wrong direction. This new regulation could exacerbate the situation. There are already dire warnings that small companies will be put out of business and others will choose to exit the Government contracting scene.

The withholding process begins when the auditor issues a report with an identified deficiency. The report is sent to the ACO. If the ACO agrees with the audit finding, he/she issues an initial determination of deficiency. The contractor has only 30 days to respond to the initial notice of deficiency. The ACO will evaluate the contractor's response and notify the contractor (in writing) of the final decision. If the ACO determines that the system contains deficiencies, he/she will also include a notice of a decision to withhold payments. Upon issuance of that notice, the ACO will immediately begin withholding 10 percent of each payment.

After the final determination is issued, the contractor will have 45 days to either correct the deficiency or submit an acceptable corrective action plan. If the corrective action plan is acceptable, the ACO will reduce the withhold percentage to 5 percent until all corrections are completed. If the contractor fails to follow through on the corrective action plan, the withhold percentage returns to 10 percent.

If the ACO is withholding payments for deficiencies in more than one business system, the cumulative percentage of payments withheld cannot exceed 50 percent ... maybe. It could go as high as 100 percent if the ACO declares an emergency. In DFARS 252.242-7XXX(d)(4) we find:

Notwithstanding ...if the ACO determines that there are one or more system deficiencies that are highly likely to lead to improper contract payments being made, or represent an unacceptable risk of loss to the Government, the the ACO will withhold up to 100 percent of payments until the ACO determines that the contractor has corrected the deficiencies.

Things could get interesting.

Withholds for Inadequate Business Systems

Yesterday we alerted you to the proposed DFARS (DoD FAR Supplement) regulation requiring contracting officers to withhold billings for contractors with inadequate business systems. These business systems include accounting, estimating, purchasing, earned value management, material management and accounting, and Goverment property.

This new regulation will affect all Defense contractors to varying degrees. It depends on the existence of other contract provisions. Absent these clauses, the withholding provisions do not apply. Following is a table that lists the pertinent clauses for each of the business systems.

You will need to review your specific contract(s) to verify whether these clauses exists. However.here are some general guidelines. The requisite clauses for accounting (propsed), estimating and purchasing are to be included in all contracts. All contractors will be affected in these three business systems. EVMS applies to cost-type contracts over $20 million. MMAS applies to most contracts however it woud be "not applicable" unless there is manufacturing going on. Government Property applies only if there are Government furnished materials under the contract.

In future posts, we will be discussing the withhold percentages, processess for determining adequacy/inadequacy, and the Government's expectations for systems' capabilities.

The Cost of Compliance is About to Increase

The Defense Department has proposed a new regulation that they say is designed to improve the effectiveness of DoD oversight of contractor business systems - Defense is going to withhold funds on cost reimbursable (and other flexibly priced) contracts until contractors fix their inadequate business systems. The withholds begins at 10 percent and could go as high as 100 percent under certain circumstances (though the higher figure seems highly unlikely). Withholds affect cash flow and disrupting cash flow will certainly get contractors' attention.

Over the next few days, we will provide analysis and comment on what this regulation portends for Defense contractors. To state that it will represent a very significant change in the way the Government does business is a huge understatement.

Currently, contractors bear no direct consequences for inadequate business systems. When deficiencies are identified, contractors are allowed time to fix those deficiencies. There is no perscribed timetable for effecting corrections nor does the Government withhold any billings until changes are made. After corrective actions are implemented, the Government (usually the auditor) has no prescribed timeframe for determining whether the actions have been effective in correcting the deficiencies. Many times, these deficiencies are "on the books" for years without any permanent resolution. Under the proposed regulations, there are very tight timetables for implementing corrective actions.

The propsed regulations set forth certain criteria for adequate business systems. Some are very objective while others are highly subjective. For example, there are 17 criteria for an adequate accounting system. One criteria is the system must be capable of segregating preproduction costs from production costs. This functionality is built in to most moden accounting software and is easy ot audit. It is basically a yes/no answer. However, other requirements are very subjective. One such subjective requirement is the contractor must conduct periodic monitoring of the system, as appropriate. What does that mean? How often is "periodic"? What is entailed in the term "monitoring"? What does the term "as appropriate" mean? These are very subjective elements and contractors are going to experience the vagaries of auditor judgement when the auditors come in to test for compliance with this standard.

The ten business systems covered by this new regulation include

• Accounting systems
• Estimating systems
• Purchasing systems
• Earned Value Management Systems (EVMS)
• Material Management and Accounting Systems (MMAS)
• Property management systems (Government property held by contractors)

To read the full text of this proposed regulation, go here.

Limits on Indirect Costs for Basis Research

The Defense Appropriations Acts for fiscal years 2008 and 2009 limit payment of indirect costs to 35% of the total cost of a contract, grant, or cooperative agreement for "basic research". If your are a recipient of "basic research" money, you need to have a system in place to ensure that your billings for indirect costs do not exceed 35% of total costs. DCAA has alerted its auditors to be on the lookout for these kinds of contracts. Auditors will be requesting recipients of such awards to demonstrate that their contract briefs identify the limitations. Auditors will also be checking to ensure that recipients have systems in place to monitor charges on an award-by-award basis to ensure the 35% limitation is not exceeded.

According to the Office of Naval Research (ONR), the majority of "basic research" is conducted by educational institutions. However, some "basic research" is also awarded to for-profit companies.

If a contract is subject to the 35% limitiation, it will include a provision similar to the following:

This contract is funded with Fiscal Year 2008 basic research appropriations and is subject tothe reimbursement limit on F&A costs set forth in Section 8115 of the Department of Defense Appropriations Act, 2008 (P.L 110-116). Payment of F&A costs for research with funds obligated by this action may not exceed 35% of the total costs provided under this contract action.

Defective Pricing - Significance

Today we're wrapping up our series on defective pricing with a few comments on what is significant when it comes to the impact of the failure to disclose current, complete, and accurate cost or pricing data. As you recall from a previous post, one of the Government's burdens of proof is that cost or pricing data must be such that a reasonable person (i.e. prudent buyer and seller) would expect it to have a significant effect on price negotiations.

Neither TINA nor FAR define "significant amount". The Courts and the BCA (Board of Contract Appeals) have made differing decisions regarding what is a significant amount. The working guideline from DCAA, the Agency responsibile for testing contractor compliance with TINA, is the lesser of five percent of the contract price or $50,000 dollars. Since the Government expends a substantial amount of resources finding, pursuing, and settling claims of defective pricing, materiality (or significance) is a key facton in determining whether to proceed. For a cost-type contract, this $50 thousand equates to a much larger figure because the potential savings to the Government is only the fee. For a cost type contract with a 5 percent fee, the defective pricing allegation would be $1,000,000.

The $50,000 potential savings to the Government is only a working guideline for DCAA and does not apply if a contractor's deficient estimating practices have resulted in recurring defective pricing or the potential price adjustment is due to a systemic deficiency which affects all contract priced during the period.

Finally, the $50 thousand guideline is a fully burdened figure. The actual defective pricing might start out a much smaller figure that grows to $50 thousand when fringe benefits, overhead, General and Administrative expenses, and profit is added.

Defective Pricing - Offsets

Failure to submit current, complete, and accurate cost or pricing data often times hurts the contractor as much or more than the Government. Bad estimating is bad estimating. When the Government alleges defective pricing, contractors have the authority to submit "offsets". Contracting officers must allow an offset for any understated cost or pricing data the contractor submitted.  However, the offset cannot exceed the amount that the Government is seeking to recover. There can never be an increase in contract price as a result of offsets.

The offset does not have to be in the same cost grouping as the overstated cost or pricing data. Material costs could offset labor costs, for example. Contractors must prove two things. First, that the higher cost or pricing data was available before the "as of" date specified on the Certificate of Current Cost or Pricing Data and secondly, the data was not submitted to the Government.

Case law has identified two instances where contractors were not entitled to an offset. In one case, the contractor knew that its cost or pricing data was understated before the certification data. In other words, if a contractor purposefully understated its bid for whatever reason (e.g. competitive pressure), that understatement would not comprise a valid offset. Secondly, the Government was able to prove that submission of the data before the "as of" date specified in the certificate would not have increased the contract pricie in the amount of the proposed offset.

Defective Pricing - Will I be Audited?

The Defense Contract Audit Agency (DCAA) is the lead Government Agency in testing contractor compliance with TINA (Truth in Negotiations Act). But they are not the only Agency performing such reviews. The Comptroller General (i.e. GAO) and the Inspector General (IG) organizations also have statutory rights. The GAO and the IG generally initiate their reviews in connection with other activities (such as a fraud referral) so most contractors will encounter only DCAA.

DCAA's selections are based on its Post Award Audit Selection System (PASS). The PASS is a risk assessment model that provides objective and verifiable risk determinations. It considers the adequacy of contractor estimating and accounting systems, historical rates of positive occurrences, and values of previous recommended price adjustments. Each of these four factors is assigned a weight between one and four with one being the lowest risk. If the result is under four, the contractor is determined to be low risk. If the result is over 12, the contractor is considered high risk. Other thresholds include medium low and medium high. The PASS rating determines how many defective pricing reviews DCAA will initiate. Obviously, the higher the risk, the more audits.

DCAA then takes the universe of contracts awarded, stratifies according to size and type (e.g. FFP, Incentive, CPFF) and selects from each strata, a number according to the PASS rating. For example, for FFP contracts between $25 and $100 million, a high risk contractor might have 100 percent reviewed while a low risk contractor might have one out of every four selected for audit. These strata and selection criteria change slightly from year to year so you should request your DCAA auditor to provide the PASS rating and the selection criteria.

Smaller contractors are automatically considered high risk so they do not have individual PASS ratings. Contracts awarded to smaller contractors are added to a pool and selection is made based on the high risk PASS rating. Because contracts are pooled and selections are somewhat random, many smaller contractors are rarely audited for compliance with TINA.

Defective Pricing - Government has Burden of Proof

Last week, we posted several articles on the Truth in Negotiations Act. We defined cost or pricing data, why it is important, the difference between facts and judgment, and some of the Government's fraud indicators related to contractor failure to comply with TINA. Today, we pick up another element of defective pricing, the Government's burden of proof in asserting defectiv pricing.

Defective cost or pricing data (Defective Pricing) occurs when, after a contract is negotiated, it is discovered that the data used to price the contract was inaccurate, incomplete, or noncurrent.. Under TINA and the contract price reduction clause, the Government is entitled to an adjustment in the contract price (including fee) when it can be shown to have relied upon the defective data. The Government always bears the burden of proof in a defective pricing case. Based on a 1993 General Dynamics ASBCA (Armed Services Board of Contract Appeals) case, the Government must prove the following:

• The information meets the definition of cost or pricing data. Refer to our January 4th post for the definition of cost or pricing data. Data must be factual, not judgmental.
• The information existed before the date of agreement on price.
• The data was reasonably available before the date of agreement on price.
• The data the contractor submitted was not accurate, complete, or current.
• The undisclosed data was the type that prudent buyers or sellers would have reasonably expected to have a significant effect upon price negotiations.
• The Government relied on the defective data.
• The Government's reliance on the defective data caused an increase in the contract price. As a side note, case law has made this final point rather easy for the Government to prove. Baring evidence to the contrary, the natural and probable consequences of defective pricing is an increase in the contract price.

If the Government fails to establish proof in any of these seven criteria, it will not prevail.

Federal Government Not Hitting Contracting Targets for Women-Owned Businesses

The U.S. Women's Chamber of Commerce (USWCC) recently released a report on the state of Federal contracting with women-owned small businesses. This report, relying on data from 2008, is at odds with the U.S. Government's success claims of meeting its goals (5 percent of Federal spending) primarily because in the current Federal contracting system, any business may simply proclaim their women-owned status when posting their company's information online without facing any scrutiny.

According to USWCC, total Federal spending in 2008 was about $537 billion. Five percent of that is $27 billion. Actual awards to women-owned business were only $15 billion leaving a shortfall of $12 billion. To make matters worse (again, according to the USWCC), the shortfall is getting worse. In 2007, the shortfall was only $10 billion.

We don't really know whose data is better, the Federal Government, or the USWCC. We are well aware of USWCC's concerns that the Government does not verify company self-certifications in its databases. That's an old story, and yet a valid concern. No one, to our knowledge, has ever tried to quantify the error rate. On the other hand  we are also aware of the problems that individual contractors have in meeting their small business targets. Although there are 75 thousand women-owned business registered with the Federal Government, it is hard to find small-businesses, much less women-owned small-businesses that can provide, say, engineering services to major aerospace firms. As a result, many Government contractors have a difficult time finding qualified women-owned business that can satisfy the technical requirements of the work to be performed. Many of these contractors frequently miss their small-business subcontracting targets. To read more of the USWCC report, click here.

DOE Revises Cost Principle on Legal Costs

On January 7th, the Department of Energy published a revision to its cost principle regarding the allowability of legal costs. In the DOE FAR Supplement 31.205-47, a reference to "10 CFR Part 708" has been changed to "10 CFR part 708". That's certainly a refleif for those of us who try to understand and apply these cost principles - it has been such a contentious issue. This simple change should indeed smooth out the Government contracting process and significantly ease pressure on Federal appropriations.

And speaking of the DOE FAR Supplement, there's a reminder here that contractors should be familiar with the specific FAR supplement of the Agency issuing the contract. Almost all Executive Agencies have FAR supplements and many of those affect cost principles in FAR Part 31. For example, the DOE FAR Supplement contains additional coverage on the allowability of insurance, pre-contract costs, professional and consultant services, independent research and development, and legal costs. The NASA FAR Supplement contains additional coverage on the allowability of compensation and precontract costs. The Department of Defense FAR Supplement adds additional coverage to compensation, lobbying, restructuring, and research and development. Here's a link to an index of all Agency FAR supplements.

Cost or Pricing Data - Facts vs. Judgment

This week we have been discussing TINA, the Truth in Negotiations Act and the law's implication for government contractors. The law applies generally to negotiated contracts. So awards based on adequate price competition, prices set by law or regulation, and commercial items are exempt. The law requires contractors to submit current, complete, and accurate cost or pricing data in support of negotiations. Cost or pricing data is generally that which is factual in nature. And herein lies one of the most contentious issues when it comes to defective pricing; is it fact or is it judgment?

The distinction between fact and judgment is often difficult to make. Information that mixes fact and judgment will require disclosure because of the underlying factual information. A management decision is that kind of information. Management decisions are generally a conglomeration of facts and judgment. To determine whether management decisions can be classified as cost or pricing data, it is helpful to consider the following factors:

• Did management actually make a decision?
• Was the management decision made by someone with the authority to approve or disapprove actions affecting costs?
• Did the management decision require some sort of "action" affecting the relevant cost element, or was the "decision more along the lines of preliminary planning for possible future action?
• Is there a substantial relationship between the management decision and the relevant cost element?
• Is the management decision the type of decision that prudent buyers and sellers would reasonably expect to affect price negotiations significantly?

For example, a management decision to give employees a five percent cost of living adjustment is cost or pricing data. But, if that decision had to be first approved by the Board of Directors, it might not be cost or pricing data, depending upon whether the Board typically, historically, and expectantly "rubber stamps" management decisions (cost or pricing data) or actively involves itself in the process of determining the rate of increase (not cost or pricing data until board approval).  A decision to defer pay raises is cost or pricing data but if a deferral was one of several options being considered as a way of cutting costs, it would not be cost or pricing data.

Fraud Indicators related to Defective Pricing (TINA)

Recently, we've been discussing cost or pricing data and some of the implications that failure to furnish current, complete, and accurate cost or pricing data can have on government contractors. If a contract price was increased because a contractor failed to submit current, complete, and accurate cost or pricing data, the contract price will be reduce by the impact of that failure. And, if that wasn't enough, the matter could be referred for criminal investigation. To assist in helping auditors determine whether TINA noncompliance should be referred to an investigative organization for potential fraud, the DoD-IG published a Handbook of Fraud Indicators.

According to the DoD Inspector General, the following are general fraud indicators that relate direct to defective pricing reviews and should be considered for referral for criminal investigation.

• High incidence of defective pricing.
• Repeated defective pricing involving similar patterns or conditions.
• Continued failure or refusal to correct known system deficiencies.
• Consistent failure to update cost or pricing data with knowledge that past activity showed that prices have decreased.
• Specific knowledge that is not disclosed regarding significant cost issues that will reduce the proposed cost.
• Repeated denial by responsible contractor employees of the existence of historical records that are subsequently found.
• Continued failure to make complete disclosure of data known to responsible personnel.
• Altered or false documents.

DCAA has taken this this matter very seriously. It has instructed its auditors to consider whether any of these fraud indicators exist for each and every postive defective pricing audit report it issues and if found, to refer the matter for investigation.

TINA - Why Cost or Pricing Data is Important

Yesterday, we discussed Cost or Pricing Data by quoting from the FAR definition and by providing examples. Today, we will discuss why cost or pricing data, in the context of pricing government contracts, is important.

Back in May 1959, GAO reported an alarming number of overpriced government contracts. By October of that year, DoD revised its regulations to require contractors to provide a Certificate of Current Cost or Pricing Data during contract negotiations. In 1961 DoD added a price reduction clause to its regulations for occurrences of defective pricing. Meanwhile, Congress was also acting on the GAO report. By 1962, the Truth in Negotiations Act (TINA) was signed into law (Public Law 87-653). TINA now applied to all Executive Branch agencies, not just the DoD.

The objective of the regulatory and statutory provisions was to require truth in negotiating. Although not all elements of costs are ascertainable at the time a contract in entered into, those costs that can be known should be furnished currently, accurately, and completely. If the costs that can be determined are not furnished accurately, completely, and as currently as is practicable, the Government should have the right to revise the price downward to compensate for the erroneous, incomplete, or out-of-date information.

TINA's purpose is to level the negotiation playing field by ensuring that government negotiators have access to the same pricing information as the contractor's negotiators. TINA requires contractors to submit cost or pricing data that is accurate, complete, and current as of the date of agreement on contract price.

Defective pricing is not fraud but could lead to fraud allegations, depending on a number of factors including intent. The purpose of TINA was never to detect fraud but over the years, audit agencies have considered whether any fraud indicators exist in each and every defective pricing situation. Those with positive indicators are referred to one or more investigative organizations for review. Tomorrow we will discuss some of those positive indicators.

Cost or Pricing Data

Various procurement reforms over the past several years have added a variety of methods by which the Government can award contracts. The preferred method is to utilize competition whenever possible. Negotiations based on cost or pricing data is now a last resort. However, quite a few contract awards are still made on the basis of cost or pricing data. At the "handshake" date, contractors are required to certify that the cost or pricing data submitted to the Government was current, complete, and accurate.

The definition of cost or pricing data is found in FAR 2.101. FAR states that cost or pricing data means all facts that, as of the date of price agreement, prudent buyers and sellers would reasonably expect to significantly affect price negotiations. Cost or pricing data are factual, not judgmental, and are verifable. While they do not indicate the accuracy of the prospective contractor's judgment about estimated future costs or projections, they do include the data forming the basis for that judgment.

Cost or pricing data are more than historical accounting data; they are all the facts that can be reasonably expected to contribute to the souondness of estimates of future costs and to the validity of determinations of costs already incurred. Thy can include such factors as

• vendor quotations
• nonrecurring costs
• changes in productions methods
• data supporting projections of business prospects
• unit cost trends
• mank/buy decisions
• management decisions that could have a significant bearing on costs.