Comments on DoD's Business Systems Proposal - Part III

Over the past few days, we have been summarizing some of the comments that were submitted in response to DoD's proposed revision to the DoD FAR Supplement to withhold payments from contractors whose business systems have been found inadequate. Up to now, we have summarized comments from two organizations that are opposed to the essence and substance of the proposal. To read Parts I and II, go here and here.

Today we are going to look at a response that believes the proposed regulation do not go far enough. Naturally, the comments are from a Governmental Agency - the DoD Inspector General (DoD-IG). The DoD-IG "generally" believes that the proposed regulations will improve the effectiveness of DoD oversight of contractor business systems. At the same time, they made two recommendations that essentially make things worse from a contractor's perspective.

The proposed regulations require that the ACO withdraw a finding of noncompliance when the contractor has "substantially corrected" the system deficiencies. The DoD-IG proposes to change "substantially corrected" to "completely corrected". This might not seem to be much of a distinction on first glance. However, the tem "substantially" implies that the ACO can make a subjective assessment of the contractor's overall progress toward correcting the cited deficiencies and if progress is being made and is following the approved corrective action plan, the contracting officer can release the billings. On the other hand, the term "completely" carries the connotation that no funds may be released until the deficiency is completely corrected.

The proposed regulations include a provision that allows the ACO to reduce the withhold from 10 to 5 percent if the contractor has submitted an acceptable corrective action plan within 45 days of receipt of a notice of the ACO's intent to withhold, but has not completely corrected the identified deficiencies. The DoD-IG believes that the reduction should be granted only to small business concerns. The DoD-IG reasons that "contractors other than small business concerns have the experience and the capability to correct system deficiencies. Reducing the amount withheld to five percent will lessen the motivation of a large business to correct their deficiencies". This is a ridiculous statement. Is the DoD-IG saying that small business concerns do not have the experience and capability to correct system deficiencies? If so, how could a small business ever comply with any acquisition regulation?

More Comments on DoD's Business Systems Proposal

Today we continue our coverage of the public comments submitted in response to DoD's proposal to withhold payments for contractors whose business systems have been found to be inadequate. Yesterday, we reported on a response submitted by an industry trade group representing many Defense contractors. To read that post, click here. Today we continue the coverage by looking at the comments submitted by the American Bar Association, Section of Public Contract Law.

First, here is what The Section of Public Contract Law writes about itself. The Section consists of attorneys and associated professionals in private practice, industry, and Government service. The Section's governing Council and substantive committees have members representing these three segments, to ensure that all points of view are considered. By presenting a consensus view, the Section seeks to improve the process of public contracting for needed supplies, services, and public works.

In summary, the Section believes that the proposed rule is not tailored to protect the Government from the risk of unallowable and unreasonable costs resulting from contractor business system deficiencies. It believes that the proposed rule is open to legal challenge and is likely to lead to increased litigation and compliance costs. We can't really opine on whether the rule, as proposed, will result in increased litigation, but we certainly share their concern about the cost of compliance. In fact we wrote about that here back in January.

The Section believes that the ten percent withholding system for each deficient business system is punitive. It treats all alleged business system deficiencies the same and fails to recognize that every business system deficiency is unique in terms of the potential risk to the Government. Under the proposed rule, the Government withhold is not reasonably related to the Government's potential harm.

The Section also addressed the numerous other contractual tools available to the Government to protect itself from any actual loss associated with business system deficiencies. FAR already limits payments to amounts determined allowable and can withhold payment until an audit is completed. There is protection built into the process of reviewing and approving provisional billing rates and final indirect expense rates. There are existing requirements with respect to maintaining adequate estimating systems. And, there is the Truth-in-Negotiation Act which acts as both a deterrent and a remedy.

Other points made by the Section include:

• The proposed rule includes incomplete definitions of acceptable business systems
• The proposed rule provides inadequate contractor processes for ACO 100 percent withholds based on elevated Government risk and inadequate guidance for ACO's to make 100 percent withhold determinations
• The proposed rule provides incomplete guidance for ACOs to approve systems when deficiencies previously have been identified
• The proposed rule should clarify an appeals process
• Any rule should allow for ACO discretion to apply or not apply a withhold
• The rule imposes potential burdensome requirements on small and mid-sized contractors.

Tomorrow we will summarize comments submitted by other responders to the proposed rule.

DoD Proposal on Withholding Billings for Inadequate Contractor Business Systems

Back in late January, we ran a series of posts discussing DoD's proposal to require contracting officers to withhold billings when contractor business systems are found to be inadequate. This proposal affects six different business systems including;

• Accounting
• Estimating
• Purchasing
• EVMS (Earned Value Management System)
• MMAS (Material Managment and Accounting System), and
• Government Property

The new regulations, if enacted, will affect all Defense contractors to varying degrees. As a general rule, the requirements for Accounting, Estimating, and Purchasing will apply to all contractors. EVMS applies to cost-type contracts greater than $20 million but Contracting Officers have discretion in adding the requirement to contracts lower than that. MMAS generally applies to a manufacturing environment. Government propoerty applies if there is Government furnished property under the contract.

The regulations require Contracting Officers to withhold 10 percent of billings for each of the six systems found to be deficient up to a maximum withhold of 50 percent.

There were a dozen or so comments submitted to the FAR councils responding to the proposed rule. Surprisingly, there were not many more comments - given the potential for this rule to significantly impact a contractor's cash flow. Understandably, comments received from Governmental Agencies were generally supportive of the rule while comments received from private companies and industry groups were not. We will spend the next several posts discussing these comments. There are some recurring themes among those opposed to the new rule. These include the lack of a clear definition of what a "deficiency" is, the punative withholding amount, and the existence of current tools that accomplish the same thing.

TechAmerica calls itself the leading voice for the U.S. technology industry, which is the driving force behind productivity growth and jobs creation in the United States and the foundation of the global innovation economy. Representing approximately 1,500 member companies of all sizes from the public and commercial sectors of the economy, it is the industry's largest advocacy organization and is dedicated to helping members' top and bottom lines. TechAmerica was formed by the merger of other industry organizations including AeA, ITAA, GEIA, and the Cyber Security Industry Alliance.

TechAmerica is opposed to the proposed regulation.

TechAmerica believes that "... DoD should focus on improving the effectiveness of DCMA and DCAA in performing their existing responsibilities, rather than imposing an inflexible regulatory regime that will usurp the ACO's role and impose potenetially draconian costs and risks on contractors." TechAmerica further believes " ... the Proposed Rule is unnecessary, overly burdensome, and counterproductive and that the concerns that led to the issuance of the rule - including minimizing the risk of unallowable costs and improving DCMA and DCAA - would be better addressed through other means." TechAmerica made the following points:

• The arbitrary withholds are unrelated to risks to the Government
• Mandatory withholding would threaten contractor solvency (and reduce competition and weaken industrial base)
• Mandatory withholding is unnecessary as the Government already possesses adequate contractual and regulatory mechanisms to address deficiencies in contractor business systems
• Mandatory withholding is not reasonably tailored to address the concerns that DoD intends to address through the proposed rule.

TechAmerica wants DoD to abandon the proposal. But, if for some reason DoD persists, TechAmerica believes the following changes to the proposed rule are necessary:

• Withholding should not be mandatory. ACOs should retain discretion.
• Withholds should be released if ACO does not make a final decision within 30 days.
• DoD should clarigy the definitions of an acceptable system and of a system deficiency
• DoD should clarify other ambiguous aspects of the rule

Tomorrow, we will summarize comments made by the American Bar Association, Section of Public Contract Law.

  

Governance, Risk, and Compliance (GRC)

GRC (Governance, Risk Management, and Compliance) is a fairly new and increasingly recognized term that reflects a way in which organizations can adopt an integrated apprach to these three areas. Governance is the responsibility of senior executive managment in setting the "tone at the top" of an organization. Risk Management leverages internal controls to manage and mitigate risk throughout an enterprise. Compliance is the process that records and monitors the policies, procedures and controls needed to enable compliance with Government regulations as well as internal policies and procedures.

There has been a definite shift in Governmental oversight activities from one that looks at a lot of individual transactions to one that relies on effective control activities to ensure the propriety of costs charged to Government contracts. This is not only evident in the audit environment but in contract administration, quality control, evarned value management, and government property. An effective GRC program will significantly enhance a company's internal controls and facilite Governmental oversight as well.

A large number of companies are now offering software that helps companies develop and maintain GRC systems. The cost of the software however is still very expensive and probably not affordable for small companies. We would like to see a decent application priced along the lines of QuickBooks. At this time, we have nothing to recommend to small companies.

The cost of the software, while expensive, is probably only a small part of the overall cost of implementation. Implementing a GRC system will also require a significant amount of development and implementation labor at the front-end as well as on-going effort to maintain the system and to ensure compliance.

If you wish to read more about this subject, a good place to start is the Wikipedia entry for GRC.

How to Avoid a DCAA Audit

Would you like to perform U.S. Government contracts without worrying about the Defense Contract Audit Agency coming in to audit your company - ever? All you need to do is incorporate in Canada, United Kingdom, France, Netherlands, or Germany.

The Department of Defense has reciprocal audit agreements with certain foreign countries to provide contract audit services and other contract administration services without charge. Under these agreements, DCAA performs audits of U.S. companies performing or bidding on contracts of the foreign country. In return, the auditors of the foreign country perform audits of the foreign companies performing or bidding on U.S. Government contracts. The U.S. currently has reciprocal audit agreements with five countries: Canada, United Kingdom, France, Netherlands, and Germany.

Well, maybe relocating to another country is a bit drastic. And, who knows. The auditors in those far off places might even be tougher than DCAA.

Accounting for Unallowable Costs

Small businesses (as defined by the SBA) are exempt from Cost Accounting Standards (CAS).  That statutory exemption leads many small businesses to assume that they do not have to concern themselves with CAS. That assumption would be a mistake. You see, many of the 19 promulgated CAS Standards have been incorporated into the Federal Acquisition Regulations (FAR) in whole or in part. And, small businesses are not exempt from FAR. One of the CAS standards that has been incorporated into FAR in whole is CAS 405, Accounting for Unallowable Costs.

FAR 31.201-6(c) states "The practices for accounting for and presentation of unallowable costs will be those as described in 48 CRF 9904.405 (i.e. CAS 405), Accounting for Unallowable Costs." In order to fully understand the accounting requirements, it is necessary to understand the requirements of CAS 405.

The fundamental requirement of FAR and CAS with respect to unallowable costs is that they be identified and excluded from any billing, claim, or proposal applicable to a Government contract. The accounting for unallowable costs requires far more effort. Essentially, the CAS accounting requirements state that the costs must remain "visible" and avilable to the Government.

1. The detail and depth of records required as backup support for proposals, billings, or claims shall be that which is adequate to establish and maintain visibility of identified unallowable costs, their accounting status in terms of their allocability to contract cost objectives, and the cost accounting treatment which has been accorded such costs.
2. The visibility requirement may be satisfied by any form of cost identification which is adequate for purposes of contract cost determination and verification.
3. Specific identification of unallowable cost is not required in circumstances where, based upon considerations of materiality, the Government and the contractor reach agreement on an alternate method that satisfies the purpose of the Standard.

To read more about the accounting requirements for unallowable costs, go here and scroll down to section containing CAS 405.

Getting Your "Inadequate" Internal Control Rating Changed

The Defense Contract Audit Agency performs various audits to assess the adequacy of contractor internal control systems. The most common reviews performed at small contractors include the timekeeping and accounting systems. Medium and large contractors may receive audits of billing, budgeting, compensation, purchasing, and more, depending on whether the particular control system is deemed to be a risk area for the Government. The audit opinions on reviews of internal control systems range from "adequate" when a contractor meets all internal control objectives to "inadequate" when significant deficiencies and/or material weaknesses are disclosed.

Before an audit report is issued, it is important for contractors to ensure that the auditors fully understand the system of internal controls. Things that might appear to be deficiencies, might not be true deficience because there are other compensating controls or contractors can show that the alleged deficiency poses no risk to the Government. One of the recent trends among auditors that frustrates contractors and befuddles us is their notion that internal controls must be devised in such a way to cover every contingency. In one recent case, a contractor did not have a policy or process to periodically review and update its interim billing rates. The fact that the contractor did not have any contracts that required billing rates was lost on the auditor. In his mind, it was still a deficiency becuase the contractor, as some point in time, might be awarded a cost-reimbursable contract where billing rates are needed. Contractors must be firm in representing their cases.

Once an audit report containing an "inadequate" opinion has been issued, its usually too late to continue letter writing letters and appeal to the contracting officer. If the deficiency is such that a corrective action plan can be easily implemented, it is often most efficient, timewise, to simply do so, even if you do not agree with the substance of the audit finding. Once corrective action has been accomplished, you can invite the auditors back. Many contractors simply wait until the auditor gets around to performing a followup audit. That could take a long time and extend the period when an "inadequate" opinion is on the street - potentially affecting your business. There is a better way. DCAA Audit policy requires the auditor to immediately schedule a followup audit when a contractor notifies it that the corrective action has been implemented and there are sufficient transactions for the auditor to examine and test to see if the correcting action has been effective in correcting the deficiency. Therefore, contractors should make every effort to expedite the corrective action process.

If the followup audit concludes that the corrective actions have been effective in resolving whatever internal control deficiency was identified, DCAA will report that fact in a followup report and reference it in other types of audit reports as well.

DoD Revises its Cost Principle on Public Relations and Advertising

The Defense Federal Acqusition Regulation Supplement (DFARS) 231.205-1, Public Relations and Advertising Costs, has been added to disallow amounts paid by contractors to the Government for leasing Government equipment, including lease payments and reimbursement for support services.

Specifically, the new DFARS states:

"Unallowable public relations and advertising costs also include monies paid to the Government associated with the leasing of Govrnment equipment, including lease payments and reimbursement for support services..."

Often times, Government contractors will lease Government equipment to use in public relations and advertising effort such as trade shows, air shows and other special events. For contracts awarded after December 24, 2009, these costs will no longer be allowable under Government contracts. This new provision does not apply to Foreign Military Sales.

DCAA has instructed its audit staff to ensure that DoD contactors have the requisite controls in place to preclude recoupment of these cots.

Government Continues to Award Contracts to Poor Performing Contractors

Yesterday, the House Committee on Oversight and Government Reform held a hearing to examine the Government's suspension and debarment process. The impetus for the hearing was recently published audits of AID, DOT and DHS that showed the Government continued to award contracts to companies who were ineligible to receive them because those companies had been suspended, debarred or had otherwise engaged in misconduct.

In his opening statement Committee Chairman Edolphus Towns noted that the suspension and debarment rules are intended to prevent "the incompetent and the unproductive, the con men and the frauds" from receiving Government contracts and grants until they "clean up their act". The problem that Towns noted was that the Government was not using the tools at its disposal, allowing poor performers to "rake in millions".

In one case, it took the Department of Transportation 300 days to reach a suspension decision and 415 days to process the decision when it should have taken 45 days total. During that time, the company received $24 million in new contracts. Another contractor admitted to filing more than 100 false claims and eventually paid back $1.3 million to USAID while continuing to receive additional contracts.

The testimony by managers from DOT, USAID, and DHS were the typical "mea culpa, didn't happen on my watch, we'll do better in the future" blather you would expect to hear in these kinds of hearings. Their words were certainly not inspiring nor were there any tangible suggestions for ensuring future compliance with existing rules and regulations.

To read more about this hearing or to watch it, go here.

Cost Allocability

Under the Federal Acquisition Regulations (FAR), the only costs that a contractor can charge to a Government contract are those that are allocable and allowable under FAR Part 31 cost principles, agency supplements, and contract terms. A cost is allocable to a Government contract if it is assignable or chargeable to one or more cost objectives on the basis of relative benefits received or other equitable relationship. To be allocable, costs must meet one of three tests:

• It must be incurred specifically for the contract (i.e. a direct costs), or
• It must benefit contracts and other work and can be distributed to them in reasonable proportion to the benefits received, or
• Is necessary to the overall operation of the business, although a direct relationship to a particular cost objective cannot be shown.

There are rarely any disputes involving the first of the three tests - must be incurred specifically for a contract. However, the second and third tests require contractors to show a sufficient nexus between the cost and a Government contract. A recent opinion by the U.S. Court of Federal Claims (Teknowledge Corp. v. U.S., 2009 WL 57014) illustrates this point.

Teknowledge is an internet transaction company that provides secure transactions over the internet. In 1999, Teknowledge began developing a program for the finance services industry. In 2001, Teknowledge charged (amortized) about $285 thousand of development costs to its Government overhead pool. Teknowledge maintained that the costs were allocable because it benefited the Government through a potential increase in business, potential reduction of indirect costs charged to Government contracts, and continued viability of the company.

The court ruled that these benefits were remote and insubstantial and do not meet the requirement of the FAR standard. The court stated that there needs to exist a sufficient nexus between a given cost and a government contract. The word "benefit" as defined in the allocability test requires some showing that the cost relates to a government contract, not merely that it promotes the Government's public policy interests.

Emerging Government Contracting Policy and Practice Issues

One of the presentations at this year's West Government Contracts Year in Review Conference - Covering 2009 was a presentation by Steven L.Schooner (George Washington University Law School) and David Berteau (Center for Strategic and International Studies) on Emerging Policy and PRactice Issues. A reprint of the conference brief can be downloaded and read here.

This paper, presented at the West Government Contracts Year in Review Conference (covering 2009), attempts to identify the key trends and issues for 2010 in U.S. federal procurement. In large part, the paper focuses upon the challenges inherited by the Obama administration and its efforts during its first year in office. Among other things, the paper suggests that the administration charted a course of what it perceived as bold action – most dramatically, touting "savings" and accountability, while permitting special interests to distract focus from value for money and customer satisfaction. Accordingly, at least to date, the Obama administration's procurement policies lack a cohesive theme, suggest a reactive rather than proactive approach, strongly indicate a special interest bias, and, at best, have sent mixed messages at a critical juncture. (March 2010).

Employee Bonuses

We recently came across a situation where a State agency, auditing under FAR cost principles took exception to employee bonuses a contractor paid to its employees because the payout did not comply with FAR requirements. The State auditors were correct in their interpretation and the contractor was unable to recover those bonuses under the State contract. We are also aware of other cases where auditors are agressively pursuing claimed bonus costs. In one case, auditors have assessed penalties against a contractor for claiming "specifically unallowable costs". Its a good time for contractors to review their bonus and incentive compensation policies to ensure they are in compliance with the regulations.

According to FAR 31.205-6(f), bonuses and incentive compensation are allowable provided the 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 the basis for the award is supported.

First of all, there needs to be a written agreement between a contractor and its employees. Too often, companies will come to the end of a successful and profitable year and want to reward its employees by giving them bonuses. That's fine to do so but don't claim the costs as compensation - it doesn't meet the requirements because there was no formal agreement in effect before the services were rendered. A certain level of specificity is implied in this requirement. A policy that provides for an unspecified amount and/or has a discretionary element to it, will not meet the FAR requirement.

Secondly, the bonus (or incentive compensation) must be supported. "Supported" means that the payout must have been calculated and disbursed pursuant to the formal agreement.

Thirdly, as in all matters related to compensation, the amount must be reasonable.

Contractors must have written plans where the criteria for award are clearly stated and understood by the employees. This usually means that the bonuses are performance related. Some contractors have based bonuses on employee performance appraisals. This might work if the appraisal is based significantly on objective rating factors. Bonuses based on subjective appraisals are at risk of being challenged by the Government.

Contractors need to be especially careful about bonuses paid to owners. Bonuses based on profitability is sometimes viewed as a distribution of profits and therefore unallowable.

Finding and Recapturing Improper Payments - Incentivizing the Auditors

Late last week, President Obama announced another program to reduce payment errors and eliminate waste, fraud and abuse in Federal programs.

Previously, last November, the President issued an Executive Order 13520 directing Executive departments and agencies to use every tool available to identify and subsequently recliaim the funds associated with improper payments.

The identification of improper payments promotes accountability at executive departments and agencies; it also makes the integrity of Federal spending transparent to taxpayers. Reclaiming the funds associated with improper payments is a critical component of the proper stewardship and protection of taxpayer dollars, and it underscores that waste, fraud, and abuse by entities receiving Federal payments will not be tolerated

To further intensify efforts to reclaim improper payments, the Obama administration is expanding the use of "Payment Recapture Audits," which have proven to be effective mechanisms for detecting and recapturing payment errors".

A Payment Recapture Audit is a process of identifying improper payments paid to contractors or other entities whereby highly skilled accounting specialists and fraud examiners use state-of-the-art tools and technology to examine payment records and uncover such problems as duplicate payments, payments for services not rendered, overpayments, and fictitious vendors.

Here's where it gets real interesting. The President emphasized one approach that has worked effectively in the past - using professional and specialized auditors on a contingency basis, with their compensation tied to the identification of misspent funds. This is going to get very interesting - hoardes of auditors paid on a contingency basis. There has never been a more important time to ensure your billing system is adequate. We can help you.

Proposed Regulations for Expediting Contract Closeout - Part 2

Today we will finish up our coverage on the Government's proposed regulations designed to expedite the contract closeout process. To read Part 1, click here. As we stated earlier, cost reimbursable contracts typically take a lot of time and effort to close. Both contractors and Government auditors and administrators share the blame here, making closings a low priority and allowing the process to fallow until everyone involved in the contract have left, moved on or moved up. In an effort to speed up the process, the Government has proposed a series of FAR changes designed to remove some of the perceived impediments to a smooth process.

The most significant change (and also the most controversial change based on public comments to the proposed change) is the definintion of what comprises an adequate incurred cost claim. Recall from yesterday that one of the propsed changes required contractors to submit adequate incurred cost claims, not simply incurred cost claims. The proposal revises FAR 52-216-7 to define the term "adequate".

In order to be considered adequate, an incurred cost proposal must include all of the following (unless otherwise specified by the cognizant Federal agency official).

1. A summary of claimed indirect expense rates
2. General and Administrative (G&A) expenses
3. Overhead expenses
4. Occupancy expenses
5. Claimed allocation bases
6. Facility Capital Cost of Money (FCCM) calculations
7. Reconciliation of books of account and claimed direct costs
8. Schedule of direct costs by contract/subcontract and indirect expense applied at claimed rates and the Government's participation in each indirect rate pool.
9. Schedule of cumulative direct and indirect costs cliamed and billed
10. Subcontract information
11. Summary of hours and amounts on T&M/labor hour contracts
12. Reconciliation of total payroll to total labor distribution
13. Listing of decisions/agreements/approvals and description of accounting/organizational changes
14. Certificate of final indirect costs
15. Contract closing information for contracts completed during the fiscal year.

In addition, the clause lists 17 other items/schedules/reports that may be submitted together with the foregoing items, stating that these additional items will be required during the audit so contractor's might as well prepare and submit them along with the required items.

Many of you will recognize this list as coming from DCAA's electronic incurred cost excel model (ICE) or its paper version Information for Contractor's Phamphlet (DCAAP 7641.90).

Proposed Regulations for Expediting Contract Closeout

Last Monday we reported on a proposed change to FAR that, if enacted, will make fee withholds automatic rather than discretionary. This proposal is but one of several ideas being proposed by the Government as a means of expediting contract close-out. Today and tomorrow we will share some of the Government's other proposals.

Historically, cost reimbursable contracts take a long time to close. There are several legal-type documents to generate (contractor's release, assignment of credits, patent report), a final report has to be submitted, and contract costs need to be audited. Its drudgery. The work is finished, the excitement is over, and everyone has moved on. The process of closing contracts is often a low priority for both contractors and the Government. Right now however, the major impediment to closing contract in a timely manner seems to be DCAA's incurred cost audit backlog - an issue that these proposed regulations will not remedy.

Quick closeout procedures. The proposed regulations represent a significant expansion on existing quick closeout procedures. Currently, FAR 42.708 allows the use of quick closeout procedures when unsettled indirect costs are less than $1 million on a particular contract and less than 15 percent of the total indirect costs to be allocated for that particular year. The proposed revision to FAR 42.708 applies to both direct and indirect costs (as opposed to indirect costs only) and the threshold increases to $4 million or 20 percent of the total contract. The 15 percent limit on total indirect costs to be allocated, is gone. By the way, DCAA opposed this provision, asserting that the 20 percent threshold would present undue risk for the taxpayer. DCAA is in favor of reducing it to 10 percent.

The Government's use of quick closeout procedures also requires that the contracting officer perform a risk assessment and determine that the use of the quick closeout procedure is appropriate. The risk assessment includes consideration of accounting, estimating, and purchasing systems; direct and indirect costs; other concerns of the cognizant contract auditors and any other pertinent information.

Final patent report. The proposed regulations set forth procedures allowing the contracting officer to proceed with contract closeout when a required final patent report is not received.

Requirement to Submit an Adequate Incurred Cost Proposal. The current version of FAR 42-705-1(b) required contractors to submit a final indirect cost rate proposal. The revised regulation inserts the term "adequate" into the requirement. This is no small matter because the proposed provision also defines the components making an "adequate" submission. We will look at that aspect tomorrow.

Cost Contingencies in Government Contracting

According to FAR (Federal Acquisition Regulations) 31.205-7, a "contingency" is a possible future event or condition arising from presently known or unknown causes, the outcome of which is indeterminable at the present time.

The allowability of costs for contingencies depends upon whether one is addressing historical costs or prospective costs. In the case of historical costs, contingencies are almost never allowable because such costing deals with costs incurred and recorded on a contractor's books. One exception to this rule might be in the case of contract terminations where a contingency factor may be recognized when it is applicable to a past period to give recognition to minor or unsettled factors in the interest of expediting settlement.

Contingencies included in estimates of future costs are sometimes allowable and sometimes not. If the contingency is based on current conditions and the impact is foreseeable with reasonable limits. An example of this would be a provision for rejects or defective work.

On the other hand, contingencies included in estimates of future costs are unallowable if the contingency is based on known or unknown conditions and the impact cannot be measured accurately enough to provide equitable results to the contractor and to the Government. For example, the outcome of a lawsuit could impact future costs however the outcome of the lawsuit is uncertain as would be the impact on costs.

In practice, estimates for contingencies in proposals are very difficult to support and sustain when negotiating contracts. When proposed, the Government will consistently challenge the cost, requiring contractors to prove that the estimates are based on current conditions and the impact is foreseeable. Where historical costs and trends can be used, contractors have improved chances of sustaining their positions.

Advice for the Air Force - Don't Rely on DCAA to Ensure Fair Prices

James Hasik (Hasik Analytical, LLC) has some advice for the Air Force now that Northrup has dropped out of the competition for the new air refueling tanker leaving Boeing the only remaining bidder. Asking the question of how to ensure a fair and reasonable price for the planes when there is only one buyer (the 767 is a 30 year old plane and commercial customers have stopped ordering them) and one seller, Hasik warns that the Air Force should not pretend that DCAA (the auditors) will save it. Hasik writes:

One could be tempted to hope  ... that once the legion problems at the Defense Contract Audit Agency (DCAA) are corrected, the watchdog will reclaim its teeth. Sure, it’s a fixed price contract, but Boeing must disclose both its costs and its profit margin, so even without competition from Northrop and EADS, the government will get a good deal, no? Eh, no. The problem is that effective regulatory regimes are generally elusive, and for four reasons:

This is true in the first place because the informational asymmetries in regulation are severe, so the perspectives that regulators develop on their subjects are almost always distorted. In theory, the government needn’t spend too much time and effort trying to gin up should-cost numbers for the 767, as that airplane has been in production for 30 years. However, with a large, technically complex, and sun-setting system like the KC-X, the problem is serious. As relative prices shift, and commercial customers for this plane that no one else wants fall away, what it should cost becomes anyone’s guess.

Further, the appropriate contracting mechanisms are not obvious. Whether contractors are regulated according to price or cost, they, their managers, or their labor forces generally find some way of gaming the system to extract at least a portion of the rents they desire. Auditors and regulators can set rules, but smart people will always find a way around them.

Besides, regulatory capture is a near certainty. Regulators are very frequently observed to go native in the firms they regulate. The problem is particularly severe in technologically intensive industries where the regulators, by virtue of the domain knowledge required to participate in the regulatory process, most frequently hail from the industry itself. Sooner or later, factions within the KC-X program office, the DCAA, and AFCAA, and any other organization with what people on Capitol Hill like to call “oversight” would come to think about Boeing’s interests as synonymous with the Air Force’s interests. It’s an industrial base thing.

Finally, the regulatory burden itself is costly, which contributes to the overall cost of the project, even if no further rents accrue to Boeing. Ultimately, the Air Force has to pay for those squadrons of bean-counters and fact-checkers, and all those clipboards and green eye shades cost money. But more significantly, at a certain point, the managerial cost of the added oversight, through gummed-up processes and drawn-out schedules, exceeds its marginal returns.

To read Hasik's entire article, click here.

More on Fee Withholds

Last week we alerted you to a few cases where DCAA had rejected billings under CPFF contracts because contractors had included amounts for fee that exceeded 85 percent of the negotiated fixed fee. DCAA erroneously cited FAR 52.216-8 that merely allows the Government to withhold fee where it was deemed in the best interests of the Government (the example used to justify fee withhold was a contractor who was consistently late in submitting its annual incurred cost claims). The clause does not require fee withhold. According to the Defense Contract Management Agency, in order to invoke that provision, the contracting officer would need to issue a contract modification to that effect. In the cases we are aware of, there were no contract modifications. We do not know how widespread the DCAA practice but we recommended that if you are having fee withheld on your contract(s), or you are voluntarily withholding fee based on some long established practice, you check your contract to verify that such a withhold is appropriate.

While the fee withhold provision is currently discretionary, there is a proposal on the table to make it mandatory. The FAR Councils proposed a rule last August to do just that. In May, the Director of Defense Procurement and Acquisition Policy (DPAP) completed an assessment of public input on systemic issues related to contract closeout. As a result, certain changes were proposed to the FAR to improve contract closeout. One of those proposed changes was to make fee withholding mandatory to

protect the Government's interest and to encourage the timely submission of an adequate final indirect cost rate proposal

The comment period on this proposed regulation closed last October. Sixteen commentators weighed in but only about half commented on this particular provision. All who did, were opposed to it, believing that it lumped the timely contractors with the recalcitrant ones, that it would have a major impact on contractors' cash flow, and the current regulations already provide for fee withhold when necessary.

This is still an active case. The report by the Implementation Team tasked with reviewing public comments and drafting the final FAR rule was expected in late January. We were unable to determine current status. If implemented as proposed, it will certainly have a significant financial impact on many Government contractors.

The Government May Be Illegally Withholding Some of Your Contract Fee

Most, but not all, cost-reimbursable contracts contain the FAR Clause 52.216-8, -9, or -10 (depending on whether the contract is fixed fee, construction, or incentive fee). These clauses states that after the Government pays out 85 percent of the fixed fee, the Contracting Officer may withhold further payment of fee until a reserve is set aside in an amount that the Contracting Officer considers necessary to protect the Government’s interest. This reserve shall not exceed 15 percent of the total fixed fee or $100,000, whichever is less. Notice the term "may withhold". The contracting officer may withhold fee, a fee withhold is not automatic.

According to Defense Contract Management Agency (DCMA) Information Memorandum No. 03-121 dated January 14, 2002,

there should normally be no need to exercise the option of withholding fee for a contractor with a record of timely submission of final cost vouchers and certified final indirect cost proposals, and that complies with other contract terms and conditions.

DCMA goes on to state that if the ACO determines that it is necessary to withhold fee to protect the Government's interests, written direction should be issued to the contractor by modification of the contract. The following paragraph provides suggesting wording for the modification:

This modification is issued to incorporate fee withholding in accordance with FAR Clause 52.216-8 (or -9 or -10, as appropriate). In order to protect the Government's interest, (contractor) is hereby directed to begin withholding fee from billings under this contract until a reserve is set aside in the amount of ....etc

DCMA also acknowledged in its Information Notice that some contractors are automatically withholding fee from billings, although not directed by the contracting officer and that DCMA has been advising contractors to stop withholding unless directed by the contracting officer.

Therefore, while the contract clause allows contracting officers to withhold fee when necessary to protect the Government's interest, in order to do so, the contracting officer must amend the contract.

Recently, we encountered a few situations where contractors had their billings rejected because they had billed in excess of 85 percent of fee. These rejections were inappropriate becuase the contracting officer had not amended the contract to require withhold. In one case, the clause was not even part of the contract. These rejections financially harmed the contractors because they disrupted their cash flows.

If you have a similar situation where the Government is withholding fee, you need to read your contract. If the withhold provision is not explicitly spelled out, you are entitled to your full fee. You should meet with DCMA and DCAA and straighten things out.

Proposed Rule to Help Women-Owned Small Businesses

The SBA has proposed a new rule to expand federal contracting opportunities to Women-Owned Small Businesses (WOSB).  The Government has never met its 5 percent contracting goal with women in at least the last 11 years. The latest numbers indicate that currently, only 3.4 percent of contracts are awarded to women-owned businesses.

To rectify this situation, SBA has proposed some new rules. First, the rule will authorize a set-aside of federal contracts where the anticipated contract price does not exceed $3 million ($5 million for manufacturing). Second, the rule significantly expands the number of industries (identified by NAICS codes) in which women-owned small businesses are under-represented or substantially under-represented from four to 83. Thirdly, unlike an earlier proposed rule from 2008 that was never finalized, Government Agencies do not need to find discriminatory contracting practices against women-owned businesses before competition could be restricted (i.e. set-aside).

The proposed rule allows women-owned small businesses to self-certify their status however SBA promises a robust certification process and a significant number of program examinations to confirm eligibility. SBA promises to vigorously pursue ineligible firms which seek to take advantage of the program and in so doing to deny its benefits to legitimate WSOBs. Presumably, this vigorous pursuit means suspension and debarment.

To be eligible for these set-asides, a firm must be 51 percent owned and controlled by one or more women, and primarily managed by one or more women. The women must be U.S. citizens and the firm must be "small" in its primary industry in accordance with SBA size standards.

You can read SBA's press release here.

Watchdog Group Expresses Continued Concerns with DCAA

The Project on Government Oversight (POGO) sent a letter to the Senate Armed Services and Homeland Security and Governmental Affairs Committees urging them to continue their oversight of the Defense Contract Audit Agency. POGO is an independent, well-respected, and vocal nonprofit that investigates and exposes corruption and other misconduct in order to achieve a more effective, accountable, open and ethical federal government. As frequent readers of their blog and news articles, we know POGO to be highly supportive of the need for strong contract audit oversight of federal procurement processes. POGO has been proposing for a long time that DCAA could be more effective if it were independent from the Department of Defense.

In its letter to the Senate committees, POGO, citing sources within DCAA, expressed concerns that recent changes within the Agency, including new leadership, have failed to address systemic problems at the Agency. POGO illustrates this concern with the following examples; (i) leadership is resisting grassroots efforts to address problems raised by the GAO and the DoD Inspector General, (ii) the hotline established to allow auditors to report conflicts with management is used for retribution, and (iii) managers and supervisors are not being held accountable for inappropriately changing audit opinions, facilitating cozy relationships with contractors and creating abusive work environments.

POGO urges the Committees to

continue your inquiry to determine if DCAA is implementing the meaningful reforms that would help the agency to become a strong and independent contract auditor to guard taxpayer dollars.

Go here to read the full POGO letter to the Senate Committees.

Alliance 2010 Conference - March 18th

The 2010 Alliance Northwest Conference lead by the Washington State Procurement Technical Assistance Center (PTAC) with support form various federal and state offices, is coming up soon; March 18th, at the Americraft Showplex Exhibition and Conference Center in Puyalup, WA.

This annual conference and trade show provides contractors and potential contractors with a full day of networking and training opportunities. Training includes basic courses on the process of selling to the Government and tips for positioning your business for success, sessions with various Federal and State offices, and match-making opportunities where companies have a chance to sit down one-on-one with an agency or prime contractor and tell about the company. Click here to see the full agenda.

If you are thinking about getting into or expanding your Government sales, this conference can help you find the not-so-secret formula for sustained financial stability by building strong relationships with fellow regional government contractors, identifying suppliers and buyers, participating in educational opportunities and network. To find out more about the conference, go here.

By the way, if you plan on coming, drop by our booth and say hello.

Provisional Billing Rates

Government contractors, regardless of size, must develop provisional indirect billing rates if they have cost-reimbursable contracts. These indirect rates are forecasts of what contractors believe will approximate their final rates for a particular accounting period (calendar year or fiscal year). The rates are applied to direct costs charged to cost reimbursable contracts and then billed to the Government. Because they are provisional, contractors must set up a system to periodically monitor their actual rates, compare then to the billing rates, and adjust the billing rates if their estimates do not track fairly closely to the actual rates. Within six months after the end of the accounting period, contractors are required to calculate their final rates and true-up or adjust their billings accordingly.

Contractors need to submit provisional billing rates to DCAA at the beginnig of each year for approval. DCAA is tightening up its procedures in this area. Whereas before, DCAA was somewhat lenient, allowing contractors a month or two to submit rates for a new year, they are not so apt to do that any longer. Now they routinely reject vouchers that are prepared without approved provisional billing rates. This can certainly affect contractors' cash flow as it adds several weeks to the process of getting paid.

The Government requires contractors to set up a process for monitoring provisional billing rates so that those rates can be adjusted (either up or down) as required. Some DCAA offices assert that the monitoring should be performed monthly. Others contend quarterly. Still others rely on judgment. The FAR does not perscribe a particular interval. We maintain that the monitoring should be performed more frequently when rates are volitile and less frequently when rates are stable. The nature of the business and business volume fluctuations have a lot to do with rate stability. Mature businesses tend to have more rate stability than start-ups. Contractors with significant backlog tend to have more rate stability than those with little or no backlog.

Usually, the process of calculating interim indirect expense rates is not difficult or time-consuming. Some accounting systems such as Deltech, do this automatically. But even if you're using QuickBooks, it is a simple matter to build a spreadsheet model to calculate rates. Most of our clients on QuickBooks can run their rates in just a few minutes.