Labor Utilization

Government contractors, particularly those with cost-type contracts, have a responsibility and obligation to ensure the efficient utilization of labor and facilities to accomplish their goals.

We've warned quite often that Government contractors should never presume that when an auditor enters their facilities, that he/she is limiting his/her purpose to the audit at hand. The good ones, and yes, most of them are very good, will be observing things and making casual seemingly innocuous inquiries. One of the things that they are trying to assess is whether there is idle capacity, idle facilities, or poor labor utilization that may result in increased costs charged to Government contracts. Any hint of these inefficiencies are then documented in "audit lead sheets" and contractors might find the auditors coming back to follow up on those leads. Large contractors are more susceptible to these reviews than small contractors based primarily on risk to the Government.

There is a particular type of review that auditors can perform when inefficiencies are noted - Labor Utilization Audit. The basic objectives of a labor utilization audit are;

• to evaluate the internal controls instituted to assure prudent utilization of staffing in the performance of Government contracts, 
• to determine whether the costs are commensurate with the benefits derived, and 
• to determine the reasonableness and efficiency of the labor utilization.

The auditor has an array of specific procedures he/she can deploy in meeting these objectives. Some of them include:

1. Ascertain whether the work performed by the contractor is required by the terms of the contract, properly authorized, and directed to the appropriate operational unit
2. Determine whether there are unwarranted variations between staffing budgets allocated by upper management and staffing budgets actually used by operating or middle management.
3. Determine whether the contractor maintains adequate control over the expenditure of the technical effort to assure maximum productivity, whether this control includes the evaluation of actual work assignments and target completion dates, and whether comparisons are made with staffing budgets and staffing tables approved by management.
4. Evaluate the contractor's personnel practices during start-up and phase out periods to determine whether the cost of excess personnel is charged to Government contracts in the build-up period and whether the Government contracts are unduly burdened with the retention of unnecessary personnel in the phase out period.
5. Evaluate the contractor's basis for assigning and phasing out technical personnel for both Government production and commercial operations. Audit emphasis should be accorded the phase out portion of the contract to determine the reasons for retaining certain classes of technical personnel to complete the contract. the auditor should also determine whether the contractor is assigning technical personnel in accordance with their skills. The use of highly trained personnel to perform routine work which could be performed by lower paid personnel is not economical. The use of less than qualified personnel to perform difficult work may result in higher costs to the Government because more time and greater supervision may be required. The type of contract should be a guide to the auditor in determining the extent of verification in these areas.
6. Examine the contractor's staffing and labor control practices to determine the effectiveness of controlling idle time. If unreasonable idle time is perceived or controls are judged to be inadequate, conduct a preliminary work sampling (probe).
7. Compare labor classifications charged to the contract with those proposed to ascertain whether the contractor is utilizing the type of personnel for which the Government has contracted.

There have been many cases over the years where challenges to a contractor's labor utilization practices have been sustained resulting in significant cost disallowances. Some of the procedures listed above could turn in to investigative referrals if an auditor determines (or suspects) that there has been intentional mischarging to Government contracts.

 

When Black and White is Not So Black and White

In 1991, MPR, a Government contractor, negotiated at arms-length, a ten-year office space lease at reasonable, below market rental rates compared to those charged for similar facilities. Three years later, MPR, set up a related company to purchase the building. The lease cost continued the same as they were before MPR purchased the building through a related company.

The Government auditors took a position that allowable costs after the purchase was limited to the actual cost of ownership,as required under the related party provisions of FAR 31.205-36 and questioned the difference. MPR argued that the costs were reasonable at the time the lease was entered into and that the subsequent purchase of the office building did not negate that fact.

There were other issues involved in the audit of costs. During negotiations, MPR and the Government reached an oral agreement on all matters in question. MPR agreed to relinquish its position on the allowability of excessive executive compensation, patent costs and B&P costs while the contracting officer agreed to allow the full rental costs.The parties reached an oral agreement, had exchanged consideration and had a meeting of the minds on the agreement's major terms with respect to the outstanding cost issues before them. All that remained was for someone to recalculate the rates based on the agreement.

Before the oral agreement was formalized in a written agreement, the contracting officer's legal counsel advised that contracting officer lacked the authority to allow costs made unallowable by FAR 31.205-36. The contracting officer then reneged on his oral agreement and issued unilateral rates with the rental costs reduced to the actual cost of ownership. MPR appealed to the ASBCA (Armed Board of Contract Appeals).

The ASBCA ruled in favor of MPR. The Board ruled that the oral agreement was binding. The Board stated, concerning the oral agreement, that

This is not a case where the ACO violated a plain requirement of a statute or regulation. There is no plain illegality here. The ACO was authorized to exercise his judgment in interpreting the regulations to resolve the rent issue under the cost principles. The ACO's interpretation of the cost principles in light of the change in appellant's status during the course of the lease was not clearly unreasonable. Under the totality of these circumstances, therefore, the ACO acted within his authority in interpreting the regulations to resolve the doubt concerning the reasonableness of the MPR rental rates and costs and entering into the oral agreement with MPR that settled all cost issues.

Obtaining Copies of Contract Audit Reports

The Defense Contract Audit Agency (DCAA) and other contract auditors including private firms performing contract audits on behalf of (and at a great cost to) the Government, do not routinely provide copies of their audit reports to the contractors they are auditing. Instead, these audit agencies and audit firms refer the contractors (the auditees) to the contracting officer who has the authority to decide whether to release the report or to withhold it.

The contracting officer's decision to hold or release an audit report depends upon the purpose of the audit report. If the subject of the audit is a pricing proposal, the Government considers the information to be part of its negotiation position and will not disclose it until after negotiations are concluded . If the audit is one that contains recommended corrective actions, the contracting officer will, of course, want to release the report so that contractors can respond and fix whatever internal control deficiency was identified. If the audit relates to investigative support (a relatively rare occurrence), the contracting officer may never release the audit report to the contractor.

Most audit reports pertaining to contracting contain a statement to the effect that the agency/organization has no objection to the release of the audit report to the authorized representatives of the company. That phrase conveys the decision on whether to release the report to the addressee, usually the contracting officer or requester of the audit services.

Contractors should always attempt to obtain copies of audit reports. Even reports that have served their usefulness, such as reports on pricing proposals, are useful for understanding weaknesses in estimating techniques and improving future bids.

And Just Like That - It's Over

Last week, DoD announced that it was discontinuing its recently implemented practice of accelerating payments to non-small business prime contractors. That policy lasted only about five months. (See Accelerated Payments to Small Business Subcontractors for a previous discussion on this topic). This practice was implemented in order to help small businesses. By accelerating payments to prime contractors, the Government believed that the prime contractors would, in turn, accelerate payments to their small business subcontractors.

The decision to discontinue the practice of accelerating payments to all prime contractors does not affect DoD's policy to assist small business prime contractors by paying them as quickly as possible after receipt of an invoice and all proper documentation. Small business prime contractors will still benefit from DoD's accelerated payment policy. It is the non-small-business contractors that must now wait the full 30 days for payment (or, whatever contract terms specify).

We do not know what precipitated this change although if we were to guess, the Government realized that expediting payments to contractors had little if any impact on expediting payments to their small business subcontractors. And it was costly from a cash management standpoint. Small business subcontracts represent only a fraction of prime contractor billings. By expediting billings, contractors received expedited treatment on total billed costs, even though the expectation was for them to, in turn, expedite payment to only their small business subcontractors. Also, there was certainly an expectation that prime contractors would expedite payments to their small business subcontractors, there was no firm requirement or incentive that they do so. Finally, some contractors found that the cost of modifying their accounting/billing systems to accommodate accelerated payments was too costly.

If you are a small business prime contractor, there is still a program to expedite payments. If you're unsure whether your small business status is classified correctly in the bowels of the Government billing system, contact your Contracting Officer Representative (COR).

2/26/13 Update:

One internet source stated that the Department of Defense dropped the accelerated payment plan in order to save up cash for a possible sequestration. We don't know how that would save any money - its a pay-me-now, pay-me-later kind of thing. In order to save money, the Government would need to issue a stop work notice or a termination for convenience, or defer task orders under an ID/IQ contract.

Economic Price Adjustments in Contracts

Most readers of this blog will be familiar with the different types of contracts the Government uses to procure goods and services; fixed price, cost-reimbursable, and time-and-materials, to name three. Within each major contract type, there are variations available, depending upon circumstances. One of the variations available under fixed priced contracts is the economic price adjustment (EPA) provision.

The use of EPA clauses is somewhat rare but they are available and useful under the right set of circumstances. A fixed-price contract with EPA will provides for upward and downward revision of the stated contract price upon the occurrence of specified contingencies. EPA typically fall under one of three general types.

• Adjustment based on established prices. These price adjustments are based on increases or decreases from an agree-upon level in published or otherwise established prices of specific items or the contract end items.
• Adjustments based on actual costs of labor or material. These price adjustments are based on increases or decreases in specified of labor or material that the contractor actually experiences during contract performance.
• Adjustments based on cost indexes of labor or material. These price adjustments are based on increases or decreases in labor or material cost standards or indexes that are specifically identified in the contract.

An EPA clause is typically used where there is serious doubt concerning the stability of market or labor conditions that will exist during an extended period of contract performance and contingencies that would otherwise be included in the contract price can be identified and covered separately in the contract. EPA clauses are normally used to cover events that are beyond a contractor's control.

Before an EPA provision can be included in a contract, the contracting officer must determine that it is necessary either to protect the contractor and the Government against significant fluctuations in labor or material costs. Usually contracting officers do not initiate such a process so contractors must be proactive in helping contracting officer understand the desirability of such a clause.

Typically, EPA clauses are used in contracts where the period of performance is several years and there is a significant component of raw materials where the price is subject to market forces, well beyond the control of the contractor. For example, if a construction contract requires steel to be purchased three years from the date of the award, an EPA could be fashioned to adjust the steel prices from the amount negotiated to the price on the date purchased. Or, if the contract is subject to the Service Contracting Act or Davis-Bacon Act, the contractor has no control over prevailing wage determinations.

The EPA provision specifically prohibits EPA be used for overhead or G&A but it does make allowances for fringe benefits. For example, a fringe benefit rate that includes a defined benefit pension plan may be impacted by stock market performance.

If this sounds like something that would be useful for your company, bring it up during contract negotiations.

Sequestration Impact - Contact Your Contracting Officer

Much has been written and discussed about the looming sequestration potential. March 1st is coming up real soon. The impact, if sequestration occurs, will impact many contractors. Those in the service sector will feel the impact more than others.

DoD issued a couple of notices on its website concerning potential sequestration. One posting addressed to the DoD workforce warned that it would be forced to place the vast majority of its civilian workforce on administrative furlough. The other posting stated that if sequestration occurs, furloughs will begin in late April. We also learned that DOE (Department of Energy) has been engaging its major contractors in discussions regarding the potential impact of sequestration.

While uncertainty abounds, contractors need to contact their contracting officers (CO) and gather as much information as possible on the impact that sequestration will have on their own contracts and programs. While contracting officers might not yet have a lot of information, anything and everything will help in planning for the impact of sequestration.

One contractor who contacted its CO got this mighty brush-off; "we don't know anything, and when we do, we'll pass it along". That kind of response is simply unacceptable. COs might not be too sympathetic right now as they are concerned about their own jobs but they are still on the clock, getting paid, and they should be doing their jobs which includes "administering" their contracts. If COs don't know, they should find out. Plans have been made and are being continuously updated. Contractors should be dogged in their pursuit of information. The sooner contractors have information concerning the impact of possible sequestration, the more time it has to plan and manage that impact.

Farewell, Kinder/Gentler DCAA

DCAA (Defense Contract Audit Agency) recently revised its CAM guidance (Contract Audit Manual) dealing with access to contractor internal audits.

Previously, the guidance in CAM Section 4-202 (Relationships with Contractor Internal and External Auditors) focused on coordinated audit planning. Coordinated audit planning is a voluntary process wherein DCAA and the contractor's internal and external auditors consider each other's work in determining the nature, timing and extent of auditing procedures. One benefit of coordinated audit planning is that, in theory, it promotes contractor self-governance , enabling organizations to better develop and maintain strong systems of internal controls. Coordinated audit planning also helps identify and eliminate duplicative audit effort, thus saving resources for all parties. Contractors were encouraged to participate in coordinated audit planning activities but it was strictly voluntary.

The previous guidance made no demands for internal audits. It simply stated that where internal audits were provided, auditors should review them to see if there was any items that impact planned or in-process audits. Also, the previous audit guidance provided that where coordinated audit planning was practiced, the contractor's internal and external auditors were authorized to review and reproduce DCAA working papers to the extent needed to document their own working papers.

Gone now is the warm and fuzzy lets get along mentality. The revised CAM Section 4-202 guidance (now re titled: Access to Contractor Internal and External Audits) sets forth a very different and perhaps confrontational approach to reviewing internal audit reports and working papers.

Under the revised guidance, auditors must establish a process and a central point of contact to obtain and monitor access to and use of internal audit reports. The process must include a method for tracking requests for internal auditor reports and working papers and the contractor's disposition of these requests.

The guidance fully expects contractors to provide access to internal audit reports and working papers. Once received, the audit is instructed to review the internal audit reports and determine if sufficient information is contained in the report for use in identifying risk in audit assignments. In order for the internal audit report to be useful in audit planning, the auditor needs to understand the scope of the review, the reported deficiencies and any recommended corrective actions. If sufficient information is not included in the report, the auditor is instructed to request access to the working papers.

If contractors choose not to provide access to internal audits, things could turn confrontational. The new guidance instructs the auditor to report the denial as an "access to records" issue, which means, it will be quickly elevated right to the top of DCAA's food chain. One possible outcome from an "access to records" charge is billing withholds until the issue is resolved.

Finally, there is no mention the revised guidance authorizing contractor personnel to review DCAA working papers.

___________________________________

Thanks to a reader who alerted us to this policy change.

Fixed and Variable Costs - Directly Associated Cost Considerations

CAS 405, Accounting for Unallowable Costs and FAR 31.201-6, Accounting for Unallowable Costs, both require that expressly unallowable costs, mutually agreed to be unallowable, and directly associated costs be identified and excluded from any billing, claim or proposal applicable to a Government contract.

Directly associated costs means any cost which is generated solely as a result of incurring another cost, and which would not have been incurred had the other cost not been incurred. When an unallowable cost is incurred, its directly associated costs are also unallowable.

One way to think about whether a cost is directly associated with an unallowable activity is to consider whether the cost is fixed or variable. An ASBCA case from 1992 illustrates this situation.

ASBCA No. 31359 (92-1 BCA 24698) involved a dispute between General Dynamics Corp (GD) and the Government over the allowability of corporate aircraft costs and costs of flights taken on those aircraft.

General Dynamics conceded that some of the flights on its corporate aircraft were taken in connection with unallowable activities but disputed whether only the variable costs of the conceded flights or a portion of the fixed costs of the aircraft as well as the variable costs associated with the conceded flights should be considered directly associated unallowable costs. The ASBCA's opinion noted that fixed costs were costs that would be incurred irrespective of whether the aircraft flew, whereas variable costs were costs incurred as a result of the flights taken.

The board agreed with GD that only the variable costs of the corporate aircraft met the definition of directly associated costs required by CAS 405 (and FAR 31.201-6) to be excluded with respect to the unallowable flights. The Board's rationale stated:

We believe it is confusing and even misleading to characterize "variable costs as aircraft costs. The concept of directly associated costs as articulated in CAS 405 is useful in drawing a distinction between aircraft costs and flight related costs. Variable costs are costs directly associated with a flight. In other words. if the flight had not taken place, the variable costs would not have been incurred. It follows that if a flight is unallowable, its directly associated variable costs should also be made unallowable. That simply, is what CAS 405 requires.

This fixed vs variable analysis could be considered when computing/calculating directly associated costs.

New Senate Subcommittee on Financial and Contracting Oversight

The following information comes from an official press release from Senator McCaskill's and posted on her Senate website last Wednesday (February 13, 2013).

Newly reelected U.S. Senator Claire McCaskill today became Chairman of a powerful new Subcommittee on Financial & Contracting Oversight - a position from which the former prosecutor and auditor plans to expand her years-long fight against government waste, fraud, and abuse, turning from a focus on contracting to the operations of every federal agency and department.

"I'm putting every federal agency on notice - any employee or contractor who wastes taxpayer money, or acts inappropriately on the taxpayer dime, will have this committee to answer to." said McCaskill, former prosecutor and State Auditor. "I plan to carry the same determination from our wartime contracting fight to this expanded effort to root out waste and fraud, protect taxpayer dollars, and bring a new level of accountability and transparency to government."

McCaskill's new subcommittee will dramatically expand her jurisdiction, allowing her an oversight role over spending at every federal agency and department and will provide more staff and investigative resources. McCaskill plans to announce hearings for the panel in the coming weeks.

During her time at the helm of the former Subcommittee on Contracting, McCaskill chaired more than 20 hearings, and launched more than 40 investigations at 22 federal departments and agencies - resulting in nearly 30 instances of misconduct referred to federal investigators. Highlights of McCaskill's contracting oversight panel included:

• Wartime Contracting: shepherding the work of the U.S. Commission on Wartime Contracting - a panel created through legislation by McCaskill and former Senator Jim Webb of Virginia - which identified at least $60 billion in waste of taxpayer dollars, and subsequently turning the Commission's recommendations into successful legislation, overhauling the way the federal government contracts during wartime

• Veterans: Chairing a Senate hearing to examine progress made by government contractors in the hiring of military veterans, and hearing input directly from a Missouri-based veterans service organization on boosting job for veterans.

• Federal Waste: Leading an investigation into the General Services Administration (GSA), helping topple its leaders for waste, fraud, and abuse of taxpayer dollars - including on a Las Vegas conference that cost taxpayers hundreds of thousands of dollars - and introducing legislation to prevent such waste in the future.

• Arlington National Cemetery: Exposing severe mismanagement at Arlington National Cemetery, replacing the cemetery's leadership, and passing legislation that successfully addressed the management failures.

• Inspectors General: Fighting to strengthen the role of Inspectors General to combat waste and misconduct within federal agencies, and leading in investigation that led to the resignation of the Special Inspectgor General for Afghanistan Reconstruction.

No mention here that she successfully toppled the former DCAA director.

Toughening Up Suspension and Debarment Procedures

House Oversight and Government Reform Committee Chairman Darrell Issa, has begun circulating a discussion draft of legislation that would consolidate more than 42 civilian agency and government corporations S&D (Suspension and Debarment) offices and functions into one centralized board.

According to Rep Issa's press release, the proposed legislation is designed to protect taxpayers in over $1 trillion in contracts and grants awarded by the federal government each year to companies and individuals that are or should be banned from receiving taxpayer funds. He states: "In the 21st century, we must have zero tolerance for fraudsters, criminals, or tax cheats receiving taxpayer money through grants or contracts.

To prevent fraud and abuse, federal agencies are supposed to conduct aggressive suspension and debarment (S&D) programs to ban unscrupulous business and individuals from receiving federal funds. However, despite intense Congressional oversight, administrative action, and public scrutiny in recent years, GAO still reports that most agencies lacked effective S&D programs, meaning that businesses and individuals who should be listed on the System or Awards Management (SAM) may still be receiving federal contracts and grants (SAM replaced the Excluded Parties List System (EPLS) last year).

Along with consolidating the S&M offices and functions into a centralized board, the legislation would

• strengthen debarment of contractors and grantees that repeatedly fail to perform
• consolidate regulations government suspension and debarment procedures
• ensure transparency in suspension and debarment proceedings, and consistent standards to treat all parties fairly and expeditiously, including small businesses with limited legal resources
• provide an expedited review process to handle contract or grant fraud in a contingency environment (e.g. Iraq or Afghanistan).

You can vies a copy of the discussion draft here.

Combatting Trafficking in Persons (TIP) - Part 2

Yesterday we discussed the FAR (Federal Acquisition Regulations) prohibition against Trafficking in Persons (TIP) and the executive order (EO) from last fall intending to beef up the current regulations. Today we're going to pick up where we left off when we stated that the EO now requires contractors and subcontractors to maintain compliance plans and to post those plans in the workplace or on their websites. What is a compliance plan, how comprehensive does it need to be, and what should be included?

The first thing we learn about the required compliance plan is that it be "appropriate for the size and complexity of the contract or subcontract and the nature and scope of the activities performed, including the risk that the contract or subcontract will involve services or supplies susceptible to trafficking". Now this is about as subjective as you can get and we suspect that there will be plenty of discussion among contractors and their contracting officers as to what is appropriate in the circumstances.

Next, we learn that the compliance plan include an employee awareness plan. The employee awareness plan must be sufficient to inform employees

• the policy of ensuring that employees do not engage in trafficking in persons or related activities (including those enumerated yesterday)

• The actions that will be taken against employees for violation of such policy

The compliance plan must also include

1. A process for employees to report, without fear of retaliation, any prohibited activities.
2. A recruitment and wage plan that only permits the use of recruitment companies with trained employees, prohibits charging recruitment fees to the employee, and ensures that wages meet applicable host country legal requirements or explains any variance.
3. A housing plan, if the contractor or subcontractor intends to provide or arrange housing, that ensures that the housing meets host country housing and safety standards or explains any variance
4. Procedures to prevent subcontractors at any tier from engaging in trafficking in persons.

Finally, contractors and subcontractors must provide an annual certification it has a compliance plan and that to the best of its knowledge, has not engaged in any prohibited TIP activities.

You can expect to see amendments to FAR Subpart 22.17 to implement these new requirements in the near future.

Combating Trafficking in Persons (TIP)

More than 20 million men, women and children throughout the world are victims of severe forms of trafficking in persons (TIP). TIP is often associated with sex trafficking but in the context of Government contracting, also include the recruitment, harboring, transportation ,provision, or obtaining of a person for labor or services, through the use of force, fraud, or coercion, for the purpose of subjection to involuntary servitude, peonage, debt bondage, or slavery.

The US has a zero-tolerance policy regarding Government employees and contractor personnel engaging in any form of these forms of criminal behavior. As the largest single purchaser of goods and services in the world, the US Government bears a responsibility to ensure that taxpayer dollars do not contribute to trafficking in persons.

With respect to Government contracting, the policy, along with violations and remedies is found in FAR Subpart 22.17. Based on various hearings and studies, that coverage has been deemed to be inadequate and ineffectual for combating TIP. As a result, the President issued an Executive Order (EO) last September to strengthen protections against TIP in Federal contracting.

Some of the improved safeguards provided by the EO to strengthen compliance with anti-trafficking laws include:

• expressly prohibiting Federal contractors, contractor employees, subcontractors, and subcontractor employees from engaging in any of the following types of trafficking-related activities:
• using misleading or fraudulent recruitment practices during the recruitment of employees, such as failing to disclose basic information or making material misrepresentations regarding the key terms and conditions of employment, includeing wages and fringe benefits, the location of work, living conditions and housing (if employer provided or arranged), any significant costs to be charged to the employee, and if applicable, the hazardous nature of the work;
• Charging employees recruitment fees (hey, Seoul CPO, are you listening?)
• Destroying, concealing, confiscating, or otherwise denying access by an employee to the employee's identity documents, such as passports or drivers' licenses; and
• For portrions of contracts and subcontracts performed outside the US, failing to pay return transportation costs upon the end of employment
• Requiring contractors and their subcontractors, by contract clause, to agree to cooperate fully in providing reasonable access to allow contracting agencies and other responsible enforcement agencies to conduct audits, investigations, or other actions to ascertain compliance with the laws, regulations, and orders.
• Requiring contracting officers to notify the agency's Inspector General and other officials if they become aware of any activities that would justify contract termination.
• Require contractors and subcontractors to maintain compliance plans and to post those plans in the workplace or on the contractors' websites.

In tomorrow's post, we will discuss what those compliance plans might look like and what they must include.

Bill Introduced to Limit Union Preferences

Last week, identical bills were introduced into the House and Senate (H.R. 436 and S. 109) which would ostensibly level the playing field for construction workers applying for federal contracts and those funded by federal dollars. According to the bill sponsors, Executive Order 13502 introduced in 2009 strengthened project labor agreements (PLAs) which favored union-based construction workers over non-union construction workers. The result has been a de-facto discrimination against non-union construction workers, costlier projects,and longer completion time.

A PLA is a job-specific collective bargaining agreement with multiple construction unions. When mandated by a government agency on a taxpayer-funded project, construction contracts are awarded only to companies that agree to recognize unions as the representatives of their employees on that job; use the union hiring hall to obtain workers at the expense of existing qualified employees; obtain apprentices through union apprenticeship programs; follow inefficient union work rules; and pay into union benefit and multi-employer pension plans.

Studies indicate government-mandated PLAs increase the cost of construction projects in numerous markets between 12 and 18 percent compared to similar non-PLA projects. That, to us, is not surprising, nor is it necessarily a bad thing.

Similar bills were introduced last year and did not make it out of committee. This time around, the House version has 55 sponsors while the Senate bill has eight.

Contractor Records Retention

This is a reminder that the Federal Acquisition Regulations (FAR) contains very explicit policies and procedures for retention of records by contractors to meet the records review requirements of the Government (see FAR 4.7).

Sometimes, even Government auditors do not know the rules.

Most Government contracts contain one of two "Audit and Records" clauses, depending upon how the contract was awarded. FAR 52.241-26 applies to sealed bids and FAR 52.215-2 applies to negotiated contracts. In either case, the Government has up to three years following final payment under the contract to come in and review books and records or a shorter period specified in FAR 4.7. This is important as auditors often cling to the three year rule and conveniently forget the "shorter period" rules. We'll look at some of these shorter periods but first, we should define "records" as used in these clauses.

The definition of "Records" as used in these clauses is very broad. It includes books, documents, accounting procedures and practices, and other data, regardless of type and regardless of whether such items are in written form, in the form of computer data, or in any other form. While this definition is broad, the records must still pertain to "costs claimed to have been incurred" under a particular contract. Sometimes, auditors tend to broaden the scope of their data requests. When they do, contractors must be prepared to challenge any request that doesn't specifically pertain to the contract under audit.

The "shorter periods" records retention requirements are found in FAR 4.705. These periods are measured from the end of the contractor fiscal year (e.g. calendar year), not from the final payment under the contract. Contractors should be familiar with these regulations when establishing their formal record retention policies and procedures. For example, concerning timekeeping, labor cost distribution, and payroll records, FAR 4.705 provides for the following:

• Labor cost distribution cards or equivalent documents: Retain 2 years (FAR 4.705-1(f).
• Payroll sheets, registers, or their equivalent of salaries and wages paid to individual employees for each payroll period, change slips; and tax withholding statements: Retain 4 years (FAR 4.705-2(a)).
• Clock cards or other time and attendance cards: Retain 2 years (FAR 4.705-2(b)).
• Paid checks, receipts for wages paid in cash, or other evidence of payments for services rendered by employees: Retain 2 years (FAR 4.705-2(c)).

If a contractor is unable to support audit requests for records on a 2006 incurred cost submission, for example, it may be because the contractor was following FAR requirements for record retention periods.

Access to Internal Audits - What's the Big Deal?

DCAA (Defense Contract Audit Agency) has, for some time, been seeking unfettered access to internal audits conducted by contractors' internal audit organizations. The Agency found an ally in the GAO (General Accountability Office) who reported that access to these internal audits would make DCAA more effective. The Senate included a provision in the 2013 National Defense Authorization Act (NDAA) that would have required contractors to grant access to their internal audits or face potential billing withholds. That provision did not survive the final bill. Instead, the NDAA passed into law only directs DCAA to request internal audits it would like to review, document the request, and document the contractor's response to the request. If the contractor denies access, there are no ramifications.

If the contractor provides access, the internal audit reports can only be used by DCAA to help evaluate the efficacy of contractor internal controls and the reliability of associated contractor business systems. Those reports cannot be used as the sole basis for determining whether contractors have sound internal control systems.

Why is this important? What is the big deal with gaining access to internal audits? It all has to do with audit efficiency. At the end of the day, an audit report provides reasonable (not absolute) assurance that a contractor's representations, be they financial statements, incurred costs, TINA (Truth in Negotiations Act) representations, are fairly presented. Auditors, not just DCAA but any audit organization or audit firm, must test the propriety of transactions. How many transactions? It depends on the level, adequacy, and compliance with internal controls.

The adequacy of contractor internal control structure is an important factor in determining audit scope. Adequate controls, sound policies, and the effective implementation of prescribed policies and procedures contribute to the reliance that the auditor can place on contractor cost representations, and permit reduction of the extent of verification which might otherwise be required.

More formalized systems, such as the accounting, estimating, and purchasing , with strong self-controls built into those systems can reduce the audit effort required to satisfy the audit objective once the system has been evaluated and determined to be adequate. Poorly defined or nonexistent systems, or those which rely on external controls only, increase the risk for cost mischarging or misallocation and could correspondingly result in an increase to the audit scope.

Additionally, the internal control structure may affect the audit scope. If there is little separation of duties and responsibilities or if the separation is not conducive to adequate internal controls, there is greater risk for costs to be mischarged or misallocated. The control environment may be such that the same management has responsibility for and control over multiple contracts and can manipulate the allocation of costs to those contracts to the Government's detriment. Also, if the internal control structure changes frequently, the audit scope must be expanded to assure that the change(s) have not adversely affected contract costs.

Do Accounting System Approvals Expire?

You work real hard to establish an accounting system that meets all of the requirements of DFARS (DoD FAR Supplement) 252.242-7006. DCAA (Defense Contract Audit Agency) or another agency comes in, conducts an audit and concludes that the system is adequate (yes, "adequate" is as good as it gets).

How long is that rating good for? Does it expire? Can you positively state one or two years later that you have an approved accounting system? What about five years later? Or seven?

When making certifications and representations, contractors may rely on the last completed accounting system audit, regardless of how many years in the past that occurred. The buying activity (contracting officer)  must exercise its own judgment on the matter and decide whether the most recently completed audit was recent enough to rely on it or whether a new audit needs to be requested. Different buying commands have different standards over what constitutes "recent enough". Some contracting officers are becoming more "liberal" in their assessment of "recent enough" because of DCAA's inability to provide timely accounting system audits. We heard of a recent case where a 2007 assessment was offered and accepted by the Government.

When requested by a buying activity, DCAA conducts preaward and/or post-award accounting system reviews. There are no set expiration periods for either. The rating (good or bad) applies until DCAA conducts a subsequent (or follow-up) audit.

From a practical perspective, the fact that a contractor's accounting system was deemed adequate in the past is a good indication (not a guarantee) that the system is still acceptable. Of course the contractor must continue to maintain the system to the standards in DFARS 252.242-7006. How will the Government know whether a contractor has continued to maintain an adequate system? It doesn't and won't until a new audit has been completed.

Improving Cash Flow by Reducing Fee Withholds

DCAA's failure to audit incurred costs in a timely manner imposes serious financial ramifications for contractors.Contractor (and small business contractors to a higher degree) are especially hurt by untimely audits for several reasons. First, the fee withhold provisions on cost-type contracts diminish cash flows. The Government has been sitting on fee withholds sometimes up to eight years (perhaps longer) without paying interest. Secondly, costs incurred in very old years, some going back to 2004 (perhaps longer) is very difficult to support. Records get moved, misplaced or destroyed according to record retention policies.
The record retention requirements for many of these records have long since lapsed. Employee turnover is a factor as well. Finally, small businesses often do not have in-house support and require costly outside support.

Yesterday we discussed the quick-closeout provisions available to close out some contracts ahead of the final audit.This will help in some cases. Another way to minimize the impact of the Government's holding onto money that is not theirs is to ensure that you have received as much of your fee as possible. There are three withhold levels.

Level 1 - In accordance with FAR 52.216-8, Fixed Fee under CPFF contracts, after payment of 85 percent of the fixed fee, the ACO may withhold further payment of fee until a reserve is set aside in an amount that the Government considers necessary to protect the Government's interest. This reserve may not exceed 15 percent of the total fixed fee or $100 thousand, whichever is less.

Level 2 - This same FAR provision requires the ACO to release 75 percent of all fee withholds after receipt of the certified final indirect cost rate proposal covering the year of physical completion of the contract, provided the contractor has satisfied all other contract terms and conditions, including the submission of final patent and royalty reports, and is not delinquent in submitting completion/final vouchers on prior years' settlements.

Level 3 - Finally, the ACO may release up to 90 percent of the fee withholds based on the contractor's past performance related to the submission and settlement of final indirect cost rate proposals.

Example: A $500 thousand contract with a fixed fee of 8 percent (or $40 thousand). Level 1, the ACO withholds 15 percent of $40 thousand or $6,000. Level 2, the ACO releases 75 percent of the $6,000 or $4,500. Remaining withhold at this point is $1,500. Level 3, the ACO releases 90 percent of the $6,000 or $5,400. Remaining withhold after Level 3 is $600. After Level 3, the contractor has received $39,400 of the total $40,000 fee.

If you have contracts that have not been closed and you haven't received 90 percent of the original fee withhold, you need to contact your ACO and have him/her release the maximum amount of fee withhold permissible. Its your cash flow.

Quick Closeout Procedures

The Federal Acquisition Regulations (FAR) contains provisions that allow the Government and contractors to close out contracts ahead of the final audit. With the well-documented and oft-discussed failures of DCAA to complete their audits of contractor incurred cost proposals in a timely manner, these provisions may be an alternative to waiting for audits to be completed. If you think they apply to your situation, you should contact your contracting officer and initiate a quick-closeout process.

FAR 42.708 provides quick-closeout procedures which allow the contracting officer to negotiate a settlement of direct and indirect costs for a specific contract, task order, or delivery order, to be closed in advance of the determination of final direct and indirect costs. The provisions for quick-closeout procedures can be applied to all open fiscal years with unsettled direct and indirect costs.

The FAR 42.708 criteria for applying quick-closeout procedures are

• The contract, task order, or delivery order is physically complete
• The total unsettled direct and indirect costs allocable to that contract, task order or delivery order is relatively insignificant. The cost is considered relatively insignificant when the total unsettled direct and indirect cost to be allocated to any one contract, task order, or delivery order does not exceed the lesser of $1 million or 10 percent of the total contract, task order, or delivery order amount.
• The contracting officer performs a risk assessment and determines that the use of the quick-closeout procedure is appropriate. The risk assessment should include
• consideration of the contractor's accounting, estimating, and purchasing systems
• other concerns of the cognizant contract auditors, and
• any other pertinent information.
• Agreement can be reached on a reasonable estimate of allocable dollars.

As you can see from the foregoing criteria, the contracting officer is afforded some flexibility and must exercise judgment in the process. We've seen a lot of inconsistency among contracting officers in applying these criteria but persistence does seem to pay off. It's your cash flow.

The Importance of Drafting Well-Written Proposals

A recent bid protest decision by the Comptroller General illustrates the importance of ensuring your proposal narrative is complete and accurate and complies with solicitation requirements. Usually offerors get only one chance to make the BQ (best qualified) list and that is why first impressions are extremely important.

In the latest illustration of this fact, LC Engineers' (LC) bid for cable assemblies was thrown out of competition because it was rated technically unacceptable. LC protested the Navy's action stating, among other things, that the Navy didn't understand or make an effort to understand its proposal. The Comptroller General disagreed and did not sustain the protest.

With respect to the technical approach, the solicitation instructed offers to demonstrate a thorough understanding of the SOW (Statement of Work) and applicable drawings and to describe their methodology, techniques and process for manufacturing the cable assemblies. Offerors were informed that the agency would evaluate the extent to which the offeror's proposal demonstrated the firm's understanding of, approach to, and ability to meet the solicitation requirements.

The Navy gave LC's submission an unacceptable technical rating based on its judgment that the proposal contained two deficiencies and a number of weaknesses. Specifically, the Navy found that LC failed to demonstrate an understanding of and adequate approach to performing the requirements. LC's proposal contained errors and missing performance steps and testing requirements. Additionally, LC did not appear to have sufficient personnel to perform the contract and that insufficient hours were included in some requirements.

LC protested, maintaining that its proposal provided the Navy with sufficient data and detail to demonstrate that it was technically capable of performing the contract. The Comptroller General, in such protests, does not re-evaluate proposals. It limits itself to examining the record to determine whether the Navy's judgment was reasonable and in accord with the stated evaluation criteria and applicable procurement laws and regulations.

Here, the Comptroller General found that the record showed that the Navy reasonably evaluated LC's proposal as unacceptable. LC failed to demonstrate an acceptable technical approach in its proposal. It failed to adequately describe its manufacturing process and the narrative contained errors and missing performance steps. The Comptroller General agreed with the Navy that LC failed to demonstrate the viability and effectiveness of their techniques.

You can read the entire decision here.

Are You a "Mission Essential" Contractor?

Are you a mission essential contractor? If you don't know, this is a good time to check your contract. For DoD contracts, the relevant clause is DFARS 252.237-7023. This clause requires the Government to specifically identify which functions of a contract are mission essential services. The clause also requires contractors who provide essential services to have a written plan to ensure the continuation of these services in crisis situations.

Essential contract 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, tornado, earthquakes, blizzards, floods, or pandemic influenza, etc. To this list we would add "sequestration".

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 orexercise authority, direction, and control.

Costs related to plan preparation and plan execution.

Plan Preparation Costs. 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 will 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. Plan execution costs should not be included in the price of a contract. The clause (DFARS 252.237-7023) requires that the contractor and Government negotiate an equitable adjustment should the contractor incur costs in connection with continued services. Contractors are 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. Since there is an equitable adjustment provision in the clause, auditors are advised to question any "plan execution" costs disclosed during a price proposal audit.