Indirect Cost Allocation Bases - Part 2

Yesterday we began a discussion on indirect cost allcoation bases focusing on the requirements of FAR 31.203. If you missed that post, click here to read it before going on. Today we will conclude our discussion with comments on what the CAS 410 (Cost Accounting Standards) has to say about the G&A (General and Administrative) allocation base. If your company is not subject to CAS, you're not bound by these requirements. However, this standard is pretty good cost accounting in our opinion and we encourage companies to at least consider the methodologies described in the standard.

First, a definition of G&A. G&A costs represent management, financial, and other expense which is incurred by or allocated to a business unit and which is for the general management and administration of the business unit as a whole. G&A expense does not include those management expenses whose beneficial or causal relationship to cost abojectives can be more directly measured by a base other than a cost input base representing the total activity of a business unit during a cost accounting period.

According to CAS 410, the cost input base used to allocate the G&A expense pool shall include all significant elements of that cost input which represent the total activity of the business unit. The cost input base selected to represent the total activity of a business unit during a cost accounting period may be:

• Total cost input (TCI);
• Value-added cost input (excludes material and subcontract costs) or
• Single element cost input.

The determination of which cost input base best represents the total activity of a business unit must be judged on the basis of the circumstances of each business unit. So, there is definately not a "one size fits all" directive to this standard.

A value added base is best when the inclusion of material and subcontract costs would significantly distort the allocation of the G&A expense pool in relation to the benefits received, and where costs other than direct labor are significant measures of total activity.

A single element cost input base (e.g. direct labor hours or direct labor dollars) is useful where that element best representsw the total activity of a business. A single element base is not appropriate when it represents an insignificant part of the total cost of some of the final cost objectives.

Whatever allocation base you use, be aware that the Government may ask you why you chose one over another. Be prepared with your explanation and logic.

What is the Best Indirect Cost Allocation Base?

Many Government contractors or prospective Government contractors ponder the decision on what cost base to use for allocating indirect costs. Both the Federal Acquisition Regulations (FAR) and the Cost Accounting Standards (CAS) contain guidance on how to detemine the best allocation base. But both doecuments require some judgement and subjectivity to bring this about. One publication called it "...more art than science." Lets take a look.

FAR requires contractors to accumulate indirect costs by logical cost groupings (this could be one rate or multiple rates) with due consideration of the reasons for incurring such costs. The contractor shall determine each grouping so as to permit use of an allocation base that is common to all cost objectives to which the grouping is to be allocated. The base selected shall allocate the grouping on the basis of the benefits accruing to intermediate and final cost objectives. CAS 418, Allocation of Direct and Indirect Costs, has similar language. CAS 410, Allocation of G&A Expenses, is more prescriptive in its requirements. Contractors that are not subject to CAS can still look to these standards for help.

The number of indirect rates usually correlates to the size of the company. Small companies often times have a single rate. Larger companies have multiple rates such as a fringe rate, an overhead rate, and a G&A rate. A small service company (e.g. one that provides primarily labor) or an engineering firm would probably choose a direct labor base. A manufacturing company would most likely choose a total cost input base. Some contractors have to be very careful in finding a base that is common to all cost objectives. For examqple, a contractor with two contracts, one predominately labor and the other predominately subcontracted effort will have a challenge in finding a base that equitably spreads its indirect costs.

Tomorrow we will look specifically at the requirements of CAS 410 and the different bases for allocating G&A expenses.

Improving Profitability

It is not to hard to figure out whether you're losing money on a particular Government contract as long as you have an adequate job cost system. It is a little more difficult to figure out why the loss is occurring. Usually it comes down to poor estimating or poor cost control, or both. Contractors often fail to factor in contingencies or have a much too optimistic view of their future work which impacts indirect rates. Some contractors, upon receipt of a contract and feeling temporarily flush, will go out and buy things they shouldn't, don't need, or could lease more cheaply, hire employees before they're really needed, or misjudge the time it really takes to perform the work.  Sometimes however, cost overruns could also occur because of changed contract performance conditions which were not anticipated in the original contract solicitation.

If you find that poor estimating practices are the source of the cost overruns, you should perform a comprehensive estimating system review and implement corrective actions to ensure that estimating problems do not affect future contract profitability. If poor cost controls are the source of the cost overruns, you should identify and implement effective budget and cost controls to ensure costs are better managed.

If you are experiencing conditions that were not anticipated based on the solicitation requirements, you should consider submitting an equitable adjustment proposal. This could include differing site conditions (construction contract), delays in receipt of Government furnished materials, and government caused slowdowns, to name a few. Preparing, submitting, and negotiating an equitable adjustment proposal can be a time consuming process; however, an equitable adjustment to the contract price is the only way to recover increased contract costs due to changed conditions.

Contractors are often limited to what they can do to recover on a previously unprofitable contract; however, steps can be taken to prevent this unwanted condition for happening on future contracts. But don't wait. The time to act is now.

Here's a List to Avoid

The byline on The Project on Government Oversight's (POGO's) website states that it is an independent nonprofit organization that investigates and exposes corruption and other misconduct in order to achieve a more effective, accountable, open, and ethical federal government. We've enjoyed POGO for years, both while we worked as Government auditors and now in the private sector - especially their efforts to promote policies that will ensure effective internal control systems and ethical conduct by companies desiring to participate in the Government contracting arena.

Recently POGO updated it Federal Contractor Misconduct Database (FCMD) with a new top 100 ranking based on fiscal year 2009 data.  This is not a database of the top 100 "misconducting" contractors. It is a database of the top 100 contractors receiving Federal funds together with the number of instances of misconduct. Of the top 100 recipients, 27 have no known instances of misconduct. Eleven others have only one instance leading POGO to conclude that since many contractors have no pattern of misconduct, is  "... further evidence that we should not accept contractor misconduct as a cost of doing business".

The Government recently launched its own contractor responsibility database - the Federal Awardee Performance and Integrity System (FAPIIS). The Government's database is not publically accessible but it would be interesting to compare it to POGO's FCMD.

Visit POGO's Federal Contractor Misconduct Database here.

Is DCAA Going to Lose Some Work?

The Panel on Defense Acquisition Reform was appointed by Chairman Ike Skelton and then Ranking Member John McHugh in March 2009 to carry out a comprehensive review of the defense acquisition system. The review was motivated by a general sense among the members of the House Armed Services Committee that the Department of Defense’s (DOD) acquisition system was not responsive enough to today’s mission needs, not rigorous enough in protecting taxpayers, and not disciplined enough in the acquisition of weapons systems for tomorrow’s wars. The breadth of the problems that had recently come to light led members to conclude that a systemic examination was appropriate. The Panel took a year to perform its review, holding 14 hearings and 2 briefings covering a broad range of issues in defense acquisition. The Panel approved its interim report on March 4, 2010. The Panel received the Department’s1 views on March 11, 2010 and received additional input from the various stakeholder communities on the interim report prior to approving this final report on its findings and recommendations. The Panel issued its final report on March 23, 2010.

Among the many findings and recommendations the Panel expressed concern about the independence and effectiveness of the Defense Contract Audit Agency (DCAA). It recommended that DoD consider shifting responsibility for certification of contractor business systems outside DCAA or to independent teams within DCAA to avoid any conflict between DCAA's responsibilities for certifying the adequacy of contractor business systems and auditing the vouchers produced by those systems. To address this issue, two of the Panel members introducede H.R. 5013 which would require that business system reviews be "performed by an audit team that does not engage in any other official activity (audit-related or otherwise) involving the contractor concerned." Interesting.

Genuinely Useful Software - Part 1

Power Utility Pak Version 7 (PUP v7) is a useful collection of Excel add-ins that brings significant new functionality to Excel 2007. When PUP is installed, you can do things with Excel in a few steps that would have taken many steps to perform withoput PUP v7. Regardless of your experience level, you'll find features in PUP that can make your job easier. PUP v7 augments Excel with about 70 new commands and 53 new worksheet functions. The product is designed to work seamlessly with Excel 2007. If you still use an earlier version of Excel, try PUP v6.

If you spend your life in Excel like we do, this utility is well worth the price. While we do not use most of the added functionality, the commands and functions we do use make it a worthwhile investment. The price is $40 but quantity discounts are available. You can download a trial version at no cost.

One of our fatovite tools in PUP v7 is the "Create Workbook Contents Sheet". This utility adds a new worksheet which functions as a table of contents for quick navigation to other sheets in the workbook. You can even choose between hyperlinks or buttons to navigate to those sheets. If you have a workbook with many sheets, this is a great way to navigate. Try it the next time you prepare your ICE (Annual Incurred Cost Proposal).

To read more about PUP v7 and to download a trial version, click here.

Excessive Pass-Through Costs - The Indirect Allocation Base Matters

In October 2009, the FAR concils published an interim rule that limits excessive pass-through costs charged to Government contracts. This rule brings the rest of Government contracting in to conformity with DoD which has had the rule since 2007.

In November of last year, we posted a comprehensive discussion of the interim rule along with some observations and implementation advice. One of the points we made was that the allocation base for allocating G&A (or Indirect Costs) matters. To read that post, click here. We continue to field a fair number of questions on this subject so we will explain what we mean when we say that the allocation base matters.

Before continuing, it may be helpful to read our prior post on the subject.

Pass-through costs are defined in FAR as indirect costs and profit (or fee). The extent to which indirect costs are allocated to subcontracts, depends wholly on the allocation base. If the base includes subcontract costs, then indirect costs will be allocated to (added to) the amount of the subcontract. Conversely, if the allocation base does not include subcontract costs, then no indirect costs will be allocated to the subcontract.

FAR requires that indirect costs be aggregated into logical cost groupings and allocated to contracts on a basis of the benefits accruing to those contracts. In some ways, the determination of the allocation base is subjective and every Government contractor must decide on the allocation base that best allocates costs to its contracts. The Cost Accounting Standards (CAS) list three acceptable bases for allocating G&A; a total cost input base that includes all direct and indirect costs (excluding G&A), a value-added base that includes all direct costs except materials and subcontracts, and a single-element base such as direct labor costs (If you've got that big Government contractor swagger, you can probably get away with a completely different allocation base but for most contractors, using one of these three bases is advised).

Of the three allocation base methodologies, only the first include subcontract costs. So, if you allocate your G&A over a total cost input (TCI) base, you will need to be concerned with excessive pass-through costs when submitting your proposal and during contract performance. If you allocate your G&A over a value-added or single element base, you will not need to be concerned with excessive pass-through costs because no indirect costs will be allocated to subcontracts. Its that simple.

The Importance of Documentation

Once again, we have a case where a contractor's claim for reimbursement was denied due to inadequate documentation. We bring this subject up frequently to underscore the importance of documentation. Just remember, you may be entitled to reimbursement of costs but the Government has no obligation to pay those costs if they are not adequately documented.

In this recent case, the Comptroller General denied a claim for costs where a protestor failed to adeuqately documents its claim and aggregated allowable and unallowable costs such that the allowable portion could not be determined on the basis of the record (or on the basis of avilable documentation). [GAO Decision B-401466.2 dated April 7, 2010]. This case began with an earlier bid protest. The protestor dropped its protest when the Government agreed to pay the contractor's reasonable proposal preparation costs. The GAO cautioned the protestor that costs were only recoverable to the extent that they are adequately documented and shown to be reasonable. Additionaly, the documentation must identify and support the amounts claimed for each individual expense, the purpose for which that expense was incurred , and how the expenses related to the claim.

The contractor submitted invoices for two firms that, according to an affidavit from its managing director, was related to services by the two firms in the preparation of the proposal. However, upon review of the documentation, the invoices indicated a much broader scope of work than just the proposal preparation. It included terms like market, demographic, financial, cost, and assistance. The Government asked for further details including an analysis of the work performed and the correlation between the work and the costs. The contractor was unable to provide this information. As a result, the GAO denied the claim.

GAO concluded that there might have been a portion of the cliamed costs that related to proposal preparation. However, in sutuations such as this one where a protestor has aggregated allowable and unallowable costs and provided insufficient documentation to support the allowable portion, the entire amount must be disallowed.

OMB Raises Ceiling on Executive Compensation

Last week, the OMB (Office of Management and Budget) announced the 2010 ceiling for executive compensation. The 2010 ceiling is $693,951 - a small increase over the 2009 ceiling of $684,181.

According to the OMB, this "...amount does not limit the amount of compensation that an executive may otherwise receive. However, the compensation costs in excess of the benchmark amount are unallowable costs for Government contract purposes."

OMB also warned that this benchmark is not necessarily a "safe harbor". Allowable compensation costs for each affected executive are still subject to the Federal Acquisition Regulation and the Cost Accounting Standards as applicable and appropriate to the circumstances, e.g., reasonableness and allocability. The Executive Compensation Cap is implemented at FAR 31.205-6(p).


In case you're wondering how this ceiling was derived, the Administrator, Office of Federal Procurement Policy, (OFPP), determines the benchmark executive compensation amount as required by Section 39 of the OFPP Act, as amended (41 U.S.C. 435). The benchmark amount applicable for a fiscal year is the median amount of the compensation provided for all senior executives of all benchmark corporations per commercially available surveys for the most recent year for which data is available at the time the OFPP Administrator determines the amount. The data used is the median (50th percentile) amount of compensation (total amount of wages, salary, bonuses and deferred compensation) accrued over a recent 12-month period for the top five highest paid employees in management positions at each home office and each segment of publicly traded U.S. companies with annual sales over $50 million. Once a benchmark compensation amount is established for a fiscal year, it is applicable for that fiscal year for a contractor and subsequent fiscal years, unless and until revised by OFPP.

Go here to read OMB's full announcement.

Revised Travel Cost Principle

Back on December 11, last year, we reported on the revision to the Travel cost principle (FAR 31.205-46) that became effective for contracts awarded after January 10, 2010. Prior to the change, allowable airfare costs were limited to the lowest customary standard, coach, or equivalent airfare. After the change, allowable airfare costs are limited to the lowest priced airfare available to the contractor. You'll probably have to read that a few times to understand the distinction. To read our previous post, click here.

DCAA recently issued audit guidance on this revised cost principle. The guidance includes steps that contractors need to adhere to in order to comply with the regulation. The focus here is on contractor policies and procedures and documentation requirements. While the DCAA expectations might seem onerous, they are proffered as a means to demonstrate compliance with the regulation. For small contractors or contractors with infrequent travel, the guidance is probably overkill. At the end of the day, however, it is contractors' responsibility to demonstrate that claimed/proposed airfares were the lowest available at the time the itenerary became known. Here's the DCAA guidance:

To comply with the revised rule, the contractor's policies and procedures should provide for advance planning of travel to assure that the lowest priced airfare available to the contractor for flights during normal business hours is documented and utilized as the baseline allowable airfare cost. To determine the lowest airfare available to the contractor for flights during normal business hours, the contractor must now consider nonrefundable airfares and lower airfares negotiated with airlines, travel service providers, credit card companies, etc. However, auditors should not question airfare costs claimed in excess of nonrefundable airfare available during normal business hours if the contractor's data show that its experience with cancelling nonrefundable tickets results in increased cost in comparison to the cost of refundable tickets. The contractor must utilize the lowest airfare so determined as the baseline allowable airfare cost unless substantiating documentation is maintained for one of the exceptions to the lowest priced airfare requirement in FAR 31.205-46(b).

 

Ordinarily, with adequate advance planning, documentation substantiating the lowest airfare available takes the form of quotations from competing airlines or travel service providers from which the lowest priced airfare can be selected, giving proper consideration to any potential discounts or credits to the contractor's cost. There may be instances where only one flight is available for a given mission need and therefore, only one quote is obtained, in which case the one quotation would substantiate the lowest priced airfare available. However, auditor observing frequent instances in which a single quotation is obtained to support the airfare should assess whether the design or execution of the contractor's policies and procedures results in unreasonable airfare costs.

 

Costs associated with cancelling or changing restricted or non-refundable tickets should be considered in ordinary and necessary business expense unless the contractor's data show the costs are the result of a history of inadequate advance travel planning procedures.

 

The exceptions that might justify higher than lowest available airfare include the following. Note however, that when an exception is used, FAR requires that the conditions must be "documented and justified."

• requires circuitous routing,
• requires travel during unreasonable hours
• results in excessively prolonged travel
• results in increased cost that would offset transportation savings
• are not reasonably adequate for the physical or medical needs of the traveler
• are not reasonably available to meet mission requirements

Proposed Change to Labor Relations Cost Principle

Soon after his inaguration, President Obama issued Executive Order (EO) 13494, Economy in Government Contracting. The EO stated that the cost of activities, when they are undertaken to persuade employees in the matter of exercising rights to organize and bargain collectively, are unallowable. According to the EO, examples of such costs include

• preparing and sitributing materials,
• hiring or consulting legal counsel or consultants,
• holding meetings,
• planning or conducting activities by managers, supervisors, or union representatives during work hours

This week, the FAR Councils published a proposed regulation to make the corresponding changes to FAR by amending FAR 31.205-21, Labor Relations Costs.

Currently, FAR 31.205-21 simply states that costs incurred in maintaining satisfactory relations between the contractor and its employees, including costs of shop stewards, labor management committees, employee publications, and other related activities, are allowable.

While retaining the current language, the proposal adds the following restrictions:

As required by Executive Order 13494, Economy in Government Contracting, costs of any activities undertaken to persuade employees, of any entity, to exercise or not to exercise, or concerning the manner of exercising, the right to organize and bargain collectively through represenetatives of the employees' own choosing are unallowable. Examples of unallowable costs ... include but are not limted to, the costs of

• preparing and distributing materials
• hiring or consulting legal counsel or consultants,
• meetings (including paying the salaries of the attendees at meetings held for this purpose), and
• planning or conducting

Written comments to this proposed change must be submitted by June 14th.

Terminations - Part IV

Today we are concluding, for now, our discussion on Terminations. We invite you to view our Termination FAQ that was edited by Terry Nuzzo. This FAQ has been available on our website (http://www.pacificnwc.com/) for a number of years or can be accessed and downloaded directly by clicking here.

In summary, the Government's primary objective for contract terminations is to compensate contractors fairly and negotiate a settlement by agreement. However, a contract termination for convenience is no simple matter and contractors should expect to expend considerable effort and cost in settling their terminated contract. Understanding the FAR cost principles, settlement proposal preparation process and the consequences of a contract termination can have a significant impact on maximizing the cost recovery. Fortunately, contractors’ costs incurred to settle a terminated contract are recoverable.

Terminations - Part III

Today we continue our discussion on contract terminations by taking a look at the settlement process. If you missed Parts I and II in this series, you can read them here and here.

Once the Government issues its termination notice, contractors typically have a year to submit their settlement proposals to the Government. Now before you think that one year is plenty of time, consider that your proposal must also include settlements of all of your subcontracts as well. Many subcontract settlements take an extraordinary amount of time to settle and one year passess very quickly. Requests for extensions of the time to submit are typically granted. However, consider that additional time affects your cash flow. You won't get paid for all your costs until negotiations are complete.

The Government will assign a Termination Contracting Officer (TCO) to your case. Once the TCO receives your proposal, he/she will need to develop a negotiation objective. Almost always, he will request an audit of the proposal to assist in preparing that negotiating objective. The audit will focus on certain risk areas inherent to termination proposals. These include:

• Ensuring that the contract uses the correct form and methodology (inventory basis vs. total cost basis)
• Assessing contractor efforts to mitigate costs
• Evaluating costs continuing after the date of termination
• Reviewing settlement expenses for compliance with FAR 31.205-42 (and other cost principles)
• Evaluating the potential that the contract was in a loss position at the time of termination.

The process is lengthy and your chances of "fast tracking" the settlement process is slim. It is important therefore to get your proposal right the first time so that it is not sent back for rework. It is also important to ensure that you claim all the costs to which you're entitled. Sometimes, professional help in preparing settlement proposals can be beneficial.

 

 

Terminations - Part II

In yesterday's post, we introduced the two ways that the Government can terminate your contract - termination for default and termination for convenience - and identified some of the costs that contractors might include in their termination settlement proposal/claim. If you missed that article, you can read it here. Today we want to go deeper into the cost allowability aspects of termination settlements. Our focus here is on Terminations for Convenience (T for C). We will not be covering Terminations for Default. The allowability of costs under T for Ds is severely limited. Hopefully, none of you will ever find yourselves facing a T for D.


The fundamental financial principle underlying a T for C is the contractors’ responsibility to mitigate costs or damages to the Government. A contractor must do everything it can to limit cost exposure to the Government. The allowability of costs under a termination for settlement is essentially the same as for pricing a contract or for seeking reimbursement of costs under a cost-type contract. However there are a few differences. These differences are identified in FAR 31.205-42. According to this cost principle, the following termination costs are allowable:

• Common items: Items purchased for the contract that cannot be reasonably used on other work. In other words, if items purchased for the terminated contract can be used on other work, the items and associated costs should be transferred to those other jobs.
• Costs continuing after termination: Costs that cannot be immediately discontinued upon the effective date of the termination are allowable so long as they are not attributable to the negligent or willful failure of the contractor to stop work. 
• Initial costs: Costs spent on preparation and startup costs that haven't been fully amortized. If you factored in a learning curve into your production cost estimates but the contract is terminated before you fully realized the effects of the learning curve, you can include "loss of learning" in your settlement proposal. 
• Loss of useful value: These costs are usually associated with special tooling and test equipment.
•  Rental costs: Contractors must mitigate rental costs and the rental period cannot exceed the initial period of contract performance.
•  Alterations of leased property: Cost to restore leases to original conditions, if required. Costs to prepare a leased property for use on another project/contract, are not allowable under this provision.
• Settlement expenses: These include accounting, legal, and clerical costs for the preparation of the settlement proposal. For example, if you hire Pacific Northwest Consultants to prepare your termination settlement proposal, those costs would be allowable as a direct charge.
• Subcontractor claims: Subcontractors must follow the same rules as the prime. Subject to this restriction, subcontractor claims are allowable.

Tomorrow we will discuss the “settlement” process.

Contract Terminations

The Government has the right to terminate a contract. It can terminate the contract for its own convenience or it can terminate the contract because the contractor defaulted on the contract. Termination for Default (T for D) is a somewhat infrequent event. Termination for Convenience (T for C) on the other hand is not that uncommon. We will focus here on "T for Cs". 
The Government's right to terminate a contract is provided for in a standard contract clause that allows it to terminate work in whole or in part. When a contract is terminated for convenience, a contractor is entitled to the following:

• Reasonable costs for the terminated work
• Termination costs
• Settlement expenses
• Reasonable profit

Under fixed price contracts, the total amount of the termination settlement, exclusive of settlement expenses, cannot exceed the total contract price. If the contract was in a "loss" position, the projected loss will be reflected in the final settlement.

Cost type contracts, on the other hand, are not subject to settlement limits or loss ratios. However the potential recovery under cost type contracts is constrained by the limitation of funds clause that exists in all cost-type contracts.

In future posts, we will discuss specific allowablility criters for termination costs, steps that a contractor must immediately take upon receipt of a termination notice, and some advice on how to "settle".

Using Statistical Sampling Techniques to Identify Unallowable Costs

Back in 2005, the FAR 31.201-6 was revised to specifically allow contractors to use statistical sampling techniques as a method of identifying and segregating unallowable costs. Prior to that, the use of statistical sampling was not specifically prohibited but its use was so discouraged by Government auditors. As a result, many contractors did not consider it to be in their best interests to apply statistical sampling techniques to identify (and exclude) unallowable costs.

A properly designed statistical sampling plan allows contractors to reduce effort in its cost assurance process yet maintain a high degree of confidence that unallowable costs do not end up on billings to the Government.

When statistical sampling is used, FAR requires the following:

• the sample must be unbiased
• the sample must represent the universe from which the sample is drawn
• large dollar and high risk transactions must still be separately reviewed, and
• the entire process must permit audit verification.

FAR also wisely recommends that the sampling process be subject to an advance agreement between the contractor and the administrative contracting officer. Without an advance agreement, the burden of proof is on the contractor to establish that its methods meet the aforementioned criteria.

If you feel like you are drowning in your cost assurance processes, consider the use of statistical sampling.

Credits

The Federal Acquisition Regulations (FAR) require that some receipts should be credited against those costs to which they relate instead of being recorded on the books as a revenue or as non-operating income. FAR 31.201-5 states that "the applicable portion of any income, rebate, allowance, or other credit relating to any allowable costs and received by or accruing to the contractor shall be credited to the Government either as a cost reductin or by cash refund."

 

Examples of such credits include

• Prompt payment or trade discounts
• Airline and other travel refunds/rebates
• Dividends or rebates under insurance policies (e.g. workers compensation)
• Sales of scrap
• Refunds on materials returned to suppliers
• Tax refunds (e.g. state income tax and state sales tax)

Sometimes, it is a challenge to find an equitable method of allocating those costs back to the Government. For example, if the credit relates to an indirect expense and the contract mix and/or Government participation changed from when the costs were initially recorded to the year that the credits were received, it would not necessarily be equitable to charge the credit to the indirect expense pool. There have been times when the easiest way to give the Government its share of credits is simply to write a check.

Incurred Cost Submissions Deadline Approaching

For contractors with flexibly priced contracts (e.g. CPFF, CPIF, FPI, and T&M) and with fiscal years ending December 31st, the June 30th deadline (six months after fiscal year end) for submitting annual incurred cost proposals is quickly approaching.

A number of years ago, DCAA developed "ICE" (Incurred Cost Electronically), an electronic version of the Model Incurred Cost Proposal found in Chapter 6 of DCAAP (DCAA Pamphlet) No. 7641.90. That model is now in Version 2.0.1. ICE provides contractors with a standard, but not-to-user friendly submission package that can assist them in preparing adequate incurred cost proposals in accordance with FAR 52.216-7, "Allowable Cost and Payment." This tool can be downloaded free from DCAA's website. 

Our staff has extensive experience in working with ICE and can assist you and your company in preparing and supporting an adequate incurred cost proposal. We can help ensure that all allowable, allocable, and reasonable costs are considered and we can help avoid pitfalls caused by inadvertent inclusion of unallowable costs in your submission to the Government.

Call us toll free at 1-866-849-4887 for a free consultation.

How to Find Your Cognizant DCAA Office

Quick link to DCAA Audit Office Locator.

Most Government contractors contractors have no problem in locating the DCAA (Defense Contract Audit Agency) office that has audit cognizance for their location. The cognizant DCAA office is usually identified in the contract itself. However, DCAA offices frequently reorganize, consolidate, or move and they are not particularly efficient in notifying contractors when that happens.

Prospective contractors might have more difficulty. Solicitations often require that offerors identify their cognizant DCAA office. For a company without previous Government experience, that information may not be well known and in most cases, the telephone book is not going to help.

Fortunately, DCAA maintains an Audit Office Locator on their website. It is searchable by ZIP code, CAGE code or DUNS number. Simply enter any one of these items and the application will provide the cognizant DCAA office. New contractors should search by ZIP since DCAA only maintains DUNS and CAGE information for existing contractors.

Updated links, 2/4/15

Employees vs. Independent Contractors

Today's post isn't specific to Government contracting but its a subject that we believe most contractors need to be reminded of from time to time (we are a CPA firm and sometimes we just cannot help ourselves). During adverse economic conditions, it is sometimes tempting for contractors to reclassify employees as independent contractors thereby saving employment related taxes, benefits, and other expenses. The Government has always been aware of the temptations and trends and considers it one of their "high risk" areas for audit and investigation. When employees are misclassified as independent contractors, it often results in failure of the workers and employers to correctly pay income taxes, Social Security, Medicare and unemployment insurance taxes. That means substantial lost revenue to the federal and state governments.


Now that the Governments are facing increased financial pressures themselves, Federal and State agencies are starting to scrutinize "independent contractor" status with new fervor. Take President Obama's fiscal year 2011 budget for example. It includes $25 million to the Department of Labor for a joint effort with the IRS to hire investigators to find workers that can be recategorized as employees. The Administration estimates that the $25 million per year investment will bring in $10 billion over the next 10 years - not a bad ROI (return on investment) if you trust those numbers.

Here are some other examples of increased scrutiny:

• Random Audits - Beginning in February 2010, the IRS launched a three-year program to randomly audit 6,000 employers. These examinations will delve into compliance with employment tax issues, including the misclassification of independent contractors, fringe benefits, reimbursed expenses and the compensation of owner-employees.
• Information Sharing - The IRS signed information-sharing agreements in 2008 with labor and workforce agencies in 29 states, to assist them in uncovering employment tax avoidance schemes" and ensure proper worker classification."

If you utilize independent contractors, there are several things that you can do to ensure those workers are properly classified.

• Have written, signed contracts with workers classified as independent contractors, spelling out the terms and conditions of the relationship.
• Once contracts are in place, give outside workers leeway over how they perform their duties. Resist the urge to supervise them the way you oversee employees.
• Send each independent contractor a Form 1099.
• Consistently treat workers performing similar tasks as either independent contractors or employees. Don't supply outside workers with services you give employees. Some companies run into trouble after they provide office space, computers, cars and other perks.
• Maintain good records - independent contractor's taxpayer ID number, business cards, a letterhead, and invoices.
• Do a self-audit of each worker's or each class of workers' status before a federal or state agency conducts one. If you are in doubt, you can always file Form SS-8 with the IRS giving them information about a relationship and asking for their determination (many companies don't like to do this for fear of attracting unwanted attention from the IRS)

Here are some of the factors the IRS considers in determining if a worker is an employee:

• Behavioral Control - An employee generally is told when, where, and how to work, as well as what order or sequence to follow.
• Tools - An employer usually gives tools, equipment and workspace to employees. In contrast, independent contractors often provide and invest their own money in equipment, tools and facilities.
• Assistants - Employees don't hire and pay others to help them do their jobs (although they may be told to hire assistants for the company). In contrast, contractors often hire, supervise, and pay their own assistants.
• Training - Employees are more likely to receive training from an organization than independent contractors.
• Other Customers - Independent contractors generally make services available to the public and are able to work for two or more businesses.
• Financial Control and Risk - An employer has the right to control the financial aspects of a job, such as the business expenses the employee incurs and how staff members are paid. On the other hand, a worker's opportunity to personally earn a profit and assume risk of loss may indicate a non-employee status.

Comments on DoD's Business Systems Proposal - Part V

All this week we have been discussing several of the comments that were submitted in response to DoD's proposal to withhold billings where contractors have deficient business systems. The systems covered by this proposal include the accounting, estimating, purchasing, earned value (EVMS), material management (MMAS), and Government Property. As a general rule, comments submitted by contractors and contractor trade organizations were opposed while comments submitted by Governmental Agencies favored the proposal. There was one response from a Member of Congress. That member opposes the proposal.

Today we will finish up with some of the issues/points raised by other respondents that we've gleaned by studying their submissions. We believe that if this proposal is implemented, defense contractors are going to experience some tough times. The cost of compliance will increase substantially and a diminished cash-flow will adversely affect a contractor's profitability and maybe even its ability to perform the contract. Another potential, but less tangible side effect from this proposal includes a reduced industrial base as some contractors might decide that the rewards of contracting with the Government are not worth the hassle.

Here are some of those gleanings.

1. The proposed rule fails to consider materiality or give adequate consideration to seriousness. Thus, even minor, administrative issues that have no material impact on the Government's rights might lead to a withhold.
2. The proposed rule offers no opportunity for contractor "due process". The rule fails to provide any machinery for disputing government findings.
3. The proposed rule requires timely consideration by DCAA to corrective action plans and DCAA has been anything but timely for a number of years now. DoD is under resourced and not ready to implement this rule at this time.
4. The proposed rule is punitive, arbitrary and capricious.
5. The proposal will impose significant administrative burdens for contractor, and disproportionately affect small businesses.
6. "Significant Deficiency" is not defined.
7. The rule runs against the guiding principles of FAR Par 1.102 - to achieve efficient operations, the System must shift its focus from risk avoidance to one of risk management. The cost to the taxpayer of attempting to eliminate all risk is prohibitive.
8. The proposed rule addresses symptoms rather than the root casuses of process problems.

  

If you missed our previous posts on this subject, you can read them here:

• Part I - An Industry Trade Group
• Part II - American Bar Association
• Part III - The Dept. of Defense Inspector General
• Part IV - The Committee on Wartime Contracting

Comments on DoD's Business Systems Proposal - Part IV

In today's post, we take a look at the comments submitted by The Commission on Wartime Contracting. Many of you are well aware of the work performed by the Commission in publicizing fraud, waste and abuse that DCAA and others have identified in contracts to support the war efforts in Iraq and Afganistan. Most recently, the Commission has been looking into why the drawdown of contractor support personnel in Iraq is not commensurate with troop drawdowns.

Like the DoD-IG that we covered yesterday, the Commission is wholly supportive of the proposed regulations that require DoD to withhold billings from contractors who have had one or more of their business systems determined to be deficient. The Commission writes: "Your proosed DFARS changes provide much needed clarification regarding system definition, requirements, and evaluation criteria, as well as penalties for noncompliance." The Commission believes however that the proposal will benefit if it included a coordination and feedback mechanism to enhance contractor progress and government oversight. This, in the Commission's opinion, would provide a method to resolve potential differences between contracting officers and the auditors.

The other comments included in the Commission's response were editorial rather than substantive. We would expect, given the Commission's high profile, that its position in this matter will carry great weight when it comes time to publish the final rule.