"Floorchecking" Employees Who Work Out of Their Homes

Last Friday, we discussed the importance of internal controls for contractor Work-at-Home (WAH) programs. It is the Government's belief that only a subset of employees can effectively work out of their homes and for those who do work out of their homes, supervision, work assessments, and timekeeping become very important.

DCAA (Defense Contract Audit Agency) and other contract auditors routinely conduct floorcheck audits. These unannounced employee interviews are designed to ensure the propriety of labor charges to Government contracts. Typically, the auditor has already made a selection of individuals he/she wants to interview prior to the unannounced visit. What happens when one or more of these individuals are working at home?

Current audit guidance states that when an employee selected to be floor checked is not present at the normal work-site due to a work at home program, the auditor should interview the supervisor. Discussions with the supervisor should concentrate on

• obtaining evidence of the employee's work
• documented evidence of supervisory control over the employee's WAH schedule

After interviewing the supervisor, the auditor should also communicate with the employee by phone to

• determine if the employee has knowledge of WAH procedures
• discuss the specific type of work being performed along with the related labor charge numbers

Finally, the employees employment should be verified to the payroll/personnel records.

One question frequently asked by employees contemplating a WAH schedule is the likelihood of a home visit by a Government auditor. That would be weird and extremely unlikely. Nowhere in the audit guidance is there a requirement that the auditor visit the employee at his/her home.

Work-at-Home (WAH) Programs

Many Government contractors have programs that allow employees to perform their work from home or from an alternative work site. There are advantages to such programs, reduced commuting time, less stress, and for the contractor, reduced overhead (assuming they can jettison some of their facilities). But with these WAH programs, comes a real need for internal controls to determine whether the program is effective. Government auditors are always concerned about potential abuse under WAH programs - many of them do it themselves and so, have first hand knowledge of potential risks, ineffective controls, and abuses.

Good internal controls over WAH programs should, at a minimum, address the following:

• Eligibility and Status - Adequate policies should include a description of the type of work that may be performed at home. For example, work that must be closely supervised, requires access to non-portable equipment or depends on the frequent interaction with others, cannot be performed at home. Policies should also include the status of employees working at home (e.g. full time, part-time, temporary, etc.) and the employees' eligibility for benefits such as insurance and leave.
• Approval policy, employee performance, work schedule and attendance. Contractor policies and procedures should require
• proper advance approval by appropriate management officials,
• continuing evaluation of the participating employee's performance in completing assigned tasks,
• written documentation of the specific tasks to be performed along with the expected completion dates
• that WAH employees attend periodic meetings at the contractor's work site to allow the employee and supervisor to discuss work progress, assign new tasks, and evaluate work performed, and
• that WAH employees work a mutually agreeable set of core hours to allow management to have access to the WAH employee at designated times.
• Timekeeping requirements - WAH employees hshould be required to submit timecards in accordance with the company-wide timekeeping system.

Contractors without the foregoing minimum controls will undoubtedly be cited for an accounting system deficiency with the potential for billing withholds.

Multiple Award Schedules - Pricing Expectations

The GSA Multiple Award Schedule (MAS) program provides companies the opportunity to sell their products to Government customers. It has been a very successful program for both the Government and companies seeking to sell goods and services. It streamlines the entire procurement process, saving significant resources from the proposal prep and negotiation phases of contracting. Contractors, for their part, must agree to provide the Government the prices afforded their most favored customers, no exceptions.

The Department of Justice just announced a $70 million settlement after GSA auditors found that a company failed to disclose "most favored" prices during the negotiation of an MAS contract and as a result, the Government paid more than it should have for the products it purchased. Like many settlements, the contractor did not admit to guilt but, bottom line, it had to pay the Government the $70 million.

The $70 million settlement resolved issues discovered during a GSA post-award audit. The audit disclosed that the MAS contractor failed to meet its contractual obligations to provide the GSA with current, complete, and accurate information about its commercial sales practices, including discounts afforded to non-Governmental customers. As a result, Government customers who purchased items under the MAS contract paid higher prices than they should have.

Companies pursuing MAS contracts are expected to disclose all sales information to the Government. Omitting sales information because it is considered outdated or not pertinent, opens the door for the Government to later charge defective pricing. It is better to provide the information to the Government during negotiations and then explain it's non-relevance than to withhold it and risk subsequent allegations.

You can read DoJ's press release on this settlement here.

What are "CD" Contracts and What Are the Risks?

Contract Definition (CD) contracts are the kind that are awarded to multiple contractors who will ultimately compete for a major follow-on prime contract. They are usually short-duration contracts. Most of the time they are fixed-price.

Upon completion, the procurement activity (contracting officer) will use the results delivered under the CD contracts to help define exactly what it wants in the prime contract. After that determination, it will then issue an informative RFP.

The Government (specifically DCAA or Defense Contract Audit Agency) considers these type of contracts to be "risky" in terms of the potential for labor mischarging. Their audit guidance in CAM (Contract Audit Manual) 6-404(b)(8) states the following:

Since the contractor's performance on the CD contract will have a direct bearing on its chance of winning the prime, there may be a tendency to spend more than the established contract value. Therefore CD contracts are highly susceptible to labor mischarging and the auditor should evaluate to make sure all allocable effort is being charged.

Similarly, DCAA's audit program for labor floorchecks (where the Agency conducts unannounced interviews of contractor employees) provides for the following:

Identify all CD contracts. These contracts are high-risk contracts and, therefore, should be evaluated to make sure all allocable effort is being charged.

With these risk factors in mind, the auditors will specifically target any CD contracts to ensure that contractors are not off-loading some of the effort onto other direct or indirect projects/contracts.

Small-Business Contracting Goals - Will Remain the Same

This is our third and final posting on the 2013 National Defense Authorization Act (NDAA) that was released from conference committee last week. This Act has yet to pass the full House and Senate but from all accounts, it will. Previously we reported on two provisions in the Senate's version that did not make it out of committee, the arbitrary caps on employee compensation and the unlimited access to internal audit reports by Government auditors.

One of the provisions that did not make the final cut was to increase the small-business contracting goal from 23 to 25 percent. Section 1631 of the Senate's version included a provision that allowed the President to set small-business contracting goals at whatever he wanted but not less than 25 percent. Every year, it seems, small-business advocates try to increase the statutory goals for awarding contracts and subcontracts to small businesses. And, each year the provisions get pulled.

Of course, goals are goals and the real measure of success is ascertaining how well the Government is doing in achieving those goals. So far, the Government has never met the old goal of 23 percent so what is the point in increasing a percentage that cannot be met? OMB (Office of Management and Budget) recently announced an initiative to help Government agencies meet those goals. You can read about that initiative here.

DCAA Access to Contractor Internal Audit Reports

Yesterday we wrote about how the conference committee eliminated a provision in the Senate's version of the 2013 National Defense Authorization Act (NDAA) that would limit the reimbursement of compensation paid to contractor employees to that of the US Vice President. Today we want to highlight another change the conference committee made to the NDAA. This one involves access to contractor internal audit reports.

Under the Senate's version of the 2013 NDAA, contractors would have been required to grant access to internal audit reports and failure to do so, could render a particular business system deficient and subject the contractor to billing withholds.

Under the conference committee's version (expected to pass), the requirement to provide internal audits has been eliminated. Instead, the Act will require that if DCAA needs internal audits, it will request them, document the request, and document the contractors' response to the request. That's it. End of story. If the contractor denies access, there are no ramifications.

If the contractor does provide access, the internal audit reports can only be used by DCAA to evaluate the efficacy of contractor internal controls and the reliability of associated contractor business systems. A determination by DCAA that a contractor has a sound system of internal controls shall provide the basis for increased reliance on contractor business systems or a reduced level of testing with regard to specific audits, as appropriate. Internal audit reports provided by a contractor pursuant to this section may be considered in determining whether or not a contractor has a sound system of internal controls, but shall not be the sole basis for such a determination. This also means that the reports cannot be used as a basis for withholding billings.

Contractor's can breathe easier, for awhile. They will not be required to turn over internal audits if they so choose.

NDAA Provision to Lower Compensation Caps Eliminated

Here's some good news for contractors. The 2013 National Defense Authorization Act (NDAA) emerged from a congressional conference committee on Tuesday missing a few provisions that contractors were opposing including caps on compensation that would limit amounts to the Vice President's salary. In lieu of this provision, the committee recommended further study on the matter.

The conference committee version of the 2013 NDAA orders up a GAO (General Accountability Office) review of the effect of reducing the allowable costs of contractor compensation. The report must include at a minimum, the following:

1. An estimate of the total number of contractor employees whose allowable costs of compensation in each of fiscal years 2010 through 2012 would have exceeded the amount of allowable costs if those costs were capped at the President's and another study if the costs were capped at the Vice President's salary.
2. An estimate of the total number of contractor employees in fiscal year 2012 that could have been characterized as falling within a narrowly targeted exception established by the Secretary of Defense (scientists and computer guys), a description of their duties and services, and their compensation.
3. An assessment of the extent to which contractor employees received compensation in the form of vested or unvested stock options
4. An assessment of the potential impact on the DoD, contractors of the DoD, and employees of such contractors of reducing the amount of allowable compensation.

The GAO report is due within 120 days of enactment of this bill.

GAO Report on DoD Initiative to Reduce Audit Backlog

The GAO (Government Accountability Office) issued a report yesterday to the Senate Committee on Armed Services that looked at DoD's initiative to address the backlog of incurred cost audits and closing out old contracts. The entire report can be found here.

To reduce the backlog of incurred cost audits, DCAA implemented an initiative to focus its resources on auditing incurred cost proposals that involve high dollar values or are otherwise determined to be high risk. Under this initiative,

• DCAA raised the dollar threshold that triggers an automatic audit on a contractor's incurred cost proposal from $15 million to $250 million, 
• revised the criteria used to determine a proposal's risk level and 
• significantly reduced the number of low risk audits that will be randomly sampled.

Go here to read more about the new DCAA policy for incurred cost audits

The GAO reported that DCAA's new initiative "appears promising" but DCAA has not developed measures by which it will assess whether the initiative reduces the backlog in a manner that protects the taxpayers' interests. Specifically, the GAO found that DCAA does not have a plan for how it will determine whether key features of the initiative, such as the revised risk criteria and the revised sampling percentages, should be adjusted in the future.

Already, the number of proposals determined to be high risk is 250% higher than anticipated. That means more audits and more audits is going to jeopardized DCAA's ability to eliminate the incurred cost backlog by 2016.

Reducing the backlog of incurred cost audits will ease one obstacle to closing old contracts. The Army recently announced a goal of closing over 475 thousand contracts by September 2014. Unless it can quick-close some of those, it will need DCAA's audits to achieve that goal. The GAO report was somewhat critical of the Navy and Air Force for not establishing similar goals.

Notification of Ownership Changes

This is an edited version of a post from 2010 but we are posting it again because of a recent situation where a company, in the process of purchasing a Government contractor, had to scale back its offer when it determined that the fair market value of the assets could not be depreciated under Government contracts.

When a contractor becomes aware that a change in its ownership has occurred (or is certain to occur) that could result in changes in the valuation of its capitalized assets in the accounting records, it must notify the ACO (Administrative Contracting Officer) within 30 days.

Additionally, the contractor must notify the ACO within 30 days whenever changes to asset valuations or any other cost changes have occurred or are certain to occur as a result of a change in ownership.

This requirement applies to negotiated contracts or for which any preward or postaward cost determinations will be subject to the FAR cost principles in Part 31 (see FAR 15.408(k)). To find out whether it applies to your contract(s), look for the contract clause 52.215-19.

Besides the notification requirements, the clause also requires that contractors;

1. Maintain current, accurate, and complete inventory records of assets and their costs
2. Provide the ACO or designated representative ready access to the records upon request
3. Ensure that all individual and grouped assets, their capitalized values, accumulated depreciation, and remaining useful lives are identified accurately before and after each ownership change
4. Retain and continue to maintain depreciation and amortization schedules based on the asset records maintained before the ownership changed

Obviously, the Government does not want to pay for assets again and again. Some business combinations result in assets being "written up" to their fair market value (purchase method, for example) and there have been cases (prior to the implementation of FAR 31.205-52) where the Government paid for assets again after it had paid for the assets, through depreciation, to the predecessor company.

This requirement also applies to negotiated subcontracts..

Compensation - Part 17 - ESOPs

Finally, we bring to a close our series on compensation costs. The FAR (Federal Acquisition Regulation) cost principle governing compensation is by far the longest and most complex of all the cost principles. Compensation costs often represent the most significant cost element in contract pricing and incurred costs. As far as the Government is concerned, compensation represents one of, if not the area of greatest risk.

An Employee Stock Ownership Plan (ESOP) is a stock bonus plan designed to invest primarily in the stock of the employer corporation. The contractor's contribution to an ESOP is made with cash, stock, or other property. It is difficult to find someone in the acquisition field that is familiar with ESOPs. Most auditors and contract administrators will spend an entire career without ever having to learn about ESOPs much less having to make recommendations or decisions.

As a general rule, the costs of ESOPs are allowable but there are a few conditions. Some ESOPs meet the definition of a pension plan. Costs of those ESOPs must comply with CAS 412 (compensation and measurement of pension costs). ESOPs that are not pensions, must comply with CAS 415 (deferred compensation). Additionally, contributions in any one year that exceed the deductibility limits of the IRS Code are unallowable.

When ESOP contributions are made with company stock, the value of the stock is limited to the fair market value of the stock on the date that title is effectively transferred to the trust. When the contribution is in the form of cash, stock purchases by the trust in excess of the fair market value are unallowable. Determining fair market value of publicly traded companies is easy. However, in the case of a closely held corporation, the fair market value is not readily determinable so this regulation requires that the valuation be made on a case-by-case basis taking into consideration the guidelines for valuation used by the IRS. As many closely-held companies know, valuation is more art than science and the true value of a company is the price that a willing buyer and seller agree upon. Closely held companies that produce a valuation to support ESOP contributions can expect close scrutiny by the Government.

Compensation - Part 16 - Compensation Caps

This section of the FAR cost principle on compensation addresses statutory limitations on the overall compensation for certain contractor personnel. These compensation caps have been around since 1995. Initially, they applied to DoD contracts only but starting in 1998, the caps were extended to all Government contracts.

In 1995, the compensation cap was $250 thousand. By 2011, the cap had risen to $763,029. The most recent cap (i.e. $763 thousand for 2011) stays in effect until revised by the Office of Management and Budget (OMB). They cannot be escalated for future years.

Compensation, as defined under this cap includes only wages, salaries, bonuses, deferred compensation and employer contributions to a defined contribution pension plan. It does not include other elements of compensation such as severance pay, early retirement incentive pay, etc.

Since 1999, the cap applies to the five most highly compensated employees in management positions at each home office and each segment of the contractor, whether or not the home office or segment reports directly to the contractor's headquarters.

Beginning in 2012, the cap was extended to all employees under DoD, NASA, and Coast Guard contracts (see Section 803 of the 2012 NDAA).

Next: Section (q) - Employee stock ownership plans (ESOP)

Audit Review Process

Have you ever wondered why it takes such a long time for DCAA (Defense Contract Audit Agency) to issue an audit report? If you've had recent experience with DCAA, you probably have wondered. There are multiple factors but one of the biggest factors is the inscrutable review process.

Before an audit begins, the auditor must hold a planning meeting with his/her supervisor, office manager, and regional audit manager to discuss the risk of fraud and noncompliances with applicable laws and regulations that could have a material effect on whatever system is being audited. They discuss prior audit experience, the contractor's environment, and more.

Throughout the audit, the auditor is conferring with his/her supervisor. After the audit, the fun begins. There is an entire infrastructure in DoD dedicated to ensuring the audit is perfect. The audit working papers and the audit report is subjected to the most of the following (and all of the following for some audits):

• First level supervisory review
• Branch manager (or resident auditor) review
• Technical specialist review
• Regional audit manager review
• Peer review
• Independent reference review
• Quality review
• CICGIE (Council of the Inspector General on Integrity and Efficiency)

Sometimes, you just have to pity the poor auditor.

Compensation Plan Requirements for Service Contracts

The Service Contract Act of 1965 was enacted to ensure that Government contractors compensate their blue-collar service workers and some white-collar service workers fairly, but it does not cover bona fide executive, administrative, or professional employees. That omission is covered in FAR 22.1103.

The Government is concerned with the quality and stability of the work force to be employed on its service contracts. Professional compensation that is unrealistically low or not in reasonable relationship to the various job categories may impair a contractor's ability to attract and retain conpetent professional service employees. Recompetition of service contracts may in some cases result in lowering the compensation (salaries and fringe benefits) paid or furnished professional employees. This lowering can be detrimental in obtaining the quality of professional services needed for adequate contract performance. Therefore, it is in the Government's best interest that professorial employees be properly and fairly compensated.

FAR 22.1103 requires that solicitations for negotiated service contracts, when the anticipated contract amount is greater than $650 thousand, and the service to be provided will require meaningful numbers of professional employees, include a requirement to submit, for evaluation a total compensation plan setting forth proposed salaries and fringe benefits for professional employees working on the contract. Supporting information is also required and should include data such as recognized national and regional compensation surveys and studies of professional, public and private organizations, used in establishing the total compensation structure.

FAR 52.222-46 cautions that "low-balling" may be viewed as evidence of failure to comprehend the complexity of the contract requirements and failure to provide a compensation plan may constitute sufficient cause to justify rejection of a proposal.

Lobbying Costs - Government Joins a Whistleblower Suit

Last month, the Government intervened in a lawsuit against Fluor Hanford Inc. and its parent company, Fluor Corporation (collectively Fluor).  The False Claims Act lawsuit was originally filed by a whistleblower  who was also a former employee of Fluor.  

Between 1999 and 2008, Fluor had a prime contract with the Department of Energy (DOE) to provide a wide variety of security, maintenance and operational services at the DOE’s Hanford Nuclear Site in southeastern Washington State.   As part of its contract, Fluor was responsible for managing and operating a federally-funded facility to train Hanford site workers as well as first responders and law enforcement personnel.  

           

The whistleblower complaint alleges that, as a condition of receiving its DOE contract, Fluor was required to certify that it would not use federal funds for lobbying activities.   The complaint further alleges that between 2005 and 2008, Fluor ignored these restrictions and used DOE funding to lobby Congress and executive branch officials for more funding for the training facility.   The complaint alleges that Fluor, and two lobbying firms hired by Fluor and paid using DOE funds, Secure Horizons LLC and Congressional Strategies LLC, lobbied members of Congress and executive branch agencies to include additional funds for the training facility in agency appropriations.  The United States intervened in the lawsuit.

 This is a significant development. Usually, these types of costs, if not excluded by contractors as part of their normal scrubbing of costs for unallowables, are flagged during the audit process and questioned. This new lawsuit by the Department of Justice takes the inclusion of unallowable lobbying costs  to an entirely new level, a False-Claims Act (FCA) action. FCA  carries significantly more liabilities than the penalties for unallowable costs provisions in FAR, including treble damages and civil penalties

Annual Audit Planning Meetings with Contractors

At contractor locations with a significant amount of planned audit activity, the Defense Contract Audit Agency (DCAA) conducts what they term, "Annual Audit Planning and Requirements Planning Meetings" with contractor representatives and contracting officers.

These meetings are typically held during the first quarter of the Government fiscal year (i.e. October -December time frame). At these meetings, the auditors present the various types of audits they plan to conduct in the current year. Applicable audit guidance also instructs them to solicit contractor and contracting officer input into the planned audit schedule.

Regardless of the meetings' ostensible purpose to solicit input from contractors and contracting officers, by the time the meeting rolls around, the audit plan for the year is very much fixed.. We know of no situation where the audit plan was changed as a result of input from either the contractor or the contracting officer.

Even though contractors have no real input into the annual audit plan, these meetings are informative for learning what the auditor(s) plan to do during the year. It is especially important to know which internal control systems will be audited, which CAS standards will be reviewed for compliance, and which contracts have been selected for defective pricing audits (compliance with TINA, or the Truth in Negotiating Act). Knowing this information will help contractors prepare for the audit and compile information and data that is likely to be required/requested.

Many times, contractors sit passively through these meetings, taking a few notes, and nodding once in awhile.   We think it is much better to use this time to engage the auditor. Once the audits begin, auditors are not likely to be very conversant. Now is the time to ask them why they chose to schedule a particular internal control audit, how they view the existing system, what were the results of audit the last time they audited and whether there are any risk indicators currently. When the discussion turns to defective pricing, be sure to ask them your PASS rating and the objective and subjective elements that made up the rating. Challenge the auditors to explain why particular CAS standards are applicable or not applicable.

Sometimes the auditors want to "call it in" rather than face to face. We don't believe that annual planning meetings make efficient conference calls - its too difficult to have meaningful communications. Have the auditors come out and make their presentations.

Feeling the Pinch Yet?

The Office of Federal Procurement Policy (OFPP), part of the Office of Management and Budget (OMB) announced yesterday that contract spending in fiscal year 2012 fell by $20 billion compared to fiscal year 2011.

According to OFPP, seven of the $20 billion came from reductions in management support services such as information technology systems, development, program management and engineering. Savings were also achieved by agencies pooling their purchases to get the same goods and services at lower prices.

The administration is proud of its accomplishments and last Wednesday, announced a new series of initiatives to continue the trend. The focus of the new initiatives is to drive even better coordination of contracting to achieve more savings in buying computers, IT software, janitorial and sanitation supplies, office furniture, building maintenance and operations services, and other professional technical services.

As almost an afterthought, the new initiatives add "To the maximum extent practicable, all strategic sourcing opportunities shall seek to increase participation by small businesses".

Access to Internal Audit Reports

Yesterday, we informed you that the Senate unanimously (98-0) passed the fiscal year 2013 National Defense Authorization Act that included caps on employee compensation. That same bill included a provision that will require defense contractors to provide not only their internal audit reports but also the supporting working papers to Government auditors.

Specifically, Section 843 will ensure that the Defense Contract Audit Agency has sufficient access to contractor internal audit reports and supporting materials in order to

1. evaluate and test the efficacy of contractor internal controls and the reliability of associated contractor business systems, and
2. assess the amount of risk and level of testing required in connection with specific audits to be conducted by the Agency.

Contractors who fail to provide access, risk having one or more of their business systems determined to be inadequate (or disapproved) and would result in billing withholds.

Last August, we wrote a three-part series on internal audits and their value in reducing the amount of audit testing by DCAA (hint: not much). You can read those postings here: Part I, Part II, and Part III. But, the GAO thinks it is important and DCAA cited the general lack of access as one of the issues causing inefficiencies in its audits.

The Senate bill must be reconciled with the House version. It is unknown whether this provision will survive the conference committee.

Compensation Caps

Yesterday evening, the Senate unanimously approved the Fiscal Year 2013 National Defense Authorization Act (NDAA) that includes a provision capping compensation of any contractor employee at $230,000 per year. It will become effective on January 1, 2013 and applies to all contracts including those entered into before, on, or after that date. The House version of the NDAA does not contain the provision. The question now is whether the Conference Committee will leave it in or take it out? Stay tuned.

Continuation of Essential Contractor Services

With all the discussion about sequestration and fiscal cliffs, contractors with DoD contracts might want to check their contracts for the existence of DFARS clause 252.37-7023. DoD Contracting Officers are required to use this clause in solicitations and contracts having essential contractor services. The clause requires the appropriate functional commander or equivalent to specifically identify which functions of a contract are mission essential services. A contractor who provides Government-determined essential contractor services shall have a written plan to ensure the continuation of these services in crisis situations.

“Essential contractor service” means a service provided by a firm or individual under contract to DoD to support mission essential functions, such as support of vital systems, including ships owned, leased, or operated in support of military missions or roles at sea, and associated support activities, including installation, garrison, and base support services. Services are essential if the effectiveness of defense systems or operations may be seriously impaired by the interruption of these services during periods of crisis caused by the changing threat environment, hurricanes, tornados, earthquakes, blizzards, floods, or pandemic influenza, etc.

“Mission-essential functions” means those organizational activities that must be performed under all circumstances to achieve DoD component missions or responsibilities, the failure of which would significantly affect DoD's ability to provide vital services or exercise authority, direction, and control.

When the clause for continuing performance of essential services is incorporated into a contract, the cost of preparing the plan and costs to keep the plan in place, such as potential retainer fees with other service providers and costs related to contracting officer directed training activities associated with testing the effectiveness of the plan, would be valid contract costs subject to the allowability, reason­ableness, and allocability provisions of FAR 31.201 and the cost principles at FAR 31.205.

Since most plans for continuation of essential services will be specific to the contract and contractor, auditors are being instructed to carefully examine the validity of these costs on a case-by-case basis. Most contractors normally allocate the costs of planning for continuing operation of the overall organization as an indirect cost. However, contractors should generally charge planning costs for contractually required continuation of essential contractor services as direct costs. While CAS 402, Consistency in Allocating Costs Incurred for the Same Purpose, requires that each type of cost is allocated only once and on only one basis to any contract, the illustrations at CAS 402-60(b) support that planning for the continuing operations of the overall organization are not incurred for the same purpose in like circumstances as the planning for continuing essential contractor services as required by the contract.


Plan Execution Costs. The contractor is required to segregate and separately identify all costs incurred in continuing performance of essential services in a crisis situation. A contractor has 90 days (longer if approved by the contracting officer) to notify the con­tracting officer of an increase or decrease in costs after he or she has directed continued performance. The parties shall negotiate an equitable adjustment to the contract price as soon as practicable after receipt of the contractor’s proposal. As DFARS 252.237-7023 provides for an equitable adjustment, costs to execute the plan should not be included in price proposals. Auditors are being instructed to question any plan execution costs included in price proposals.

IG Faults DoD Decision to Raise Audit Thresholds

A little more than two years ago (September 2010), the Department of Defense raised the threshold for price proposals requiring audit to $10 million for fixed priced contracts and $100 million for cost-type contracts. Last month, the DoD Inspector General's Office (DoD-IG) issued a scathing report on that decision stating that the Department had not performed a business case analysis to support it.

That decision, according to the DoD-IG will cost taxpayers $249 million per year in lost return on investment from DCAA contract audits.

The audits under the DCAA threshold were given to DCMA (Defense Contract Management Agency) but according to the DoD-IG, DCMA is not prepared to perform contract cost analaysis in place of DCAA and that DCMA cannot reliably report performance. Furthermore, the Department of Defense has no idea whether DCMA has even a remote chance of replicating the $249 million that DCAA could have achieved had the audit thresholds remained at their pre-September 2010 levels. Finally, the DoD-IG found that the Department did not demonstrate why they chose to direct taxpayer resources to DCMA to perform a job that it was not prepared to perform when DCAA had existing infrastructure in place to get the job done.

Perhaps the Department of Defense did not perform a business case analysis for shifting work from DCAA to DCMA but the fact is, DCAA was not getting the job done and their failure was significantly delaying the awards of contracts. The decision was borne more out of frustration than anything else.

The DoD-IG made a number of recommendations including a return to the old audit thresholds. You can read the entire report here.

Compensation - Part 15 - Postretirement Benefits Other Than Pensions

Post retirement benefits other than pensions (PRBs)" means exactly what it says. PRBs includes any benefits (other than cash benefits and life insurance benefits paid by pension plans) provided to employees, their beneficiaries, and covered dependents during the period following the employees' retirement. These include postretirement health care, life insurance provided outside a pension plan, and other welfare benefits such as tuition assistance, day care, legal services, and housing subsidies provided after retirement. This is not an all-inclusive listing but out of this listing, health care coverage for retirees is the most significant in terms of costs and the most likely to attract the attention of the Government.

There's a two-step process for determining whether PRBs can be charged to Government contracts. The first test is to determine whether the contractor is obligated to pay. To be allowable under this first test, PRBs must be incurred pursuant to

• law,
• employer-employee agreement, or
• an established policy of the contractor.

If it passes this first hurdle, then things get a little more complicated. The rules are different depending upon the way that funding is structured.

Pay-as-you-go plans - PRB costs are not accrued during the working lives of employees. Costs are assigned to the period in which

• Benefits are actually provided; or
• The costs are paid to an insurer, provider, or other recipient for current year benefits or premiums

Terminal funding - PRB costs are not accrued during the working lives of the employees
Terminal funding occurs when the entire PRB liability is paid in a lump sum upon the termination of employees (or upon conversion to such a terminal-funded plan) to an insurer or trustee to establish and maintain a fund or reserve for the sole purpose of providing PRB to retirees. Terminal funded costs shall be amortized over a period of 15 years.

Accrual basis - PRB costs are accrued during the working lives of employees. This method gets complicated very quickly. It requires actuarial assumptions on how long employees (or their dependents and beneficiaries) will live, healthcare inflation assumptions, investment earnings, and methods and time-frames for accruing actuarial gains and losses.

Needless to say, there are pros and cons to each of these methods. The first two methods (pay-as-you-go and terminal funding) saddle future work with past promises (e.g. look at the American auto industry). The accrual basis does the best job at matching expense with revenues but reduces short-term profits.

Next: Section (p) - Limitation on allowability of compensation for certain contractor personnel

Compensation - Part 14 - Employee Rebate and Purchase Discount Plans

This next prohibition/limitation on compensation is very straight-forward and almost needs no explanation. Based on our research, there has never been a board case that addressed this section of the FAR (Federal Acquisition Regulations).

The prohibition states:

Rebates and purchase discounts, in whatever form, granted to employees on products or services produced by the contractor or affiliates are unallowable.

There was a time when employee discounts were common and prior to this prohibition, there were questions surrounding the allowability of such costs. Back in the 1970s when Ford was in the aerospace business (Ford Aerospace), the company offered employees significant discounts on the purchase of Ford autos. Also, back in the 1970s, when GTE Sylvania was in the electronics business, it offered deep discounts to employees on its consumer products (Sylvania TVs, stereos, etc).

These days, except for airlines and universities, we do not see many examples where Government contractors offer discounts to employees on products they produce (It doesn't seem likely that Boeing will offer employee discounts on their 737).

Companies can still offer discounts to employees, they just cannot charge the discounts to the Government, either directly or indirectly.

Next: Section (o) - Postretirement benefits other than pensions (PRB).

Incurred Cost Proposals - Inadequacy Letters from DCAA

Recently, DCAA offices from around the U.S. that have been assigned the responsibility for clearing out the backlog of incurred cost proposals (ICPs), have been making assessments as to the proposals' adequacy. In many cases, the auditors have identified one or more deficiency and have returned the proposal to the contractor with a punch list of items requiring correction. Here in the Seattle area, DCAA brought the auditors together for what they termed a "get it done" day to review the adequacy of contractor ICPs that have been stacking up. Following are a few comments and observations.

1. Extensions of the requested due date for revising your ICP is usually obtainable. For convenience sake, requests should be addressed to the contracting officer with a copy to the cognizant auditor (see FAR 52.216-7(d)(2)(i)).
2. Most of DCAA's required corrections are understandable to accountants with contract costing experience. However, sometimes, DCAA rationale for calling something a deficiency is not clear at all. Do not hesitate to call the DCAA point of contact  for clarification. Sometimes they are helpful but they can only provide limited explanations before they cross the line and impair their independence. That's where firms like PNWC and other government contracting consulting groups can be helpful. 
3. One common misconception among contractors is to assume the ICP audit is over once DCAA accepts the ICP as meeting the requirements of an adequate submission. This is incorrect. DCAA uses a two-step approach that culminates in a rate agreement letter. The first step is to test the ICP to determine if it is likely to be adequately prepared. The second step is to perform an audit or a review, based on risk assessment. This second step could range from simple "desk" procedures to a full audit. Although the Government reserves the right to subsequently review and question direct costs, it is very rare for them to re-visit or re-audit your claimed incurred costs once both you and DCAA have signed the rate agreement letter. 
4. Sometimes the basis for inadequate claims are without merit. FAR 52.216-7(d)(2)(iii) lays out the data that constitutes an adequate claim; 15 items (and not all of those 15 items will be applicable). If it is not on that list, it cannot be used by DCAA or anyone else to claim that a proposal is inadequate. We saw one letter from DCAA last week claiming that a proposal was inadequate because the contractor did not provide copies of its IRS Forms 941. Those forms are not on the listing of data necessary for an adequate claim.

If you've received one of these letters and would like to talk to someone about it, contact David Koeltzow ("Kelso") at 866-849-4887, extension 6.

GAO Bid Protests

Filing a bid protest with the Comptroller General's Office (GAO) is very easy. There are no fees. There is no prescribed format, you do not need an attorney and you can mail, email, fax, or hand deliver your protest. Within 100 days, but usually much sooner, a decision is issued.

The GAO recently floated the idea of charging a fee for filing a protest. BusinessWeek called it a "Put Up or Shut Up" Fee. A flat fee of $240 would generate about $600 thousand and would fund an online docket system to help the Agency deal with a rising caseload.

In fiscal year 2012, there were 2,475 protests filed. These filings generated about 16 thousand e-mail messages that are manually filtered by GAO staff. An online docket system would improve and streamline how protests are handled and reduce the risk of mistakes and delays.

The GAO does not believe that a fee would significantly reduce the volume of protests filed but speculated that there are those in Congress who might oppose it because of the impact on small businesses.

Canadian Companies with DoD Contracts and Subcontracts

The Canadian Government (specifically Public Works and Government Services Canada or PWGSC) has been performing contract audits U.S. contracts and subcontracts awarded to Canadian companies. That is about to change. Beginning January 2013, the Canadian Government will no longer perform contract audits of contracts and subcontracts awarded to Canadian firms. Any audits and pricing evaluations that need to be performed, will need to be addressed by U.S. authorities.

The Department of Defense has now addressed this policy shift from the Canadian Government. For DoD contracts and subcontracts, the Defense Contract Audit Agency (DCAA) and the Defense Contract Management Agency (DCMA) will conduct audits as delineated in DFARS PGI 215.404-2(c). DCAA will perform proposal audits on fixed-price proposals exceeding $10 million and on cost-type proposals exceeding $100 million. Regardless of the amount being proposed, DCAA also will perform proposal audits if assistance is requested by a DCAA office. DCAA may also perform proposal audits under the audit threshold if exceptional circumstances are explained to the contracting office in the request for audit.

There is no word yet on how other Governmental agencies plan to address their audit/pricing needs when it comes to contracts awarded to Canadian companies.

DoD Publishes BBP 2.0 Initiatives

Last week, the Under Secretary of Defense for Acquisition and Logistics issued a memorandum to the Defense Acquisition Workforce introducing his preliminary version of the Better Buying Power 2.0 initiative. Although BBP 2.0 is intended for the acquisition workforce, "industry" stakeholders are also invited to comment on these 36 initiatives intended to improve the way that the Department does business.

We encourage contractors (and prospective contractors) to study these initiatives to determine their potential impact on operations. There are some that try to squeeze more product out of fewer dollars. Here's a sampling:

Better define value in "best value" competitions: In competitive bidding processes, industry tends to default to threshold performance levels because they are less costly and source selections seldom give predictable credit for performance above threshold. In addition, when the Department buys non-developmental items (NDI) or near-NDI products, it often must select among products with varying levels of performance and with inherent cost differentials. The Department needs to improve its ability to define the value to the Department of performance that is above minimum levels so that it can make appropriate source selections and so that industry can bid intelligently. This will spur innovation by providing a predictable basis by which companies can bid enhanced performance with he knowledge that any increased costs are within an acceptable range.

Many competitive awards list a variety of evaluation criteria, specify the relative importance of each and then states that the award will be based on "best value to the Government". A lot of contractors think that this phrase is the Government's opening to award the contract to whoever they want to award it to because it allows subjectivity and judgment in the selection process. So, this initiative seems pretty good to us.

Reduce backlog of DCAA Audits without compromising effectiveness: The Department has a significant backlog in both closeout and pre-award audits. DCAA, with the assistance of DCMA and DPAP, is increasing audit resources and developing a risk-based process for reducing the audit backlog. We expect to make major gains in reducing audit-associated delays in both contract closeouts and pre-award audits in 2013.

All contractors will appreciate having their backlog of completed contracts closed out. The interesting thing about this initiative is the comment that DCMA will be helping DCAA clear out this backlog. We wonder whether this represents a further dimunition of DCAA's authorities and responsibilities.

Proposed Caps on Compensation - Update

We've been bringing you periodic updates on the various attempts to lower the caps on compensation that the Government will reimburse under its contracts. The last update was about a month ago. There is nothing new on the legislative front since our last update but there is continued pressure (lobbying?) by various groups encouraging Congress to cap compensation at lower than current levels.

On November 13th, the same consortium of public interest, government accountability, research, and labor groups that we wrote about in our last update (plus one additional group, bringing the number to eleven), issued a similar letter to the Senate and House Financial Services Committees urging them to lower the compensation cap to $400 thousand for non-defense contracts. As you recall, the previous letter addressed a cap of $230,700 for defense contracts. These two caps are currently included in the Senate versions of the Fiscal Year 2013 Financial Services Appropriations Bill and the National Defense Authorization Act of 2013, respectively. Except for a bit of tweaking to specify the respective bills, the letters are identical.

These caps, if implemented, will likely affect many contractors, especially the $230,700 cap for defense contracts. There are many engineering, IT, and medical jobs that already exceed that amount, no matter what benchmark you use. The prospect of having dual caps, one for Defense and one for non-Defense will certainly complicate matters as well. It will affect both direct labor rates and indirect expense rates.

Some say that these bills do not limit what contractors can pay their employees. They only limit the amount of the reimbursement that contractors can receive from the Government. While true, the amount of unreimbursed salaries would have to be paid for with profits and we wonder whether contractors profits can absorb a significant amount of unallowable compensation.

Cost Accounting Standards - Proposed Revision to an Existing Exemption

Certain contracts are exempt from CAS (Cost Accounting Standards). There are ten general categories of exemptions found in 48 CFR 9903.201-1 including contracts awarded based on a sealed bidding process, commercial items, competitive awards and many others. Previously, we discussed the CAS Board's proposal to modify the (b)(15) exemption to include the word "certified" before the phrase cost or pricing data. This was to distinguish awards based on certified cost or pricing data from awards based on "other than cost or pricing data".

Yesterday, the CAS Board published a proposal to modify another exemption, the (b)(6) exemption which currently reads:

Firm fixed-priced, fixed-priced with economic price adjustments (provided that price adjustment is not based on actual costs incurred), time-and-materials, and labor-hour contracts and subcontracts for the acquisition of commercial items.

The proposed rule would eliminate the detailed listing of permissible contract and subcontract types and simply state:

Contracts and subcontracts for the acquisition of commercial items.

Over the years, the permissible contract types for the acquisition of commercial items has expanded. Statutes such as The Federal Acquisition Streamlining Act (FASA) of 1994, the Federal Acquisition Streamlining Act of 1994 (FARA) and the Services Acquisition Reform Act of 2003 (SARA) have added to the number of contract types that can be used for commercial item procurement. The CAS exemption listing permissible contract types is now too restrictive and has not kept pace with these and other statutes.

The current listing of all CAS exemptions can be found here.

GAO Bid Protest Statistics for FY 2012

Last week, the GAO (Government Accountability Office) released its fiscal year 2012 bid protest statistics. Companies files 2,475 bid protests in FY12 (fiscal year 2012), a five percent increase from FY11.  GAO closed slightly more than that number, 2,495. Of the cases that were closed, 570 were decided by a GAO merit decision. The remainder were closed because the cases were settled before a decision or were withdrawn.

The bid protest process is fairly quick. All cases are decided within the 100 days allowed under the Competition in Contracting Act. Most cases are decided within 30 days.

Of the 570 cases that were decided based on merit, 106 or 18.6 percent were decided in favor of the protestor. However, this statistic does not tell the entire story. The GAO report contains an "effectiveness rate" measured by a protestor obtaining some form of relief. In FY12, the effectiveness rate was 42 percent. This rate has not changed much. It was 42 percent in FY08, FY10, and FY11 as well. Only FY09 was different at 45 percent. The effectiveness rate not only includes cases where the GAO sustained a protest but also cases where an ADR (alternative disputes resolution) process were utilized and cases where the procurement agencies offered some form of relief before the GAO made a decision on the merits of the case.

All in all, 42 percent is pretty good odds. If you have a sound basis for filing a protest and you file in a timely manner, these are excellent odds for obtaining some form of relief.

Travel Costs - Additional Documentation Requirements

Why do Government auditors always seem to include travel costs when reviewing contractor incurred costs audits? Even where travel costs are not significant, auditors often spend a disproportional amounts of time reviewing travel costs. There are several reasons and those reasons have a lot to do with the explicit documentation requirements of FAR 31.205-46, Travel Costs. This is one of those "low hanging fruit" areas that we've talked about before. Contractors, especially small contractors with limited internal control systems, do not do a very good job of complying with the documentation requirements of this standard. The auditors know this and they can come up with some easy audit findings and cost disallowance and have a fair chance at sustaining the findings.

Besides what you would normally expect to document the allowability of costs (e.g. authorization, invoice, payment), the travel cost principle requires the following: additional documentation:

• Date and place (city, town, or other similar designation) of the expenses
• Purpose of the trip
• Name of person on trip and that person's title or relationship to the contractor

Additionally, this FAR cost principle requires that airfares be limited to the lowest priced airfare available to the contractor during normal business hours (with a few limited exceptions). Think about a contractor's difficulty in proving that it obtained the lowest priced airfare. Think about the added difficulty when the auditor begins the review several years after those costs were incurred and booked and the supporting data has been archived. Contractors need great internal control systems to ensure that they bought and claimed the lowest priced airfare as well as efficient documentation retention practices.

Travel Costs - Excess Over Maximum Per Diem

FAR 31.205-46, Travel Costs, requires that, except in special and unusual situations, costs incurred by a contractor for lodging, meals, and incidental expenses shall be considered to be reasonable and allowable only to the extent that they do not exceed on a daily basis the per diem rates in effect as of the time of travel as set forth in the Federal Travel Regulations (for the lower 48), the Joint Travel Regulations (Alaska, Hawaii, Puerto Rico, and other U.S. territories and possessions) and State Department Regulations (foreign travel).

What, according to FAR are the "special and unusual" situations  that would justify travel costs in excess of those limits? There are four.

1. Lodging and/or meals are procured at a prearranged place such as a hotel where a meeting, conference or training session is held.
2. Costs have escalated because of special events (missile launching periods, sporting events, World's Fair, conventions, natural disasters; lodging and meal expenses with prescribed allowances cannot be obtained nearby; and costs to commute to/from the nearby location consume most or all of the savings achieved from occupying less expensive lodging
3. Because of mission requirements
4. Any other reason approved within your organization.

FAR further requires a written justification for use of the higher amounts and this justification must be approved by an officer of the contractor's organization or designee to ensure that the authority is properly administered and controlled to prevent abuse. This approval justification must be retained as part of the contractors documentation to support actual costs. Also, receipts for expenditures greater than $75 must be retained as part of the documentation package.

Finally, whenever the actual expense method is used the amounts allowable under Government contracts can never exceed 300 percent of the maximum per diem rates specified in the JTR/FTR/State Department regulations.

Note, FAR 31.205-46 requires other documentation in connection with travel costs. We will discuss that tomorrow. In the meantime, contractors should ensure that their policies for justifying and documenting the incurrence of travel costs in excess of the maximum per diem amounts line up with these requirements. Failing to do so risks subsequent disallowance and perhaps penalties.

Compensation - Part 13 - Fringe Benefits

Fringe benefits are allowances and services provided by the contractor to its employees as compensation in addition to regular wages and salaries. Fringe benefits include, but are not limited to, the cost of vacations, sick leave, holidays, military leave, employee insurance, and supplemental unemployment benefit plans. Executive fringes may include such things as free parking, the use of a company-owned auto, life and disability insurance, and memberships in social, dining, or country clubs.

Except as provided otherwise in FAR Part 31.2, the costs of fringe benefits are allowable to the extent that they are reasonable and are required by law, employer-employee agreement, or an established policy of the contractor. Fringe benefits that may be unallowable based on other FAR criteria might include memberships in social, dining, or country clubs (see FAR 31.205-14, Entertainment Costs).

That portion of the cost of company furnished automobiles that relates to personal use by employees (including transportation to and from work) is unallowable regardless of whether the cost is reported as taxable income to the employee.

Auditors will sometimes become fixated on particular fringe benefits that they deem unreasonable even though not specifically unallowable. Executives seem to come under closer scrutiny than non-executives. At one time, incentives for employees to utilize public transportation was routinely challenged until the Government came up with its own program to subsidize public transportation costs for Federal workers. Then, those challenges quietly disappeared. We have heard of a couple of cases recently where auditors were challenging free parking provided to some but not all, employees (usually for the company executives).

Auditors frequently misapply the FAR reasonableness criteria but contractors can be better prepared to defend themselves by understanding and applying those criteria. Follow this link for a discussion on reasonableness criteria.

Next: Section (n) - Employee rebate and purchase discount plans.

Compensation - Part 12 - Compensation Incidental to Business Acquisitions

This is the so-called "Golden Parachute/Golden Handcuff" clause. Compensation that is paid or accrued incidental to business acquisitions are unallowable. Specifically FAR states that the following costs are unallowable.

1. Payments to employees under agreements in which they receive special compensation, in excess of the contractor's normal severance pay practice, if their employment terminates following a change in the management control over, or ownership of, the contractor or a substantial portion of its assets (Golden Parachutes).
2. Payments to employees under plans introduced in connection with a change (whether actual or prospective) in the management control over, or ownership of, the contractor or a substantial portion of its assets in which those employees receive special compensation, which is contingent upon the employee remaining with the contractor for a specified period of time (Golden Handcuffs).

These prohibitions were added in 1988.

Next: Section (m) - Fringe Benefits

Compensation - Part 11 - Deferred Compensation

Deferred compensation is an award made by an employer to compensate an employee in a future cost accounting period for services rendered prior to receipt of compensation. It does not include the normal year-end salary, wage or bonus accruals.

The costs of deferred compensation awards are allowable subject to the following limitations:

1. The costs shall be measured, assigned, and allocated in accordance with CAS 415, Accounting for the Cost of Deferred Compensation
2. The costs of deferred compensation awards are unallowable if the awards are made in periods subsequent to the period when the work being remunerated was performed.

The trick here is to charge only the present value of the award to the current accounting period. This means that contractors will need to reasonably estimate when the payouts will occur (one of the conditions of CAS 415).

Next: Section l - Compensation incidental to business acquisitions.

Whistleblower Action

The Justice Department announced in a press release yesterday that it has intervened in a whistleblower lawsuit against Fluor Corporation in the U.S. District Court for the Eastern District of Washington. The False Claims Act lawsuit was originally filed by a former employee of Fluor.

The whistleblower complaint alleges that, as a condition of receiving a Government contract, Fluor was required to certify that it would not use federal funds for lobbying activities. The complaint further alleges that between 2005 and 2008, Fluor ignored these restrictions and used Government funding to lobby Congress and executive branch officials for additional funding on an existing contract.

The complaint was filed under the False Claims Act, which authorizes private parties to sue on behalf of the United States and share in any recovery. The act authorizes the United States to intervene in such a suit and take over the responsibility for litigating it.

The claims asserted in this case are allegations only, and there has been no determination of liability. However, the Government, prior to intervening in the case, saw the evidence and based on that evidence, decided to join in the suit. Many times, the Government does not intervene in whistleblower suits because of there is not sufficient evidence to take the allegations forward.

There has been a marked increase in the number of whistleblower (qui tam) lawsuits in recent year. The potential of a big payday awaits those who persevere.  The Justice Department reported that a record of 638 qui tam lawsuits were filed in 2011, after hovering between 300 and 400 a year for most of the prior ten years. Contractors are advised to ensure that their system of internal controls, codes of conduct, and ethical practices are implemented and operating effectively.

Rent Paid to Related Parties

There's one final lesson we want to draw out of the ASBCA (Armed Board Services Board of Contract Appeals) decision that we've been discussing this week, ASBCA No. 57795, Thomas Associates, Inc. Thomas had included expressly unallowable costs in its 2004 incurred cost proposal. The auditor discovered the costs during the audit and the contracting officer levied a penalty. Thomas lost its appeal of the contracting officer penalty determination.

One of the expressly unallowable costs included in Thomas's incurred cost submission was facility rent paid to a related party; Thomas's president, Ms Thomas. To support the reasonableness of those rental payments, Thomas provided rental information on comparable properties in the area which, unsurprisingly, were higher than what Tomas was paying.

The problem here for Thomas was that FAR 31.205-36, Rental Costs, limits allowable costs to actual cost of ownership for related party transactions. The pertinent section of FAR 31.205-36 reads::

(3) Charges in the nature of rent for property between any divisions, subsidiaries, or organizations under common control, to the extent that they do not exceed the normal costs of ownership, such as depreciation, taxes, insurance, facilities capital cost of money, and maintenance (excluding interest or other unallowable costs pursuant to Part 31), provided that no part of such costs shall duplicate any other allowed costs...

We frequently encounter similar situations where small businesses (and some not-so-small businesses) lease facilities from related parties. It is surprising the number of times that these businesses have the mistaken notion that they can claim "market rates" for rental payments.

One final note, "normal costs of ownership" by definition includes facilities capital costs of facilities (FCCM). When tallying the normal cost of ownership, many contractors fail to include FCCM. As we've discussed here on this blog, FCCM, in many cases, can be significant, especially when real property is involved.

Excuses that Didn't Work

For the past two days, we've been discussing various aspects of the Thomas Associates (TAI) decision from the ASBCA (Armed Services Board of Contract Appeals). This case involved the inclusion of expressly unallowable costs in the contractors annual incurred cost claim and the eventual assessment of penalties and interest for doing so.

The ASBCA did not buy the contractor's argument that the costs were not expressly unallowable but just plain unallowable. Expressly unallowable costs carries a penalty while non-expressly unallowable costs do not. The contractor found out the hard way just how significant these penalties can become. Penalties and interest totaled 45 percent of the expressly unallowable amounts included in the incurred cost claim.

In its complaint, the contractor requested that the penalties be waived. FAR 42.709 allows the Government to waive penalties under three circumstances.

1. The contractor withdraws its proposal before the Government begins its audit
2. The amount charged to Government contracts is less than $10 thousand
3. The contractor can show that it had good policies and procedures for identifying and excluding unallowable costs from its proposal but there was an unintentional error notwithstanding the exercise of due care.

ASBCA denied TAI's waiver request.

The contractor first argued that the unallowable costs, individually, did not exceed $10 thousand. The ASBCA rejected the argument stating that the $10 thousand threshold is an aggregate amount.

The contractor then argued that the penalties represented a financial hardship. The Board rejected this on the basis that "there is no known regulatory or decisional authority for considering "financial hardship" as a basis to waive penalties".

Finally, the contractor argued that it had not been audited previously and that this was a "learning experience". The ASBCA ruled that "learning experience" was not a condition for waiver of penalty and there was no evidence that the contractor submitted the expressly unallowable costs "inadvertently" or due to "unintentional error".

Entertainment vs. Employee Morale

Yesterday we discussed a recent ASBCA (Armed Services Board of Contract Appeals) decision where the judge sided with the Government on the question of whether certain costs included in an annual incurred cost submission, were specifically unallowable under FAR cost principles. Claiming those costs resulted in the imposition of penalties and interest. There are other aspects of the decision that are instructive for contractors in identifying unallowable costs.

There were five items of cost involved in this case. Four of those were questioned by the auditors as unallowable entertainment (FAR 31.205-14). The contractor claimed that these costs were incurred to improve employee morale, fitness and teamwork and therefore unallowable under FAR 31.205-13 (Employee Morale). These expenses included executive membership to a private club, concert tickets, flowers, and a Christmas party (that included alcohol). The ASBCA did not buy these "employee morale" arguments.

These two cost principals, employee morale (FAR 31.205-13) and entertainment (FAR 31.205-14) need to be considered in concert when deciding whether costs are allowable or not. From the Government's perspective, if the cost do not meet the narrowly defined activities included in employee morale cost principle, they will be inclined to categorized the costs as unallowable entertainment.

The DCAA Contract Audit Manual (DCAM) is quite emphatic, stating it this way:

By statute, entertainment costs are expressly unallowable, without exception. Consequently, the entertainment cost principle at FAR 31.205-14 takes precedence over any other cost principle.

DCAM further states:

Entertainment costs are expressly unallowable, without exception. Therefore, even if the principal purpose for incurring an entertainment cost is other than for entertainment, the entertainment cost is unallowable. For example, while the cost of a contractor open house for employee families is generally allowable, the cost of entertainment provided as part of the open house is unallowable.

If the Government can find a way to classify a cost as entertainment, it will do so. Sometimes, however, they are not correct in their assessment. The arguments proffered by the contractor in this case, seem sophomoric and doomed from the start. However, contractors should not be dissuaded by this case from claiming costs that are truly expenses related to employee morale.

You can read the full ASBCA decision here.

Penalties for Unallowable Costs

Most Government contractors know that there are penalties involved when claiming specifically unallowable costs. In an ASBCA (Armed Services Board of Contract Appeals) decision handed down last month, a contractor found out the hard way how significant those penalties can become.

In 2007, DCAA finished its audit of Thomas Associates Inc's. (TAI) 2004 incurred cost submission. It found about $38 thousand in costs that were specifically unallowable according to FAR cost principles. The contracting officer agreed and levied penalties for including unallowable costs in its claim. TAI appealed to the ASBCA, offering a number of defenses, including the idea that the costs in question were not specifically unallowable but were unallowable as a matter of interpretation.

The ASBCA ruled that Government had "sustained its burden of proof" that the costs in question were specifically unallowable under the respective FAR cost principles involved and denied TAI's appeal.

The penalties together with interest totaled about $17 thousand or about 45 percent of the specifically unallowable costs. That's significant.

You can read the decision here.

Compensation - Part 10 - Pensions

There are essentially two types of pension plans, defined benefit and defined contribution. A defined benefit plan gives a retiree a certain amount of money for the rest of his/her life. Social Security is a defined benefit plan. A defined contribution plan  puts money into a workers account. Earnings on the account stay with the account. Upon retirement eligibility  the worker can start drawing from the account. The popular 401(k) plans are defined contribution plans.

FAR 31.205-6(j) requires contractors to follow CAS (Cost Accounting Standards) 412 and 413 to measure, assign, and allocate pension plan costs, even for contractors that are not CAS-covered. Pension costs are allowable subject to those Standards as well as other cost limitations and exclusions further enumerated in the FAR 31.205-6(j) cost principle.

We will not be discussing defined benefit pension plans in this post. Frankly, there are relatively very few of those types of plans remaining and they are almost non-existent at small Government contractors. These plans have turned out to be too costly and have contributed to the financial woes of many companies including the U.S. automobile industry.

For defined-contribution plans (including profit sharing, savings plans, and other such plans), allowable pension cost is limited to the net contribution required to be made for a cost accounting period after taking into account dividends and other credits, where applicable. For 401(k) plans, this is usually a fairly straight-forward computation and there is rarely any disputes with the Government as to the propriety of such costs. Just remember that if any employee compensation is determined "unreasonable" (e.g. it exceeds the OMB ceiling on employee compensation), any portion of pension plan contributions related to that excess amount should also be excluded from any proposal or incurred cost submission to the Government.

Contractors need to fund their plans on time. If by failing to fund the plans on-time a contractor must pay interest, the interest is unallowable. Also, any increased costs that result from contractors moving pension funds from one plan to another are unallowable.

Excess funding is not allowable. Any amount that exceeds what is "assignable" to a fiscal year is not allowable under Government contracts. Contractors cannot "make up" prior years' funding requirements in the current year.

Pension payments must be paid pursuant to an agreement entered into in good faith between the contractor and employees before the work or services are performed and to the terms and conditions of the established plan. Don't come to the end of the year, find out that you have a little extra cash on-hand and decide to pay it out to employees in the form of pension contributions. That scenario would not meet this requirement.

There is much more to this subject than can be summarized easily into a blog post. In summary, if you're a small contractor with a 401(k) plan that is being administered by a third party that specializes in retirement plans and are making timely contributions to the administrator of that plan, you're unlikely to run afoul of any restrictions contained in this section.

Next: Section (k) - Deferred Compensation other than Pensions.

Compensation - Part 9 - Changes in the Prices of Corporate Securities

This section of the compensation cost principle is unlikely to apply to most small companies.

Sometimes, executive compensation (and less often, employee compensation) includes payments in the form of the contractor's corporate securities such as stock options and stock appreciation rights.

In general, securities must be valued at their fair market value on the measurement date (i.e. the first date the number of shares awarded is known). Any accruals for the cost of securities before issuance to the employees must also take into account the possibility that the employees' interest in the accruals might be forfeited.

There are a number of other restrictions that apply.

• Any compensation which is calculated, or valued, based on changes in the price of corporate securities is unallowable.
• Additionally, any compensation represented by dividend payments or which is calculated based on dividend payments is unallowable. Presumably, this restriction is because dividends are normally distributions of profit.
• Finally, a contractor pay an employee cash in lieu of exercising the security. Specifically, the regulation states that if a contractor pays an employee in lieu of the employee receiving or exercising a right, option, or benefit which would have been unallowable under this paragraph, such payments are also unallowable.

These restrictions highlight the Government's long-standing position that compensation based on changes in securities prices is not compensation based on work actually erpformed and thus, is unallowable. Further, dividend payments are essentially a distribution of profits and likewise should not be reimbursed by the Government.

The application of this cost principle is not without controversy and if you are one of the few Government contractors who compensate employees with corporate securities, we recommend that you refer to the audit guidance in DCAA's Contract Audit Manual 7-2123.

Nect: Section (j) - Pension Costs

Compensation - Part 8 - Backpay

Backpay is a retroactive adjustment of prior years' salaries or wages. Backpay should not be confused with deferred compensation. While backpay is generally unallowable, deferred compensation is usually allowable if a deferred compensation plan is set up correctly.

This provision changed significantly in 2003. Prior to that, backpay included settlements for violations of Federal labor laws and the Civil Rights Act of 1984 (e.g. improper discharge or discrimination). Under the 2003 revision, backpay is defined as additional compensation for work performed.

According to FAR 31.205-6.(h), backpay is unallowable except for a few situations.

1. Payments to employees resulting from underpaid work actually performed are allowable, if required by a negotiated settlement order, or court decree. Contractor intending to claim backpay under this provision will most likely need legal assistance.
2. Payments to union employees for the difference in their past and current wage rates for working without a contract or labor agreement during labor management negotiation are allowable.
3. Payments to nonunion employees based upon results of union agreement negotiation are allowable only if
• A formal agreement or understanding exists between management and the employees concerning these payments, or
• An established policy or practice exists and is followed by the contractor so so consistently as to imply, in effect, an agreement to make such payments.

This rule effectively takes away situations where if a survey shows an employee is underpaid in a particular year, the contractor could make that underpayment up in a future year.

The allocation of backpay costs can be tricky. Usually settlements occur several years after the period to which backpay is allocable. If you have a backpay situation, we advise that you pursue an advance agreement (see FAR 31.109) with the contracting officer. Otherwise, you are risking time-consuming arguments with the auditors.

Next: Section (i) - Compensation based on changes in the prices of corporate securities

Compensation - Part 7 - Severance Pay

Severance pay is a payment, in addition to regular salaries and wages, by contractors to workers whose employment is being involuntarily terminated. Severance pay is only allowable under Government contracts to the extent that it is required by

• Law
• Employer-employee agreement
• Established policy that constitutes, in effect, an implied agreement on the contractor's part; or
• Circumstances of the particular employment.

These are pretty broad categories and we do not recall when a contractor's intention to pay or actual payment of severance pay was successfully challenged by the Government for failing to meet one of these four conditions.

Back in the 1970s and perhaps the early 1980s, as service contracts changed hands, winning contractors would hire the employees of the incumbent contractor and those employees would continue to do the same work that they had been performing. Sometimes, hiring incumbent employees was a requirement of the solicitation and other times, it was convenient and made business sense. However, upon losing the contract, incumbent contractors were paying their employees a severance pay and seeking reimbursement for those costs from the Government. That precipitated a new rule where payments made in the event of employment with a replacement contractor where continuity of employment with credit for prior length of services is preserved under substantially equal conditions of employment or continued employment by the contractor at another facility, subsidiary, affiliate, or parent company of the contractor are not severance pay and are unallowable.

There are two kinds of severance pay addressed in this cost principle; normal severance pay and abnormal severance pay.

Actual normal turn over severance payments shall be allocated to all work performed in the contractor's plant. However, if the contractor uses the accrual method to account for normal turnover severance payments, that method will be acceptable if the amount of the accrual is

• reasonable in light of payments actually made for normal severances over a representative past period, and
• allocated to all work performed in the contractor's plant.

Abnormal or mass severance pay is of such a conjectural nature that accruals for this purpose are not allowable. However, the Government recognizes its obligation to participate, to the extent of its fair share, in any specific payment. Thus, the Government will consider allowability on a case-by-case basis.

Specific requirements for foreign national employees. The costs of severance payments to foreign nationals employed under a service contract performed outside the US are unallowable to the extent that such payments exceed amounts typically paid to employees providing similar services in the same industry in the US. Further, all such costs of severance payments that are otherwise allowable are unallowable if the termination of employment of the foreign national is the result of the closing of, or the curtailment of activities at a US facility in that country at the request of the government of that country. This does not apply if the closing of a facility or curtailment of activities is made pursuant to a status-of-forces or other country-to-country agreement entered into with he government of that country before November 29, 1989. Applicable statutes permit the head of the agency to waive these cost allowability limitations under certain circumstances.

Next: Section (h) - Backpay

Mandatory Disclosure Requirements - A Reminder

In November 2008, FAR was amended to require mandatory disclosure requirements involving fraud and overpayments on contractors (and subcontractors). These disclosure requirements apply to contracts greater than $5 million and a performance period greater than 120 days. This disclosure requirement applies to most types of contracts including commercial items and contracts awarded and/or performed overseas.

FAR 52.203-13 requires timely disclosure of violations against criminal and civil laws. Criminal laws include fraud, conflict of interest, bribery, or gratuity violations. Civil laws include the False Claims Act. There must be credible evidence of a violation and the violation must have been committed by any contractor principal, employee, agent, or subcontractor.

Disclosures must be made in writing to the appropriate Inspector General (e.g. the DoD Inspector General for DoD Contracts) and the contracting officer. The reporting period extends from contract award to three-years after final payment. Many contractors do not realize that the reporting period extends beyond the contract period of performance.

The term "credible evidence" is undefined. but the FAR Councils have noted that the term indicates a higher standard than "reasonable grounds to believe". Implicit in this distinction is an allowance of time for a contractor to investigate matters to make a "credible evidence" determination. Failure to disclose credible evidence of criminal and civil violations (and significant overpayments) constitute grounds for suspension and debarment.

Sleeter Group Announces 2013 "Awesome Applications"

Each year since 2006, the Sleeter Group has culled through dozens of QuickBooks add-ons to select a few that rise above the others. They awarded these applications their "Awesome Add-on Award".  This year, the Sleeter Group changed its format to include non-specific QuickBooks products and renamed their promotion from "Awesome Add-ons" to "Awesome Applications. While some QuickBooks specific add-ons made the winner's circle, many of the applications are stand-alone, not requiring QuickBooks to function.

As consultants with many clients using QuickBooks, we are always interested in any improvements to the basic platform as well as improved or added functionality provided by third-party add-ons. With hundreds of add-ons available however, it is difficult to assess which ones are worthwhile and which should be avoided. Having reviews by an independent (and reputable) organization certainly helps in assessing a product's strengths  weaknesses, and value.

Click here to read about the winners of the 2013 Awesome Applications. Go here to read about previous winners.

Of the nine winners, the following three have the most potential for benefiting Government contractors and prospective contractors.

• BillQuick by BQE Software. This is a repeat winner. BillQuick is an integrated solution for time & expense tracking, billing and project management. Many Government contractors use this product.
• Cloud9 Real Time by Cloud9 Real Time. This application hosts all of your applications, data, and users in one central location, in the "cloud".
• Concur Small Business Edition by Concur. This is an office expense management and reporting application. Contractors who perform a lot of travel and have inefficiencies in collecting travel expense information might benefit from Concur SBE.

eFAACT, a QuickBooks solution for Government contractors was a finalist in this year's selection process. If you are looking for something to facilitate indirect rate development and billings under Government contracts, you might want to evaluate this product. Our impression? Powerful but expensive.

Preaward Accounting System Survey Checklist

FAR 16.301-3 states that a cost-reimbursement type contract may be used only when the contractor’s accounting system is adequate for determining costs applicable to the contract. Contracting officers must make this determination prior to the award of a contract. If the contracting officer has insufficient information to make this determination, it will request DCAA or another audit organization to perform a Preaward Survey of Prospective Contractor’s Accounting System (SF Form 1408).

DCAA has been instructing contracting officers to send out a preaward survey checklist to prospective contractors to complete prior to requesting a preaward survey of the accounting system. This checklist will help ensure that the contractors understand the requirements of the SF Form 1408 and to ensure that they are ready for DCAA to come in a perform an audit.

This checklist essentially mirrors the requirements of the SF Form 1408 however there are a few additional items that require contractor response. These are:

• Are you planning on bidding on cost type contracts?
• Are you ready for a DCAA audit?
• Have you read the requirements in the SF Form 1408?
• Have you read the "Information for Contractors" pamphlet?
• Please identify the DCAA office cognizant of your company.
• Please identify your company's point of contact.
• If an outside CPA/Consultant/Non DoD agency has reviewed your Accounting System, please provide a copy of the report.

This last bullet requires some clarification. The "review" that is referred to here is an attestation engagement performed in accordance with Generally Accepted Government Auditing Standards (GAGAS) a.k.a. a "Yellow Book" audit. It would not include the results of, say, an outside firm (like PNWC) performing a review to identify potential weaknesses in a contractor's accounting system and making recommendations, as appropriate, on improving the system to meet Government contracting requirements. Those are not "reviews"  conducted in accordance with GAGAS.

Companies looking to enter the Government contracting arena or existing contractors looking to bid on cost-reimbursable contracts, will find this checklist useful.