How to Determine Whether a Cost is Reasonable

One of the overarching criteria for deciding on whether to charge a particular cost to a government contract, either directly or indirectly, is whether it is reasonable in amount. We often mention "reasonableness" in this blog when discussing cost allowability criteria. A couple of days ago, we discussed reasonableness as it relates to bonuses and incentive compensation. Since then, we've been asked how one goes about determining whether a cost is reasonable.

As everyone soon learns, there are no hard and fast standards for determining "reasonableness". It is a highly subjective area and one in which reasonable persons can and do disagree. Contractors, of course will make a broad argument while the Government will take a more limited or restrictive view. Some contractors like to use the New York Times test; how would this look in the news? If the public disclosure of the cost would embarrass the company, they may choose not to claim it. Some situations are obvious. You wouldn't pay executive level salaries to clerical employees and you wouldn't charter a private jet to go to a negotiation conference with the Government. Most disagreements about reasonableness however are in those grey areas where neither side has the compelling argument. Publically held, heavily commercial or fixed price oriented contractors are less risky from the Government's perspective than are contractors with mostly cost-type contracts. The "market place" adds a level of restraint on how a company expends its funds. Closely held companies with mostly cost-reimbursable contracts are higher risk for incurring unreasonable costs because the market forces are not in play. So, what does FAR have to say about "reasonableness"?

FAR 31.201-3 states that a cost is reasonable if in its nature and amount, it does not exceeds that which would be incurred by a prudent person in the conduct of a competitive business. From the Government's perspective, it is the contractor's responsibility to establish that each cost is reasonable. There is never a presumption that a cost is reasonable.

As general guidance, we recommend that contractors consider four questions when deciding whether a cost is reasonable.

1. Is the type of cost generally recognized as necessary in conducting business? The purchase and up-keep of an ocean-going yacht for exclusive use of the company president is not a necessary cost of doing business.
2. Is the cost consistent with sound business practice, law, and regulation, and are purchases conducted on an "arms-length" basis? To pay a premium price for materials on a Government contract while receiving a bargain price for the same materials on a commercial job may not be consistent with sound business practices.
3. Do your actions reflect a responsible attitude toward the Government, other customers, owners, employees, and public at large? Excessive salaries to executives and unconscionable retainers for retired executives as consultants are not acting responsibly toward owners and employees.
4. Are your actions consistent with established practices? If your established practice has always been to perform design work in-house but for some reason you decide to out-source it at a higher cost (and you had available capacity), it would be unreasonable to out-source it.

As you consider these matters, it would also be a good practice to prepare documentation to support your decision making process. If challenged, contemporaneous documentation prepared before the incurrence of the cost will carry much more credibility than documentation prepared at a later date.

When "ADEQUATE" is the Best That You Can Be

Many times during our years as Government auditors we would sit down with contractor representatives after finishing an audit of one or more of their internal control systems and proclaim that their system was "adequate".

"Adequate!, only adequate?" was a typical response. "We've done this and we've done that, we have great policies and procedures, we have superb controls with internal reviews and other checks and balances. We train everyone, as we should. How can you say that our system(s) are only adequate?"

We would then explain that "adequate" was as good as it gets. Under Generally Accepted Government Auditing Statndards (GAGAS), an internal control system is declared "adequate" when no significant deficiencies are found. The alternative would be either a significant deficiency or a material weakness.

A significant deficiency in internal control system is a deficiency that adversely affects the entity's ability to initiate, authorize, record, process, or report financial data reliably in accordance with Generally Accepted Accounting Principles (GAAP) such that there is more than a remote likelihood that a misstatement will not be prevented or detected.

A material weakness is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement will not be prevented or detected.

Get used to the terminology. "Adequate" is good. Anything else is bad.

Bonuses and Incentive Compensation

With all the news lately concerning excessive executive bonuses, it is advisable for contractors to take a look at their compensation practices with respect to bonuses. Bonuses and incentive compensation fall under the Compensation cost principle, FAR 31.205-6. Compensation in general, must be reasonable. This cost principle carries an unusual warning that there is no presumption of allowability where a contractor introduces major revisions of existing compensation plans and has not afforded the contracting officer an opportunity to review beforehand for allowability of changes. There is also a total compensation cap that applies to the five most highly compensationed employees in management positions at each home office and segment. Compensation, in this context means the total amount of wages, salary, bonuses, deferred compensation, and employer contributions to defined contribution pension plans, whether paid, earned, or otherwise accruing, as recorded in the contractor’s cost accounting records for the fiscal year.

Within these parameters, bonuses and incentive compensation are allowable provided

• Awards are paid or accrued under an agreement entered into in good faith between the contractor and the employees before the services are rendered or pursuant to an established plan or policy followed by the contractor so consistently as to imply, in effect, an agreement to make such payment; and
• Basis for the award is supported.

It is important to understand these conditions. The government considers this a high risk area and will challenge bonuses that do not meet these criteria. Many contractors have been tripped up in this area because they did not have an agreement in place prior to services being rendered.  

What To Do When Your Finances Aren't Too Great

A couple of days ago, we discussed the Government's interest in assuring that its contractors (and potential contractors) have the financial resources necessary to see the contract through to fruition. Go here to read that post. The key here is to have plenty of cash on hand and/or a revenue stream from other work to finance the Government work. The amount of money needed will vary depending upon the size of the contract of course. The duration of the financing will depend on the type of contract. For the typical cost-reimbursable contract where contractors can bill monthly, three months of working capital is necessary. In the first month, contractors incurr the cost. After month end, its takes a week or two to post the accounting records and prepare billings. The Government takes up to 30 days to pay. Allowing time for requisite approvals by the auditor and contracting officer, a contractor is looking at about three months from contract start to when payments begin coming in. For fixed price contracts, the time will depend upon payment methods - cost, milestones, or deliveries. For fixed price, three months is also a minimum but it could be significantly more.

So how is a contractor with limited cash and backlog going to demonstrate financial capability to skeptical financial analysts from Defense Contract Management Agency or auditors from Defense Contract Audit Agency? Here are some ideas.

• Go to your bank and secure a line of credit. Even if you do not use it, having one increase the analyst/auditor's confidence that you have sufficient financial resources to perform under the contract.
• Secure personal loans or promises/commitments from Stockholders. The downside to this is that the Stockholder will need to be prepared to open his/her personal finances to the Government to prove the existence of those resources.
• Secure equity financing. Usually a last resort.
• Liquidate assests - especially those that are idle, underutilized or obsolete. 
• Defer or reduce discretionary expenses.
• Defer salaries to owner(s). Don't forget the payroll tax implications on deferred compensation.
• Consider leasing over buying. This is sometimes more costly in the long-run but it does even out cash flow.
• Restructure your debt to reduce debt service cost.  

Government to Consolidate Nine Contract Performance Databases

GSA (General Services Administration) awarded a contract to IBM to consolidate nine acqusition-related databases that track pre and post award contract data across the entire federal civilian and defense acquisition communities. Readers of this blog are familiar with many of these databases and will certainly welcome this effort to make the federal acquisition process more efficient and transparent.

According to GSA, the consolidated databases will

“...improve the efficiency of the contracting process by providing federal acquisition professionals with a streamlined tool for all of their pre-and post-award reporting and tracking work ... It will also improve transparency of the process by providing the public with a single, comprehensive source for contracting data from all levels of government.”

The nine separate databases tagged for consolidation are:

• FedBizOpps - The single government point-of-entry for posting solicitations over $25,000, allowing commercial business suppliers to search, monitor, and retrieve opportunities in federal government markets.
• Wage Determinations On-Line - This governmentwide Web site makes Service Contract Act (SCA) and Davis-Bacon (DBA) wage determinations easily accessible by the contracting community. 
• Central Contractor Registration - Vendors wanting to do business with the government are required to register in CCR and revalidate annually. This provides payment information, validates Small Business Administration certifications as small, disadvantaged, 8(a), or HUBZone businesses, calculates business size, and validates taxpayer IDs with the IRS. 
• Federal Agency Registration - Information about federal entities that buy and sell from other federal entities can be found on this government-only registration system. 
• Online Representations and Certifications Application - This Web-based application allows vendors to enter Representations and Certifications once for use on all federal contracts. Vendors update these "reps and certs" annually. 
• Past Performance Information Retrieval System - The federal acquisition community can access timely and pertinent contractor past performance information via this Web-enabled, governmentwide application. 
• Excluded Parties List System - Parties excluded from receiving federal contracts and certain subcontracts are identified on this Web-based system. Also identified are individuals excluded from certain types of federal financial and non-financial assistance, including benefits.
• Federal Procurement Data System-Next Generation - This online repository provides data on all federal contract actions over $3,000. Standard and custom reports are easily accessible.
• Electronic Subcontracting Reporting System - This system is designed for prime contractors to report accomplishments toward subcontracting goals required by their contract.

Financial Capability Reviews

Contractor financial difficulties may disrupt production schedules, cause inefficient use of resources, and result in contract nonperformance. These conditions may also result in monetary loss to the Government on progress payments.

Prior to the award of any contract, the Government will assess whether a potential contractor has the financial resources needed to perform the contract. These are called Financial Capability Reviews and are usually conducted by DCMA's (Defense Contract Management Agency) Financial Analysis Center at the request of a contracting officer. The authority to conduct these reviews is found in FAR 9.104-1.

The review begins when DCMA sends a request for documentation. This request is no small matter. Contractors will be required to respond to 20 or more items and furnish the Government a significant amount of proprietary financial information. Click here to see a sample of the request letter. Among the items requested are

• Certified financial statements with footnotes
• Interim financial statements not over 90 days old
• Accounts payable and accounts receivable aging reports
• Cash flow forecasts signed by a financial officer
• Names, addresses, phone and fax for banks and other lending institutions
• Number of customers comprising your overall business base
• Gross profit margins
• Sales backlog
• Sales forecast
• Inventory methods
• Outstanding lawsuits, liens, and judgments including current status
• And many others

The Financial Analysis Center performs these reviews in their own office. Rarely will they visit a contractor's office as an auditor might and it is also unusual for the analysts to call and ask questions or request clarification. Their assessments will be based entirely on the data submitted. Therefore it is essential that contractors' exercise due diligence when providing the requested information - ensuring completeness and clarity.

Every Company Needs an Ethics Programs

If your company does not have a Business Ethics and Compliance program, its time to change the situation. Right now, the FAR threshold for implementing a mandatory program is a $5 million contract that lasts for at least four months. However, many of the companies that have been suspended or debarred from Government contracting because of ethical lapses have had contracts much smaller than $5 million.

The Defense Industry Initiative on Business Ethics and Conduct has developed a tool kit to help Government contractors develop an ethics program. This toolkit is available at their website http://www.dii.org/ which has many other resources to help contractors develop robust ethics programs. For example, the toolkit will help contractors identify risk areas such as

• sloppy timekeeping practices
• business courtesies
• supplier kickbacks
• environmental protection

The kit will also help companies

• establish procedures to detect and prevent occurrences of unethical activities
• establish internal compliance programs
• set up training programs.

One of the most important elements to an effective business ethics and compliance program is to set a proper "tone at the top". According to the Association of Certified Fraud Examiners, "tone at the top"

refers to the ethical atmosphere that is created in the workplace by the organization's leadership. Whatever tone management sets will have a trickle-down effect on employees of the company. If the tone set by managers upholds ethics and integrity, employees will be more inclined to uphold those same values. However, if upper management appears unconcerned with ethics and focuses solely on the bottom line, employees will be more prone to commit fraud because they feel ethical conduct is not a focus or priority within the organization. Employees pay close attention to the behavior and actions of their bosses, and they follow their lead. In short, employees will do what they witness their bosses doing.

Travel Costs - Documentation Required

It is well known that allowable costs for lodging, meals, and incidental expenses is limited to maximum reimbursements listed in the Federal Travel Regulations (FTR) for travel in the lower 48 and in the Joint Travel Regulations (JTR) for overseas travel including Alaska and Hawaii. Unfortunately, more than a few contractors forget that the cost principle covering travel costs also includes specific documentation requirements.

FAR 31.205-46(a)(7) states that travel costs shall be allowable only if the following information is documented:

• date and place of the expense
• prupose of the trip
• name of person on trip and that person's title or relationship to the contractor

Contractors who fail to maintain this documentation are at risk of having the costs suspended or disapproved.

One of the first tests an auditor is trained to perform is to assess the availability and adequacy of documentation. Sometimes, adequacy is a subjective assessment. Other times, such as in the travel cost principle, the adequacy of documentation determination is very objective - date, location, purpose, and name/title.

Auditors will look for contemporaneous documentation - documentation prepared at the time of travel. Some contractors attemp to prepare documentation after the fact, sometimes years after the fact. There are several problems with this practice. First, auditors will consider it a high risk area and increase the level of transaction testing. Second, after-the-fact documentation preparation is time consuming. Thirdly, trying to "remember" the purpose of the trip months or even years after the fact is very difficult. Finally, sometimes, everyone who might remember trip details have left the company.

To avoid problems in this area, contractors should examine their travel policies and procedures to ensure that the required documentation is captured and maintained.

Cost Accounting Standards

Some Government contractors and prospective Government contractors panic when they hear the word "CAS". They envision more regulations, red tape, and endless documentation and incessant oversight. In reality, CAS, which stands for Cost Acounting Standards, is a series of promulgations designed to promote fair and consistent cost accounting practices and more often than not, are practices that contractors have already implemented.

Some contractors are exempt from CAS. For contractors that are covered by CAS, there is full and modified coverage. First of all, CAS applies only to negotiated contracts. Sealed bids, awards based on adequate price competition without submission of cost or pricing data, contracts in which the price is set by law or regulation, and commercial items are all exempt. Additionally, contracts under $650 thousand, contracts awarded to small businesses (as defined by SBA) and contracts executed and performed outside of the US are also exempt.

The thresholds for full and modified coverage are $50 million and $7.5 million respectively. Modified CAS coverage requires compliance with CAS Standards 401, 402, 405, and 406. Full CAS coverage requries compliance with all 19 CAS Standards. Whether exempt, modified or fully covered, the substance of many CAS standards have been incorporated into the Federal Acquisition Regulations over the years. Take CAS 405 for example. CAS 405 requires contractors to identify and exclude unallowable costs from proposals and billings to the Governments. The same requirement is found in FAR 31.205.

CAS Disclosure Statements

A CAS Disclosure Statement is a written description of a contractor's cost accounting practices and procedures. In general, it is required for fully CAS covered contractors and must be completed prior to the award of a CAS covered contract of $50 million or more. Additionally, corporate offices or other intermediate home offices that allcoate costs to one or more disclosing segments must complete Part VIII of the disclosure statement.

Once submitted, the contracting officer will request auditors to determine adequacy. This determination assures that the disclosure statement has adequately disclosed the practices required to be disclosed by the CAS Board's rules, regulations, and standards. The Government's objective is to obtain an adequate description of the accounting system. During an adequacy review, contractors (or prospective contractors) are usually given the opportunity to revise any identified deficiencies, clarify wording, or expand upon a description or accounting practice.

There are eight sections to a CAS disclosure statement;

1. General information
2. Direct costs
3. Direct versus indirect costs
4. Indirect costs
5. Depreciation and use allowances
6. Other costs and credits
7. Deferred compensation and insurance
8. Home office expenses

Click here for a flowchart to help you determine your level of CAS coverage and disclosure statement responsibility.

Terminations for Convenience

Every Government contract includes a clause that gives the Government the absolute right to terminate the contract for convenience (T4C). There are no limitations on the circumstances under which the Government can exercise its rights. A T4C does not mean that the contractor has failed to perform under the contract. In most T4C cases, the Government decided that it doesn't need or can no longer fund a project, system, or service.

When a contractor receives a notice of termination, it must comply with the notice. Generally, the notice will require the contractor to stop work immediately, terminate all subcontracts, immediately advise the terminating contracting officer (TCO) of any special circumstances precluding the stoppage of work, perform any continued protion of the contract, protect and preserve government property in the contractor's possession, settle outstanding liabilities, submit a settlement proposal, and dispose of termination inventory.

Timing is critical. When the Government directs contractors to stop work immediately, it really means immediately. Settlement proposals greater than $100 thousand will be audited. One of the first audit steps an auditor will undertake is to check for costs (including labor costs) incurred after the date of termination. Such costs will be challenged and unless the TCO has approved specific costs incurred after termination, will be disallowed.

Settlement expenses are a special category of costs under termination settlement proposals and are generally allowable. Settlement expenses include accounting, legal, clerical, and similar costs reasonably necessary for the preparation and presentation, including supporting data, of settlement claims to the TCO, reasonable costs for the storage, transportation, protection, and disposition of property acquired or produced for the contract, and indirect costs related to salary and wages incurred as settlement expenses. 

Contractor Disclosure Program

In December 2008, the Federal Acquisition Regulations were changed to require all contractors to timely disclose to the Government in connection with the award, performance, or closeout of a government contract or a subcontract, credible evidence of a violation of federal criminal law involving fraud, conflict of interest, bribery, or gratuity violations, or violations of the false claims act and remit any significant overpayment amount.

In connection with this rule, the Department of Defense, Office of Inspector General, established a Contractor Disclosure Program which affords contractors a means to disclose such incidences either in writing or electronically.

Contractors must disclose early and fully cooperate with the investigation and resolution. The Government's aim is to encourage contractors to self-report, respond quickly, speed up Department of Justice decisions, focus and complete investigations, establish coordination between the IG and contractors, and provide feedback to contractors.

About a year has passed since the rule became effective and the Contractor Disclosure Program was established. Since then, eighty disclosures have been submitted to the Government from companies of all sizes. Three of the eighty were administratively closed. Contractors were probably erring on the side of caution in submitting those three. Sixteen of the 80 have been referred for investigation. Twelve have been investigated and closed. The remaining 49 are still under consideration by the IG's office.

Contractors have disclosed such things as kickbacks to suppliers, labor mischarging (timecards), defectively priced contracts, and misrepresented certifications (SBA 8a certification).

In deciding whether to disclose under this regulation, a key consideration is that there must be "credible evidence" of a wrong-doing. That is a subjective term but certainly it requires something more than a hunch or suspicion. Once credible evidence has been established, the regulations require "timely" disclosure to the Government. 

Midwest Training Opportunies

For government contractors, prospective government contractors and anyone interested in exploring Government contracting opportunities, we heartily recommend The Contracting Academy (TCA) based in Oklahoma City as a source to meet your training needs and requirements. TCI offers affordable and targeted training opportunities related to Government contracting as well as opportunities to network with key like-minded professionals. Courses are presented by industry specialists.

We were honored to present "An Introduction to Government Contracting" at a recent TCA event in Oklahoma City. The organization, facilities, meals, and refreshments were absolutely first class. The participants were actively engaged and either desired to enter the Government contracting areana or expand upon their company's existing Government work. Here's the class photo.

If interested, contact TCA on the web or call Kay Bills directly at 405-603-5306.

You might also enjoy reading this news article concerning TCA.

Acquisition Related Thresholds Due to Increase

On February 4, 2010, the FAR Councils published a proposal to increase many acquisition related dollar thresholds. The National Defense Authorization Act from 2005 requires an adjustment every five years of acquisition-related thresholds for inflation using the Comsumer Price Index for all urban consumers. The last imflation adjustment was in 2005.

An acquisition-related threshold is a threshold that is specified in law, executive order, or regulation as a factor in defining the scope of the applicability of a policy, procedure, requirement, or restriction provided in that law, executive order or regulation. Examples of thresholds that are not viewed as acquisition-related are those relating to claims, penalties, withholding, payments, required levels of insurance, small business size standards, liquidated damages, etc.

This proposed rule affects thresholds in dozens of FAR sections - to numerous to include here. However, changes to the heavily-used thresholds include:

• The micro-purchase base threshold of $3 thousand will not change.
• The simplified acquisition thresholde will be raised from $100 thousand to $150 thousand.
• The FedBizOpps preaward and post-award notices remain at $25 thousand because of trade agreements.
• Commercial items test proram ceiling will be raised from $5.5 million to $6.5 million.
• The cost and pricing dta threshold will be raised from $650 thousand to $700 thousand.

To view all current FAR thresholds, click here. This reference should update once this is published as a final rule.

Better Pay Your Taxes

Soon, disputes with the IRS on tax matters could impact contractors' ability to secure Federal contracts.

On January 20, 2010, the White House issued a memo to Executive Agencies noting that federal contracts are awarded to thousands of companies with serious tax delinquencies. The total amount of unpaid taxes owed by these companies is estimated to be more than $5 billion.

“Studies by the Government Accountability Office have identified tens of thousands of such dead-beat companies that are being awarded government contracts,” Obama said. “One company owner who owed over $1 million in taxes was paid over $1 million as a defense contractor — and instead of using that money to pay his back taxes, he chose to buy a boat, some cars, and a home abroad with his earnings. The total amount owed in unpaid taxes by companies like that is estimated at more than $5 billion.”

Obama went further to call on Congress to pass legislation to allow the IRS to share information about tax delinquency with contracting officials. The President also said that he would reintroduce a budget proposal that would delay payment to a tax-delinquent contractor until after taxpayers are paid back in full.

The President directed the IRS to review certifications of non-delinquency in taxes that companies bidding for Federal contracts are required to submit per the Federal Acquisition Regulations and report back to the President in 90 days on the overall accuracy of contractor certifications.

Additionally, the President directed the OMB (Office of Management and Budget) to review existing procedures and make recommmendations to ensure contractors with serious tax delinquencies are not awarded Federal contracts. He is also looking for a plan to make this information available in a Government-wide database.

Accounting System Adequacy - Part III

This is the third and final post on our discussion of two contractors who protested a contracting officer decision to reject their bids due to inadequacies in their proposals. If you missed the first earlier posts, read Part 1 and Part 2 first.

In advising PMO that it was rejecting its proposal, FTA cited the following deficiencies, based on BMC’s audit report.

1. The cost proposal does not reflect that the JV is operating as an independent entity with an indirect rate structure that would be unique to the joint venture as required by FAR 31.203, and
2. The proposal was not prepared in all material respects in accordance with FAR and the Transportation Acquisition Regulations.

The three companies comprising the PMO joint venture proposed to contribute labor to the joint venture, burdened by the overhead rate from the “sending” company. The BMC auditors, like DCAA in the case of the MD joint venture, believed that the joint venture should develop a single rate specifically for the joint venture. BMC cited as authority for its position, FAR 31.203 [later refuted by GAO]. During the appeal process, FTA wrote that the arguments in PMO’s protest did not address the real issue in this case, and that is, by not submitting a single overhead rate, PMO is in non-compliance with CAS 401. Here again, FTA raises the specter of CAS 401 when it was not cited in the BMC audit report, two months after BMC’s audit report was submitted. A month after that, at FTA’s behest, BMC issues a memo stating that PMO’s failure to propose a single rate was a noncompliance with CAS 401. As we discussed concerning a similar DCAA memo related to MD, the BMC memo doesn’t carry the weight of an audit opinion and the sequence of events calls into question the audit firm’s independence.

GAO’s Decision

GAO upheld both protests. GAO ruled that FTA’s CAS 401 argument represented “…a misunderstanding of the CAS regulations.” There is nothing in CAS that requires a joint venture to establish indirect rates that are specific to the joint venture. Moreover, small businesses are exempt from CAS and FTA had previously determined both joint ventures to be small businesses.

GAO soundly criticized the depth of the support for the Government’s position. It called them “conclusory statements” without any analysis or legal authority as to why the proposed rate structure violated CAS 401. Nor could GAO conceive on its own how the proposed rate structures violated CAS 401 or any other authority. GAO also found it “notable” that the original audit reports and FTA’s determinations and findings supporting the rejections, made no mention of CAS 401 violations.

GAO concluded that FTA had not provided a reasonable explanation why the joint ventures accounting systems were unacceptable, and therefore, sustained both protests.

If you would like to read the complete GAO decisions, click here for the MD joint venture and here for the PMO joint venture.

Accounting System Adequacy - Part II

This is a contuation of our discussion on two contractors who protested a contracting officer decision to reject their bids due to inadequacies in their proposals. If you missed the first part, read it here first.

After declaring both MD and PMO’s proposals to be technically acceptable, the FTA contracting officer sent the proposals out for audits. FTA requested audits of proposed costs including direct labor rates, escalation and indirect rates in order to determine if the proposals were acceptable for negotiating a price. FTA sent MD’s proposal to DCAA on March 18, 2009 and sent PMO’s proposal to BMC on June 9, 2009. [Incidentally, DCAA issued its report on September 21, 2009, six months after the request while BMC issued its report on September 24, 2009, about three and a half months after the request. This is not really relevant to this discussion but for those of you who despair of the time it takes DCAA to conduct audits and issue reports, it is illustrative of DCAA’s demise. At one time, DCAA endeavored to issue those kinds of reports in 30 days.] In both cases, the auditors concluded that the proposals submitted by MD and FTA were not adequate to negotiate fair and reasonable prices. Based on these audit reports, the contracting officer determined that both proposals were unacceptable and advised the companies. FTA advised MD of its rejection on September 22, just one day after the date of DCAA’s audit report. FTA advised PMO of its rejection on October 5, about two weeks after the date of BMC’s audit report.


So what was so terrible about these proposals that they were rejected? Here’s where the two cases diverge a bit so we’ll look at them individually.

MD’s proposal

In advising MD that it was rejecting its proposal, FTA identified the following deficiencies as noted in the DCAA audit report.

1. Since the accounting system was to be maintained in Canada, there was no assurance that it would be maintained in accordance with U.S. generally accepted accounting principles (GAAP) as required by FAR.  
2. There is no evidence that the joint venture is an independent entity with its own employees and indirect rates.
3. The joint venture did not prepare budgets for the entire performance period but used the same indirect rate for each year.

During the appeal process, there was correspondence between GAO, FTA, and MD in an effort to get to the real issues. Ultimately, FTA abandoned its contemporaneous basis for rejecting MD’s proposal (the three issues listed above) stating that “The basic failure of [MD] is compliance with Cost Accounting Standard (CAS) 401”. The real problem, according to FTA (and later on, the DCAA) was with the indirect rate(s). The MD joint venture was comprised of two companies. Each of those companies proposed to contribute labor to the joint venture, burdened by their respective overhead rates. FTA alleged that the joint venture should have its own overhead (indirect) rate as required by Cost Accounting Standard (CAS) 401. This was the first time that CAS 401 was raised as an issue. DCAA had not mentioned it in its audit report and FTA had not mentioned it in its rejection notice.

To buoy its position, FTA requested DCAA corroboration. On December 15, almost two months after it issued its audit report and nearly a month and a half after FTA propounds its CAS 401 theory, DCAA provided FTA a memorandum stating that MDs failure to submit a unique indirect rate was a violation of CAS 401. The DCAA memo is troubling for two reasons. First, it is rendered without an audit opinion. The initial report had an opinion that MD’s proposal was inadequate for the reasons stated above. DCAA did not retract this opinion. It appears that once it became evident to FTA and DCAA that the initial position was not defensible, they had to cobble together a different reason. The new basis, however, did not come with a duly formulated audit opinion based on sufficient evidential matter. The second problem with DCAA’s memo is that it appears that DCAA lacked independence in formulating its CAS 401 position. FTA came up with the CAS 401 angle six weeks before DCAA issued its memo. It appears to the casual reader of the protest decision that FTA influenced the contents of that memo.

We will continue this series tomorrow with a discussion of FTA’s rejection of PMO’s proposal and the basis that GAO used to sustain the appeals of MD and PMO.

Accounting System Adequacy - Part I

Yesterday we discussed a GAO decision regarding the appeal of a prospective contractor who was excluded from the bidding process because its accounting system had not been reviewed for adequacy by a federal audit agency. The solicitation required that prospective contractors be able to demonstrate that their systems had been approved by the Government. The contractor believed that this requirement was unreasonable. After all, how does a contractor or prospective contractor go about securing a government audit? It cannot. Audits are only initiated at the request of a contracting officer or because a company was actually awarded a contract. A prospective contractor cannot go out and order up a federal audit. So, for this particular solicitation, only existing government contractors could bid. Timing is everything however. GAO stated that if the company believed the requirement to be unfair, the time to protest would have been prior to submitting the proposal, not after bid submission. The protestor had spent a lot of time and effort to find a work-around alternative to having a federal agency audit of its accounting system. It should have used that time to file a protest.


Today we will discuss two additional GAO protest decisions related to accounting systems. In both of these cases, the contracting officer disqualified prospective contractors because they had inadequate accounting systems. The companies protested and GAO sustained their protests because the contracting officer had relied on advice based primarily on unreasonable or unsupported conclusions – in one case, this advice came from DCAA (Defense Contract Audit Agency) and in the other case, this advice came from a private firm contracted by DOT to conduct audits, BMC. The GAO also stated that the Agency's reliance upon the advice of an auditor, such as the DCAA, does not inslulate the Agency from responsibility for error on the part of the advisor.

The two cases are somewhat related. Both involve an RFP issued by the Federal Transit Administration (a Department of Transportation Agency) to provide support to ensure compliance with statutory, administrative, and regulatory requirement and to monitor the projects to determine whether the projects are progressing on time, within budget, and in accordance with plans and specifications. The solicitation contemplated the award of 15 to 25 cost-reimbursement ID/IQ task order contracts. Award was to be made to responsible offerors whose proposals contained the combination of criteria offering the best value to FTA, considering the following evaluation criteria; technical and management, cost/price, and socioeconomic status.

Two of the bidders were joint ventures formed specifically for the purpose of bidding on this effort. One was PMO-JV formed in Florida and the other was MD-JV formed in Delaware. Both submitted timely proposals. FTA reviewed the proposals and determined that both were among the most “highly rated” technical proposals. Both contractors were invited in to make oral presentations on technical aspects of their proposals. After the oral presentations, FTA rated the technical proposals from both joint ventures as technically acceptable. So far, so good.

But, the goodness did not last. Tomorrow we will tell you why.

GAO Denies Accounting System Protest

GSA (General Services Administration) issued an RFP (Request for Proposal) for IT (Information Technology) Services anticipating the award of 25 to 30 contracts under a multiple-award, ID/IQ (indefinite-delivery/indefinite-quantity) with a NTE (not-to-exceed) price of $50 billion (how's that for using a bunch of acronyms in a single sentence?).  Obviously that's a lot of money even though its unlikely the Government will really spend $50 billion. Nevertheless, there was tremendous potential and many contractors submitted bids to vie for a piece of the action.

Awards were to be made on a "best value" basis, with proposals evaluated under two equally important technical factors; past performance and contract planning. These factors, when combined, were significantly more important than price. Prior to the evaluation, proposals were to be reviewed for acceptability on a pass/fail basis. Those failing this review would not be considered further.

Proposals were required to include the Defense Contract Audit Agency's (DCAA), or other federal audit agency's verification that its accounting system had been audited and determined adequate for determining costs under cost-reimbursable contracts. Any offeror that did not have audit verification but was certain that its accounting system has been determined adequate could provide contact information from a cognizant auditing representative office. Offerors were warned that their proposals would be rejected if the agency was unable to obtain audit verification.

One of the bidders was A-TEK, Inc. A-TEK had a number of cost-reimbursable contracts and had submitted provisional billing rates to DCAA. However, when GSA contacted DCAA, it could not verify that DCAA had ever reviewed and/or approved A-TEK's accounting system. When GSA requested additional contact information, A-TEK argued that the requirement was arbitrary, and asked GSA to come in and perform its own audit of the accounting system. Instead, GSA rejected A-TEK's bid. A-TEK protested GSA's action to the GAO.

GAO upheld the GSA rejection. GAO stated that GSA's evaluation was reasonable. The RFP unequivocally required offerors to have DCAA or other federal audit agency verification that the firm's accounting system had been audited and determined adequate for determining costs under cost-reimbursable contracts. The GAO found that A-TEK did not have any cost-reimbursement contracts in place; had never been audited by DCAA; and had never been subject to a pre-award survey of its accounting system. Furthermore, A-TEK's submission of provisional rates was not relevant because it lacked any existing cost-type contracts. The GAO decision cited a number of other factors but in short, A-TEK failed to provide any information that satisfied the RFP requirement. Based on A-TEK's failure to provide the required information, GSA reasonably concluded that the firm lacked a properly audited accounting system, and thus reasonably rejected the firm's proposal.

A-TEK asserted that since only the government can request and perform the required audit, meeting the requirement is beyond the firm's control, and it should not be penalized as a result. GAO, in a back-handed way, agreed with A-TEK's assertion that the requirement may not have been reasonable. However, GAO also stated that this requirement should have been protested prior to the closing for accepting proposals, not after. Since the protest was received after the closing date, the appeal was untimely and not sustained.

In this solicitation, any contractor that had not had its accounting system audited by DCAA or another federal audit agency and declared adequate for cost-reimbursable contracts were effectively eliminated from the bidding process. We agree with A-TEK that the requirement is not reasonable. However, the lesson to take home from this case is that contractors must immediately protest any such unreasonable solicitation requirements. Do not wait until after bids are due and do not try to finesse your way through with "alternative" methods of satisfying specific requirements.

Accounting Systems for SBIR Phase II Contracts

There is a provision in most SBIR Phase I contracts cautioning contractors that if they intend to submit a proposal for Phase II work on a cost reimbursement basis,they must begin implementing a Government-approved accounting system if they do not already have an approved accounting system.

This is really poor wording. The Government does not approve or disapprove accounting systems or the software program that drives those systems. It reviews accounting systems to determine whether they are adequate to meet requirements for Government contracting purposes. For more on the myth of Government approval, see our earlier blog post here. Okay, so maybe you're thinking we're making too fine of a distinction here - "approved" or "adequate" - there are still certain expectations, right? Yes there are certain expectations. Those expectations are captured in the SF Form 1408, a form the Government uses to determine whether an accounting system is adequate for the type of contract contemplated. You can download a copy of the form here. SBIR contractors contemplating a Phase II proposal should download the form and use it to self-assess their systems.

Another great (and free) source of information is Information for Contractors published by DCAA. Although the current version is five years old and sorely needs updating, it remains a good resource for contractors trying to navigate the contracting environment. Chapter 2 of this Guide includes details on what the Government considers when using the SF Form 1408 to assess the adequacy of an accounting system. Where the form is lacking in information and detail, this Guide will help you understand what the Government requires and why it is important. You can download the Guide here.