Commercial Items - Part II

We began this series yesterday discussing the Government's preferred method of acquiring goods and services; making every effort to buying commercial items. Beginning with the Federal Acquisition Streamlining Act (FASA) in 1994, the Government signaled a shift from traditional buying of goods and services tailored exclusively for its own use and purposes to buying commercial items and using commercial buying practices. One of the impediments to buying commercial items is deciding what is and is not a commercial item. Obviously COTS (Commercially Available Off-The-Shelf) items are commercial but the Government's definition is much broader.

Items that require modifications of a type customarily available in the commercial marketplace, or require minor Government-unique modifications, can still be considered commercial items. To qualify as a minor modification, of a type on customarily available in the commercial marketplace made to meet Government requirements, the modification must significantly alter the nongovernmental function or essential physical characteristics of an item or component, or change the purpose of a process.

The FAR commercial item definition includes many services as well as products. A service is considered a commercial item when it is provided in support of a commercial item. A service is also considered a commercial item when it is of a type offered and sold competitively in substantial quantities in the commercial market on the basis of established catalog r market prices for specific tasks performed under standard commercial terms and conditions.

The phrase "of a type" broadens the definition so that qualifying items do not have to be identical to those in the commercial marketplace. This takes full advantage of the opportunities for modified commercial items.

If a commercial item evolves through technical or performance advances and that is not yet available in the commercial marketplace, it still meets the commercial item definition, as long as it will be available in time to satisfy the  Government's requirement (e.g. product updates, model changes, and product improvements).

For minor modifications of a type not customarily available in the commercial marketplace, the Government considers value, size, and comparative value and size of the final product. Dollar value and percentage are used as guideposts, but are not conclusive evidence that a modification is minor.

Commercial Items - Part I

Over the next few days, we will be discussing "commercial item" procurement; what are commercial items, from the Government's perspective?, the Government's preference for buying commercially, and criteria used in making source selections. Companies that can offer their products and services to the Government as commercial items have a distinct advantage over those who do not.

Since the passage of the Federal Acquisition Streamlining Act of 1994 (FASA), the preference within the Federal Government has shifted from the acquisition of items developed exclusively for the Government to the acquisition of commercial items.  This change was designed to take advantage of available and evolving technological innovations in the commercial sector.

FASA represented a dramatic shift in acquisition policy for the Federal Government.  FASA promoted maximum use of commercial items to meet the government’s needs and streamlined the process of acquiring such items following commercial market practices.  Under FASA, the concept of commercial practices is overarching and affects every functional area within the acquisition process.  Source selection is made on a "best value" rather than a "cheapest price" basis.  

The Government's preference for commercial item pricing is stated right at the beginning of FAR. The "guiding principles" section at FAR 1.102(b) states that Federal Acquisition System will:

1. Satisfy the customer in terms of cost, quality, and timeliness of the delivered  product or service by;
• Maximizing the use of commercial products and services,
• Using contractors who have a track record of successful past performance or who demonstrate a current superior ability to perform, and
• Promoting competition;
2. Minimize administrative operating costs;
3. Conduct business with integrity, fairness, and openness; and
4. Fulfill public policy objectives.

Definition

Commercial items include any item of a type customarily used by the general public, or by nongovernmental entities, for purposes other than governmental purposes that has been sold, leased, or licensed, or offered for sale, lease, or license to the general public (see FAR 2.101). The definition also includes items that are not yet in the commercial marketplace, as long as they will be available in time to satisfy Government requirements. 

Commercial items do not necessarily have to be “off-the-shelf”.  Items that require modifications of a type customarily available in the commercial marketplace, or require minor Government-unique modifications, can still be considered commercial items.  We will go into more detail tomorrow on what constitutes "minor modification".

The "Buy American Act" - Briefly

Nearly every Government contract that exceeds the micro-purchase threshold (currently set at $3,000) contains the "Buy American Act" clause (FAR 52.225-1). The Act restricts the purchase of supplies, that are not domestic end products, for use within the United States. A foreign end product may be purchased if the contracting officer determines that the price of the lowest domestic offer is unreasonable or if another exception applies. A listing of these exemptions is found in FAR 25.1. The Act also requires the use of only domestic construction materials in contracts for construction in the United States. Here again, there are a few exceptions.

The Buy American Act uses a two-part test to define a domestic end product.

1. The article must be manufactured in the United States; and
2. The cost of domestic components must exceed 50 percent of the cost of all the components.

The Act applies to all contractors including small business set-asides.

FAR 52.225-2 requires contractors to certify compliance with the Buy American Act.

Contract Audit Reports

The DoD Inspector General just issued its semi-annual report to Congress covering the period October 2010 to March 2011. It summarizes not only its own activities but incorporates audits and investigations performed by the military organizations and by DCAA (Defense Contract Audit Agency).

Many people in the contracting community, including Government contractors sense that DCAA is not getting its work done. The reasons probably stem from GAO reporting that cast doubt on the adequacy of their audits and all of the negative fallout that ensued. Many contractors we talk to are frustrated however because they cannot close out old contracts due to DCAA's languishing incurred cost audits. Conversely, some contractors seem pleased because fewer audits mean less disruption. Bottom line however, its difficult to see how the interests of either the Government or its contractors are served by the current state of affairs.

The semi-annual IG reports readily show the precipitous drop off in the number of contract audit reports. During the six month period ended March 2008, DCAA issued 13,807 audit reports. During the six month period ended March 2011, DCAA issued only 3,821 reports, a 72 percent drop from three years earlier. The number of incurred cost audits (audits required before contractors can close out contracts) dropped by 77 percent from 8,689 to 1,974. The amount of dollars audited dropped by 82 percent from 73.1 billion to $12.9 billion.

DCAA audit coverage is falling seriously behind the pace of Government spending. We wonder how long this will be allowed to fester before someone in the administration or Congress takes notice and takes action.

CAS Board Activities

The CAS (Cost Accounting Standards) Board recently published the minutes of the final two meetings held in 2010. There were four in all; February, August, September, and November. Very little happened during the year. Personnel-wise, a new OFPP Administrator (Daniel Gordon) took over as Chairman and the DoD representative transitioned from April Stephenson to Patrick Fitzgerald. Otherwise, it was a very uneventful year.

February: Staff updated board members on the ongoing project to harmonize the pension standards (CAS 412 and 413) with the Pension Protection Act (PPA) of 2006.

August: Again, the only topic of discussion was the CAS Pension Harmonization.

September: Discussed the pension harmonization again. Also discussed a proposal to tie the CAS applicability threshold to the TINA (Truth in Negotiations Act) threshold (currently set at $700 thousand).

November: Same topics as the September meeting.

DCAA Areas of Focus

Michael Bame, who works for a defense contractor and blogs about contracting matters, wrote recently that he  was briefed by DCAA on areas that the Agency expects to concentrate on in the coming months. On an annual basis, DCAA meets with major contractors (those having more than $100 million in flexibly priced contracts) to discuss audit plans for the upcoming fiscal year. These briefings focus on areas that are somewhat unique to risks associated with the particular contractor being briefed. Most likely, the briefing described by Mr. Bame was tailored for his employer because the Agency has not issued "audit alerts" that correspond to these items. Nevertheless, the areas of emphasis he listed, while not "new", are interesting and informative in a general sense.

Online Source

The areas of identified DCAA focus include the following:

• Distinguishing between business development and marketing costs (in general, business development is allowable while marketing costs are not).
• More scrutiny in making sure contractors do not exceed the cap on meals, lodging, and incidental expenses (Historically this has not been a high risk area meaning that findings have been rather insignificant. After 15 years, most contractors have this one down pat).
• Assessing adequacy of estimating and purchasing policies, procedures, and practices
• Making sure that bonuses are paid pursuant to a formal plan
• Personal use of company cell phones (We wonder why DCAA would expend resources auditing this area. How significant would any incremental costs be?)
• Health insurance paid for nonqualified dependents (this was the subject of an audit alert a few months back).
• Making sure contractors retain original documents after scanning (We're not sure what this has to do with audits of costs. Its more a record retention issue under the purview of the contract administrator.)

Defective Pricing Risk Assessments

The Truth in Negotiations Act (TINA) was enacted to provide the Government with a contract price reduction mechanism if a contractor fails to disclose the most accurate, complete and current data as of the date of agreement on price, and the contract price was increased as a result of that failure. TINA applies to negotiated contracts greater than $700 thousand, regardless of type.

In order to determine whether Government contractors comply with TINA, auditors from various agencies conduct systematic reviews of contracts subject to TINA. The GAO (Government Accountability Office, the various IGs (Inspector Generals') offices, and DCAA (Defense Contract Audit Agency), are among those agencies. As a general rule, the larger the contract, the more likely it is to be audited for compliance with TINA. There is a threshold above which audits are certain. At one time, this threshold was $100 million. There are other factors that affect the number of audits to be conducted at a particular contractor. These include, but are not limited to (i) prior findings, (ii) the adequacy of a contractor's estimating system, and (iii) "audit leads" derived from any number of sources.

Once a contract has been selected for review, the auditor will perform a risk assessment to determine the likelihood that defective pricing occurred. Based on the risk assessment, the auditor will decide whether to continue the review or cancel it. In order to perform the risk assessment, the auditor will, at a minimum, request the following items from the contractor. The Government (the auditor) has a contractual right, affirmed by various courts, to access this data.

• Copies of the initial and any revised proposal
• Identification of significant subcontract
• Identification of significant inter-organizational transfers
• Final Certificate of Current Cost or Pricing Data
• Identification of all cost or pricing data submitted before or during negotiations
• A listing of additional data submitted after date of agreement on price (if any)
• Costs incurred to date by cost element and estimates at completion (EAC) by cost element

Recently, the audit program for TINA compliance (i.e. defective pricing) was modified to include a significant new step to the "risk assessment" phase of the audit. This new step, called the "walk-through" is potentially onerous and we advise contractors to prepare ahead of time. This new audit step reads:

Coordinate a date with the contractor to provide a walk-through of its certified position and the major events associated with this pricing action.  Invite the Contracting Officer.  This should include the following:
     a. Highlighting all significant cost or pricing data provided to the contracting officer (e.g., latest certified proposal plus any subsequent cost or pricing data submitted up to the time of price agreement to include sweep data) to include a discussion of the contractor’s documentation of negotiations.
     b. A discussion of the contractor’s internal controls in place at the time of negotiations to ensure that the most accurate, complete and current data were disclosed to the Government.  
     c. Have the contractor identify how the costs were accumulated in the accounting system to facilitate a comparison of the actual costs to the proposed/negotiated costs.  For example, if the contractor proposed by WBS, have the contractor identify the charge numbers for each WBS.  Another example would be if the actual costs were accumulated in more detail than the proposed costs.  In this case, the contractor would need to identify how the actual costs roll up to the proposed costs in order to perform an accurate over/underrun test. 

DoD to Increase Usage of Fixed-Price Incentive Contracts

DoD updated their acquisition regulations to increase the used of fixed-price incentive contracts, especially for acquisitions moving from development to production. The theory is that contracts with incentives will increase productivity and innovation in industry and ultimately reduce costs to the Government.

Under the new provision at DFARS 216.403-1, contracting officers are instructed to "give particular attention" to the use of fixed-price incentive contracts. The default ceiling is 120 percent and the default share ratio is 50/50. Both the ceiling and share ratio can be adjusted when properly justified and documented by the contracting activity.

Contractors who agree to fixed-price incentive contracting must be extremely confident of their estimated costs, including indirect expenses/rates. Volatility and uncertainty of costs can adversely affect a contract's profitability.

Award Fee Reductions or Eliminations

The Department of Defense issued an interim rule that requires contracting officers to include in the evaluation criteria of any award-fee plan, a review of contractor and subcontractor actions that jeopardized the health or safety of Government personnel (either military or civilian) through gross negligence or reckless disregard for the safety of such personnel.

There was a similar interim rule published last November. That one required conviction in a criminal proceeding, or finding of fault and liability in a civil or administrative proceeding. This one adds contractors and subcontractors that are not under the jurisdiction of the U.S. courts, presumably to include foreign companies that provide support for overseas deployments (Germany, Korea, Japan, Iraq, Afghanistan, etc). For those contractors, a final determination of fault resulting from a DoD investigation is required.

Under the interim rule, the contracting officer shall consider reducing or denying award fees for a period if contractor (or subcontractor) actions caused serious bodily injury or death of civilian or military Government personnel during the period under review. Serious bodily injury is defined as a "grievous physical harm that results in a permanent disability."

In addition, this rule requires that information on the final determination of award fee be entered into the Federal Awardee Performance and Integrity Information System (FAPIIS).

New FAR Cost Principles Guide

The FAR Cost Principles Guide has now been updated through FAC 2005-52 (June 2011) and is available for download here. The previous update was through FAC 2005-41 (April 2010). This guide keeps track of all changes to cost principles since the FAR was first published in 1984. If there is ever a question over the allowability of costs under a particular contract, this is a great resource for determining the specific regulations in effect at the time of contract award.

A few FAR cost principles have not changed since 1984 (e.g. bad debt expense, alcoholic beverages) but most have. For example, the Compensation cost principle which covers the allowability of compensation costs has changed 30 times. That averages to more than once a year.

DoD and Its Hotline Posters

Today, the DoD published a final rule requiring all contractors with a contract greater than $5 million, to prominently post the DoD IG hotline poster in common work areas within all business segments performing work on DoD contracts and, if the contractor maintains a company website as a method of providing information to employees, the contractor must display an electronic version of the poster there as well.

FAR (Federal Acquisition Regulations) has contained a requirement to display hotline posters for several years. However, FAR has an exemption for certain contractors. FAR 52.203-14(c) states that if contractors have implemented a business ethics and conduct awareness program, including a reporting mechanism, such as a hotline poster, the contractor need not display any agency fraud hotline posters.

The DoD IG (Inspector General) determined that this exemption has the "potential to make the DoD hotline program less effective by ultimately reducing contractor exposure to DoD IG fraud hotline posters and diminishing the means by which fraud, waste, and abuse can be reported under the protection of Federal whistleblower protection laws".  According to the DoD IG, some contractors' posters may not be as effective as the DoD poster in advertising the hotline number, which is integral to the fraud program.

The new DFARS (DoD FAR Supplement) clause, 252.203-7004, replaces FAR 52.203-14 and provides no exception to the use of the DoD hotline poster for contractors that have implemented a business ethics and conduct awareness program, even those that include a reporting mechanism such as hotline poster.

You can download or order hotline poster at the DoD-IG's website.

Accelerating Payments to Small Businesses

The Office of Management and Budget (OMB) has just released a memorandum to all executive agencies to accelerate payments to small businesses for goods and services from 30 days to 15 days. This is very good news for small businesses.

According to OMB, "As critical drivers of job creation and economic growth across the country, small businesses must receive, in a timely and efficient manner, the money that the Federal Government owes them for the goods and services that the Government has accepted. All told, the Federal Government pays small businesses nearly  $100 billion each year for goods and services. By taking actions that will enable these payments to be made as promptly as possible, we will improve cash flow for small businesses and provide them with a more predictable stream of resources, thereby preserving and increasing small business participation in Federal contracting."

The Prompt Payment Act (PPA) generally requires an agency to pay its contractors within 30 days of receipt of relevant documents, including a proper invoice for the amount due and confirmation that the goods and services have been received and accepted by the Federal Government. The OMB memorandum outlines the new policy that, to the full extent permitted by law, agencies shall make their payments to small business contractors as soon as practicable, with the goal of making payments within 15 days of such receipt.

The establishment of this accelerated payment policy, and its implementation by Federal agencies, does not change the application of the PPA's late-payment interest penalty provisions.

Accenture Agrees to Pay U.S. $64 Million

The Department of Justice announced this week that Accenture LLP has agreed to pay the United States $64 million to settle a Qui Tam lawsuit alleging that it had accepted kickbacks from IT companies to recommend their products to its government clients. Accenture denied any wrongdoing, of course, stating that it settled in order to save time and get the embarrassing issue behind it. Accenture was a spin-off from Arthur Anderson, the accountancy firm which collapsed after a U.S. court found that it had obstructed an investigation into Enron. Accenture has about 223 thousand employees in 120 countries with revenues last year of $ 35.4 billion.

Accenture had contracts with various Governmental agencies to recommend IT solutions. In exchange for recommending specific products, vendors like HP, Cisco, and IBM would pay (or, to use the DoJ term, "kickback") a sum of money to Accenture. Accenture called this practice "alliances" and claimed they were common in the industry.

Accenture has a very strong code of business ethics and a robust ethics and compliance program. It includes   mechanisms for employees to report concerns, it claims to have transparency in its operations, and it has specific standards for federal business ethics and conduct. Obviously, something went very wrong.

QuickBooks 2012

QuickBooks 2012 will become available later this month. We received advance copies because we're Certified Pro Advisers and we think that some of the new features will be beneficial to Government contractors. According to Intuit (publishers of QuickBooks) 95 percent of small business enterprises choose QuickBooks financial software. Among small businesses with Government contracts, the percentage is very high as well.

One question we're frequently asked is whether to upgrade. The answer is not so simple. QuickBooks publishes annual upgrades and the changes from one version to the next may or may not be useful, depending upon the needs of the company. Additionally, many Government contractors use "add-ons" to QB that may not be compatible with new versions. As a general rule of thumb, if your using QB and it is meeting all of your needs, consider a three-year upgrade cycle. Intuit supports their products for three years. If you're using a version earlier than 2009, its probably time to upgrade. If you're using the "Pro" or "Premier" version, wait until it goes on sale at Office Depot or Staples. If you're using "add-ons", first consult the publisher of the add-on for compatibility. If the new version has a feature you can use, consider upgrading. For example QB 2012 Enterprise editions will, for the first time, support the FIFO (First-in, First-out) inventory method. Until now, QB has only supported the weighted average inventory method.

One feature that is new for 2012 which we think will be very beneficial to Government contractors is the enhanced Excel integration capabilities. If you export an Excel report and then make changes to it such as fonts and added information, you can save this as a template so that if you export the same report later, your modifications will continue to the newly export report. Additionally, you can update the data in your report from Excel itself without having first open your QB company file. So, for example, if you export data to Excel to calculate indirect rates, you must arrange data into indirect expense pools and their respective allocation bases. Now, once you've developed a template, you will be able to run the template thereby saving a lot of time whenever you need to update your indirect rates.

Relocation's "12-month" Rule

A contractor relocated an employee from one coast to the other. After a few months, the employee (and his family) became very unhappy with the new living situation. Since the employee was highly-valued, the contractor relocated him and his family back to their original location. Both of the relocations occurred within a nine month period. The cost of both relocations are unallowable under Government contracts.

Relocation costs are costs incident to the permanent change of assigned work location for a period of twelve months or more of an existing employee or upon recruitment of a new employee. Relocation costs are generally allowable but since it usually represents a significant cost to contractors, FAR 31.205-35 has caps and limitations on different components of relocation costs. One area where auditors are instructed to focus their efforts is on the "twelve-month" minimum relocation period rule. If relocation costs for an employee have been allowed either as an indirect or direct cost and the employee resigns with 12 months for reasons within the employee's control, contractors must refund or credit the relocation costs to the Government (see FAR 31.205-35(d)).

Government contractors should include recapture provisions in relocation agreements so that it can recover relocation payments from the employee if that employee does not fulfill his/her twelve month minimum. Contractors should also implement a follow-up system to collect refunds when appropriate and to ensure that the refunds are appropriately credited back to the Government. Regardless of whether a contractor can recover relocation payments from an employee, it is still required to make appropriate refunds to the Government.

End to a Small Disadvantaged Business Preference

FAR 19.11 allows the Government to take 10 percent off the price of bids or offers submitted by "small disadvantaged businesses" (SDBs) in determining which bid or offer had the lowest price or represented the best value for the Government. This regulation was designed to help Agencies meet their small business targets. In Rothe v. Department of Defense, the U.S. Court of Appeals for the Federal Circuit struck down the DOD preference program, holding that Section 1207 was facially unconstitutional because Congress did not have sufficient evidence to conclude that there was racial discrimination in defense contracting when it
reauthorized the program in 2006. In 2009, a District Court enjoined all further application of this regulation.

Now the FAR councils are proposing to remove subpart 19.11 from the regulations as well as other related coverage. Under the proposed revision, Federal agencies will no longer be authorized to apply certain procurement mechanisms that had offered a benefit for SDB awards.

Provisional Billing Rates

Some Government contractors have been receiving letters from DCAA requesting early submittal of their 2012 provisional billing rates. Provisional billing rates are used in to bill the Government for indirect costs on vouchers and progress payments.

The text within the letters vary a little but state something along the lines of:

In order to expedite the establishment of provisional billing rates prior to the start of the next calendar year, we are hereby requesting you to submit your provisional billing rate packages to our office by such and such a date. By obtaining the packages at this time, we can review and establish rates prior to submission of vouchers to the Government in 2012. By establishing your provisional billing rates prior to the start of 2012, this will ensure minimal delay in voucher processing.

The letter goes on to request that several documents be provided along with the rates including

• 2012 budgetary data for each pool and base cost element
• Year to date rates including amounts by pool and base cost element
• Identification of unallowable expenses by amount and account nomenclature, and
• Estimated 2011 year end rates including pool and base amounts by cost element.

There are several problems with this request. First, in at least one case, it went to a company with no active Government contracts. Second, there is no contractual requirement to submit provisional billing rates this early. Contractors need only submit rates prior to their use. The earliest that these rates will be needed is sometime in February 2012, when contractors bill for January 2012 costs. Thirdly, most small contractors do not prepare future year budgets this early in the year. Calendar year contractors have only eight months of "actual" costs at this point in the year (January through August).

Finally, the letter contains an implied threat. It states that "By establishing your provisional billing rates prior to the start of 2012, this will ensure minimal delay in voucher processing". We ask, why should there be any delay at all, much less a minimal delay. The Government is bound by the terms of cost reimbursable contracts to reimburse contractors in a timely manner. Failing to do so (according to some legal experts) is a breach of contract.

DCAA has been losing both influence and workload while retaining the same level of staffing. DCAA no longer audits proposals under $100 million dollars, the organization does not conduct financial capability reviews any longer. DoD took away their EVMS reviews (except when specifically requested). Non-Defense agencies are looking elsewhere for their audit needs. Sounds to us like the Organization is looking for things to do so now they've decided to tinker around with contractors' cash flows.

Contracting Officers

The Federal Acquisition Regulations (FAR) and the various agency FAR Supplements make frequent references to "contracting officer". For example, in several places, FAR states "The contracting officer may ... ". For companies just entering the Government contracting arena, it is sometimes confusing as to just who that person is. Actually, a contracting officer could be one of several persons/positions, depending on the situation. In general, a PCO (Procurement Contracting Officer) is the one negotiating and awarding contracts. After award, many of the duties associated with administering the contract are delegated to an ACO (Administrative Contracting Officer). In DoD, the ACO function is usually delegated to DCMA (Defense Contract Management Agency) although sometimes, the PCO will retain the "administrative" function. The PCO can also make limited delegations. The contract document will state whether "administratvie" duties have been delegated or assigned and whether there are any limitations on those assignments.

The term "contracting officer" is defined in FAR 2.101.

A "contracting officer" means a person with the authority to enter into, administer, and/or terminate contracts and make related determinations and findings. The term includes certain authorized representatives of the contracting officer acting within the limits of their authority as delegated by the contracting officer. "Administrative contracting officer (ACO)" refers to a contracting officer who is administering contracts. "Termination contracting officer (TCO)" refers to a contracting officer who is settling terminated contracts. A single contracting officer may be responsible for duties in any or all of these areas.

New Business Systems Rules will Affect 20,000 Government Contractors

For those of you following this blog, you know that we have closely followed the development of the DoD's business system rules that require contractors to implement well documented and effective internal control systems for six systems including accounting, estimating, purchasing, EVMS, government property and material management. Contractors that fail to do so are faced with up to 10 percent withhold of their billings until the Government determines the deficiencies are fixed.

These new rules apply to contracts awarded after August 16, 2011, and there are now contracts out there with the clause.

Last week, we heard the first estimate of how many contractors will be impacted by the new rules. A DCMA (Defense Contract Management Agency) spokesperson stated that approximately 20,000 contractors under the jurisdiction of that Agency will eventually be subject to the rules. They must first be awarded a "triggering" contract.

A system must still be determined "materially deficient" before the Government begins withholding however. That means the deficiency must affect the ability of the Government to rely on the information provided by the systems.

Last October, DCMA "decertified" Lockheed Martin's EVMS system. They found the system deficient in 19 of 32 areas. Had the decertification occurred after August 16, the Government would have had a vehicle to withhold payments to Lockheed until those deficiencies were corrected.

Commission on Wartime Contracting Issues Final Report

The Commission on Wartime Contracting (CWC) was created in 2008 to study (i) the extent of reliance on contractors for logistics, security, and reconstruction operations in Iraq and Afghanistan, (ii) determining the amount of waste, fraud, and abuse in those theaters, (iii) assessing the extent to which offenders have been held accountable, (iv) examining the appropriateness of policies and practices for managing contracts, and (iv) recommending improvements. The commission, during its three-year tenure, held 25 formal hearings, participated in more than 1,000 meetings, made repeated fact-finding trips to theater, and maintained liaison offices in Baghdad and Kabul. It published two interim reports and five special reports to congress. This week (August 31, 2011) the committee issued its final report.

The final report found that $31 billion (and possibly as much as $60 billion) has been lost to contract waste and fraud and concluded that major reforms are required. The report spreads blame for the waste and fraud to just about everyone. The executive summary states:

Much of the contingency-contract waste and fraud could have been avoided. Unless changes are made, continued waste and fraud will undercut the effectiveness of money spent in future operations, whether they involve hostile threats overseas or national emergencies here at home requiring military participation and interagency response. Responsibility for the state of affairs lies with Congress, the White House, federal departments, the military services, agency leadership, contractors, and individuals who abuse the system.

The final report is divided into eight chapters and contains 15 recommendations to Congress. Chapter headings include:

1. Agencies over-rely on contractors for contingency operations
2. Inherently governmental rules do not guide appropriate use of contractors in contingencies
3. Inattention to contingency contracting leads to massive waste, fraud, and abuse
4. Looming sustainment costs risk massive new waste
5. Agencies have not institutionalized contracting as a core function
6. Agency structures and authorities prevent effective coordination
7. Contract competition, management, and enforcement are ineffective
8. The way forward demands major reforms

The Commission's final report can be read or downloaded here.

Accounting System Adequacy

A recent bid protest decision illustrates the importance of maintaining an adequate accounting system as well as the importance in resolving potential issues as they arise.

A prospective contractor lost out on a contract because it did not have an adequate cost accounting system. The contractor appealed, maintaining that DCAA's audit of the accounting system was deficient and that the Army unreasonable relied on DCAA's audit because it did not consider other information provided by the protester. The protest was denied.

FAR 9.104(e) requires that prospective contractors have the necessary organization, experience, accounting and operational controls, and technical skills, or the ability to obtain them. FAR 16.301-3(a)(1) requires contractor's accounting systems be adequate for determining costs applicable to the contract. Offeror responsibility is to be determined based on all information received by the contracting officer who has broad discretion in making an adequacy determination. That discretion, however, does not insulate the contracting officer from responsibility for error on the part of DCAA.

The contractor argued that DCAA had acted improperly in conducting the Accounting System Review because it did not limit its review to a follow-up of corrective actions taken as a result of findings in a 2009 audit but conducted a new accounting system audit from scratch. The contractor, however, provided no support to show that DCAA was limited in its scope so GAO threw out this argument. GAO added that DCAA's identification of additional concerns was consistent with that Agency's responsibility for verifying the adequacy of the accounting system.

The contractor also argued that the Army unreasonably relied on the DCAA report in concluding that the system was inadequate because the contractor "assurance" that it had addressed all deficiencies. However, there was no record that the contractor provided any substantive information to demonstrate that it had addressed those deficiencies. The only record was a letter from the contractor stating that it was in the process of addressing the deficiencies.

Bottom line, the contractor had agreed to fix five of six identified deficiencies but disagreed with the auditor's position on the sixth. With respect to the sixth deficiency however, the contractor did not say why it disagreed with DCAA or how it would otherwise address the issue. By the time the audit concluded however, the deficiencies were not corrected and DCAA recommended future monitoring of the corrective actions to ensure they would really get fixed. Based on that, the GAO saw nothing unreasonable in the Army relying on the DCAA audit report and denied the protest.

Contractors (and prospective contractors) should not leave anything to chance and need to take seriously any issues identified by auditors and/or contracting officers. Accounting systems should be reviewed periodically for compliance with FAR requirements for an adequate system. If you do not have the expertise in-house, contact a firm (like PNWC) to come in and perform a "mock" audit to identify any system deficiencies and vulnerabilities. Doing this before the auditors arrive will allow time to make any necessary changes and prevent situations such as this case to arise in the first place.