A La Carte

DLA (Defense Logistics Agency) just announced a new initiative to standardize contract award procedures and reduce the time the Agency spends to award contracts from start to finish. They hope to finish by September. We hope they're successful. Everyone from the war-fighter to the contractor will appreciate an expedited process.

A caution to contractors thinking about hiring former Government employees. Under 18 USC 207, a person who works "personally and substantially" on a particular matter for the Government may not represent anyone other than the Government with respect to the matter. If the former Government employee negotiated the contract or worked on an audit, they would face a lifetime ban on representing anyone other than the Government. If they violate that, a very serious criminal conflict of interest issue would arise.

Did you know that there is a U.S. Office of Government Ethics set up to prevent conflicts of interest in the Executive Branch. If you're thinking about hiring former Government workers, you might want to become familiar with its website.

It seems like several times a week we read of another indictment, conviction or guilty plea in Government contracting circles. In the past few days, the Department of Justice announced;

• Three individuals were convicted for padding invoices sent to the Government
• State Department employees indicted for steering contracts to their own company
• Government contractor indicted for paying bribes to a Post Office official
• Guilty plea from a Bureau of Prisons employee accepting gratuities from a supplier

Have you heard that many companies do not want to be labeled as "subcontractors" under a Government prime contract. Seems they would prefer to be "suppliers". There are a lot fewer requirement imposed on suppliers than on subcontractors. If you have a choice, take "supplier".

Congress worked pretty fast to get those furloughed air traffic controllers back to work. Will they do the same for acquisition personnel and contract auditors? We're not holding our breath.

The CAS Board has not published any meeting minutes since October 5, 2011. Have they stopped meeting or are they really late in publishing their minutes?

Pricing Out Deleted Work

In cases of contract change orders, modifications, and claims, contractors are often required to price out the cost of work not yet performed. The work was part of the original contract but for some reason, is no longer required. The question that often arises is: At what price do you value the deleted effort - the price originally negotiated or the price based on current estimates. This is not an insignificant question as it could directly affect a contractor's bottom line.

Say for example, in 2012, a contractor negotiated a contract with indirect rates based on the current FPRA (Forward Pricing Rate Agreement). The G&A rate was 25 percent. In 2013, because workload diminished, the G&A rate jumped to 35 percent. Do you burden the deleted work with a 25 percent rate or a 35 percent rate? Similarly, if the price of raw materials (e.g. steel) jumped significantly from 2012 to 2013 do you price out the deleted work at the negotiated prices or the prices in effect today.

FAR 15.408, Table 15-2, Instructions for Submitting Cost/Price Proposals When Certified Cost or Pricing Data Are Required, answers this question pretty plainly. Table 15-2, Section B.(2) states:

Include the current estimates of what the cost would have been to complete the deleted work not yet performed (not the original proposal estimates), and the cost of deleted work already performed.

So there you have it; you must use current estimates. This represents a potential significant risk to contractors (it could also allow contractors to reap a windfall if prices and rates go down from what was originally bid/negotiated). Even where the initial contract price was based on competition or data other than certified cost or pricing data, modifications to those contracts often require the submission of certified cost or pricing data. Contractors that aggressively priced a contract for competitive reasons, could easily find that they have to delete more costs than they negotiated.

The contracting officer does have some discretion in determining what is fair and reasonable (to both parties). If you ever find yourself in this situation, be sure to let your contracting officer know. Maybe fairness and equity will prevail.

The Equal Access to Justice Act (Briefly)

The Equal Access to Justice Act (EAJA) awards attorney's fees and litigation expenses to eligible individuals who are parties to litigation against the Government. An eligible party may receive an award when it does not exceed the size limits set by the Act (net worth of $2 million or less or net worth of $7 million or less with 500 employees) and can show it is a "prevailing party"

The EAJA is a statutory exception to the standard American practice in which prevailing litigants bear the burden of paying their own attorneys' fees. Congress enacted EAJA as a fee-shifting statute to let private litigants recover certain costs associated with litigation against the Government.

The EAJA addresses the concerns of Congress over access to the courts for individuals. Congress's intent in promulgating EAJA was to provide a means to prevent individuals, as well as small business concerns, from being deterred by potential costs of litigation from seeking redress for allegedly unreasonable government action.

Eligibility under EAJA is only the first step in successful application for costs and attorney fees. Under EAJA, an eligible party must also meet certain threshold requirements before a court will order reimbursement of their litigation costs.

What are these threshold requirements? The EAJA provides that attorneys' fees and certain costs associated with litigation, incurred by a prevailing party in either an agency (e.g. ASBCA) or court adjudication against the Government, may be recovered unless the position of the Government is "substantially justified" or unless special circumstances make the award unjust.

What does "substantially justified" mean? The term "substantially justified" means justified to a degree that could satisfy a reasonable person. Even though a position taken is not correct, it can still be substantially justified if a reasonable person could think it correct, that is, if it has a reasonable basis in law and fact. In this case, the Government bears the burden of proving that its position was substantially justified.

The EAJA is a significant benefit to Government contractors who, for lack of resources, might have a valid and legitimate basis for raising a claim against the Government.

Obstruction of Federal Audit

Did you know that lying to a Federal auditor is a felony? That's right. Back in 1988, due to widespread concerns about procurement fraud against the United States, Congress passed a series of laws designed to provide the Government with additional criminal and civil remedies to target and reduce that fraud.

One of those legislative actions was the Anti-Drug Abuse Act of 1988. Buried within the act, now codified under 18 U.S.C. Sec. 1516, is an obstruction of federal audit statute. This statute makes it a crime to influence, obstruct, or impede a federal auditor in the performance of official duties. Section 1516 carries a maximum punishment of imprisonment for five years and a fine of $250 thousand for an individual and $500 for an organization.

Congress felt that this protection was warranted because "in many successful investigations, government contractors have been able to avoid earlier detection by obstruction audits". Section 1516 applies to an endeavor to influence, obstruct, or impede a federal audit by fabrication (to include making a false statement or giving false testimony), altering, destroying, or concealing information; threatening an auditor, offering an auditor bribes or gratuities; or threatening or otherwise encouraging a third party not to cooperate with an auditor.

The following five elements must be present to support a conviction under Section 1516.

1. The federal auditor must be in the performance of official duties
2. Those official duties must relate to a person or organization receiving in excess of $100 thousand, directly or indirectly from the US in a one-year period under a contract or subcontract.
3. The defendant must know that an auditor was in the performance of official duties
4. The defendant must endeavor to influence, obstruct, or impede the federal auditor in the performance of his or her official duties
5. The defendant must act willfully, with the intent to deceive or to defraud the United States.

Despite the rather expansive scope of Section 1516, it is surprising to us that it is rarely employed. Our research disclosed a couple of cases that went to trial; one involved the creation of bogus checks and bank statements in an endeavor to conceal fraud and the other involved a health care provider misleading an federal auditor. (Our research is extremely limited; we are not attorneys and we do not have access to extensive legal research).

New Version of the FAR Cost Principles Guide Has Been Published

Note: For an update of this posting, click here.

The FAR (Federal Acquisition Regulation) Cost Principles Guide has now been updated through FAC (Federal Acquisition Circular) 2005-65 (January 2013) and is available for download here. The previous update was June 2011 through FAC 2005-52.

The FAR Cost Principles Guide traces all the changes to FAR cost principles since the inception of the FAR system in 1984. It is useful for determining the precise cost principle in effect at the time a particular contract was awarded. While some cost principles have not changed in the ensuing years (e.g. bad debt expense, alcoholic beverages) most have undergone some form of revision and some have even been eliminated (ADP equipment). The Compensation cost principle (FAR 31.205-6), for example, has been revised 33 times.

The Government is now clearing out its backlog of old incurred cost submissions. These audits, going back to 2004 (and perhaps earlier), must evaluate costs based on the cost principles in effect during that year or, in some cases, when the contract was awarded. Any challenges to claimed costs must cite the correct cost principle version.

(Cost Type) Contractors Must "Audit" Their (Cost Type) Subcontracts

The Government employs hundreds of contractors that perform essential mission work under cost reimbursable contracts. To achieve their missions, these contractors often utilize the services of subcontractors, often on a cost-reimbursable basis.

When subcontracts are structured as cost-type, including T&M (Time and Materials) and cost-reimbursable subcontracts, prime contractors are contractually required to ensure that associated costs incurred are audited to provide assurance that the costs are allowable, allocable to the subcontract, and reasonable.

Prime contractors can use their internal audit staff to conduct these audits, engage outside auditors, or, in some cases, utilize the services of the Defense Contract Audit Agency (DCAA), especially where that Agency already has a presence at the particular subcontractor.

One of the problems that has surfaced recently is that prime contractors are not doing a very good job of auditing their subcontractors. That deficiency lies not with the work that DCAA or another contracted audit organization performs but with work performed by internal staff. Audits must comply with professional standards, e.g. Generally Accepted Government Auditing Standards (GAGAS), or standards promulgated by the Institute of Internal Auditors (IIA), to name two. Reviews by various Inspector General organizations have disclosed serious deficiencies in the conduct of these audits - to the extent that these prime contractors have no idea as to whether their subcontract costs are allowable.

Not everyone in the Government is on board with this concept however. A number of years ago while we were still working for DCAA, we conducted a review to determine how well a large Government contractor managed its subcontractors. DCAA, more than any other organization in the Government, has a pretty good idea of what it takes to evaluate incurred costs. They do it for a living. Applying these same standards to contractor reviews of subcontract costs, we found many areas for improvement. However, the contracting officer (DCMA) did not agree. He thought the contractor had done a bang-up job of reviewing subcontract costs and didn't think that internal contractor staff should be held to professional auditing standards.

While that attitude may persist in some organizations, the various agency IGs are working to change attitudes, ensure compliance, and preserve the integrity of costs charged to Government contracts.

Submitting Certified Cost or Pricing Data Does Not Necessarily Mean You'll Be Audited

The question arises often - we're required to submit certified cost or pricing data for this particular solicitation, does that mean we'll be audited? Not necessarily.

The term "audit" no longer has the precise meaning it once had. At one time, the term, as used in Government procurement meant DCAA (Defense Contract Audit Agency). In today's vernacular, it could just as easily, or perhaps more likely, include DCMA (Defense Contract Management Agency) who for all intents and purposes, took over the function of evaluating contractor proposals once DCAA raised its threshold to $10/$100 million Fixed/Cost and later subsumed DCAA's program for evaluating indirect expense rates. In fact, DCMA won't correct you if you refer to them as auditors even though they do not adhere to anything close to Generally Accepted Government Auditing Standards when conducting their reviews.

Contracting officers are required protect the taxpayer's interests by ensuring that negotiated prices are fair and reasonable. Even when the circumstances require the submission of certified cost or pricing data, the contracting officer has wide latitude on how to best to evaluate a particular proposal. He/she might request an audit from DCAA (if its over their threshold), request assistance from DCMA (regardless of threshold), request assistance from the group that prepared the IGE (Independent Government Estimate), or perform their own analysis - especially when there is current, relevant data available in their files.

 According to FAR 15.404-1(a)(3), cost analysis can be performed without validating (auditing) the submitted data. The Government does have the right to examine the records that formed the basis for the pricing proposal up until the time of award but that does not mean that the Government is required to do so. There are many cases where solicitations requiring certified cost or pricing data, are awarded without audit.

DoD's Fiscal Year 2014 Budget Overview - DCAA and DCMA

Earlier this month, the DoD released its Fiscal Year 2014 Budget Request to Congress. This is only a request and things will change once Congress begins its deliberative process. We were interested in finding out what the Department had in mind for DCAA (Defense Contract Audit Agency) and DCMA (Defense Contract Management Agency) staffing-wise and whether any of their roles were expected to change.

DoD is proposing to grow both organizations. For DCAA, the Department is proposing to add 332 new auditors on top of the 563 new auditors it is hiring this year. That's almost 900 more auditors than were running around last year (about a 20 percent increase). According to DoD, the additional staffing is needed to reduce the incurred cost backlog:

In FY 2014, the DCAA will assign additional auditors to reduce the incurred cost review backlog. Reducing this backlog will: (1) assist in achieving auditable financial statements; (2) provide the DCAA with data needed for forward-pricing audits; (3) prevent undue delays in payments of fees to contractors (a portion of fees to contractors is delayed until the contract is closed).

For DCMA, DoD is proposing to add 347 new positions to the whopping 1,628 positions it is adding this year (FY 2013). This represents a 22 percent increase in staffing over the two year period. According to DoD the additional staffing is needed to improve oversight:

In FY 2013, the DCMA continues the Department's efforts to grow the acquisition workforce, in order to mitigate known acquisition oversight workforce shortfalls, primarily in the areas of price costing, earned value, and quality assurance.

We don't know if this is good news or bad, from a contractor perspective. On one hand, there is a lot of money being withheld by the Government pending completion of very old incurred cost audits. On the other hand, increased oversight by DCMA is certain to cause some friction.

18th Annual Government Contractor Survey

For the past two years, we have provided summaries of the annual government contractor industry survey published by the accounting firm of Grant Thornton. The results of its 16th annual survey is summarized here and its 17th annual survey is summarized here. Grant Thornton recently published the results of its 18th annual survey and the highlights can be viewed here. Following are some of the survey summaries.

Resolution of contract issues

The trend is worsening  Only 18 percent of survey participants believe contract issues are resolved efficiently by the government. Last year it was 22 percent and the year before that, 26 percent. Of those reporting inefficiencies, 56 percent blame DCAA and 26 percent blame the contracting officer.

Relationship with DCAA

The majority of surveyed companies have an adverse opinion of the DCAA and its work product: 53 percent believe the DCAA's audit conclusions are arbitrary and not appropriately referenced to procurement regulations. Sixty percent believe that the DCAA is inflexible and rarely receptive to contractor rebuttals.

Fringe benefits

The fringe benefit rates reported in this survey are higher than any of the rates reported in the four previous surveys. It appears that the primary cause was, not unexpectedly, the increasing cost of health benefit plans.

Earned value management systems (EVMS)

41 percent of companies with EVMS reporting requirements indicated they consider it a cost-effective management tool. Only 34 percent of EVMS contractors ever receive meaningful feedback.

Business ethics and conduct

59 percent of the respondents believe that the requirements regarding codes of business ethics and conduct are excessive and not cost-effective.

Business systems

29 percent of respondents reported that they have made improvements to business systems as a result of the new standards. 33 percent have had one or more of their systems audited.

What You Might Expect When Your Incurred Cost Audit Begins

You've submitted your annual incurred cost proposals and finally passed DCAA's grueling "adequacy review". Now it's time for DCAA to conduct its audit. What might you expect:? As much as you might think that the audit process is standardized, there is a lot of variability in audit approach and the scope of information and data requested among DCAA's Regions, Offices, and auditors. Fundamentally, they're all trying to do the same thing - assessing the propriety of costs charged to cost-type contracts. However, the means for accomplishing that vary greatly.

The other day, a company received an email notification from DCAA that the Agency was about to begin its audit of the 2006 and 2007 incurred cost submission. The notification included the following comments and request for data:

1. "I would like to meet with you to conduct a walk-through of the proposals. During the walk through, I go over (company's) internal control as well. This meeting should not take more than 3 hours."

There's no explanation of a "walk-through". There's no further description of what internal controls the auditor wants to review.

2. "FY 06 & 07 company-wide trial balance and G/L. Please make sure that the G/L is in Excel format."

Some companies limit trial balances and general ledger listings to just those accounts that affect or impact incurred costs. There is no requirement that contractors disclose "profit" information to the Government or provide data from which profit percentages can be derived.

3. "Invoice submitted in December 2007 ..."
4. FY 06 & 07 listings for G&A and (specific contract) employees. The listings should identify employees by name and labor category."
5. "A copy of the proposal that (Contractor) submitted to the prime contractor.

This request is unusual. We don't know how an initial pricing proposal is relevant to an incurred cost audit.

6. "Please identify the rate (Company) used to escalate labor rates in FYs 06 & 07"

We don't know the relevance of this request to an incurred cost audit. Compensation should be evaluated on the basis of reasonableness and the rate increases by year are irrelevant to that determination.

7. "A copy of all subcontract modifications."

Why just the modification? Why not the basic subcontract as well?

8. "FY 06 & 07 labor distribution reports (Excel) for (contract) and G&A employees."
9."FYs 06 & 07 Board of Director's minutes."

DCAA loves to ask for minutes. Most companies don't have any. We do not know of any cases where information contained in minutes were in any way relevant to the determination of incurred costs though conceivably, there could be some.

10. "Description of changes in any changes in accounting practices (ie charging direct and indirect costs, unallowable costs, indirect rates or etc)."

This information, if applicable, is already shown in Schedule M of the incurred cost submission.

11. A copy of the health care plan(s) that (Contractor) provided to (contract) and G&A employees in FYs 06&07."

Presumably to look for payments made to ineligible dependents.

12. "Did (Contractor) submit any delay or termination claims in FYs06 & 07?"

Unsure why this is relevant to an incurred cost audit.

13. "Was (Contractor) involved in any lawsuit or legal proceeding in FYs 2006 & 2007?"

Unsure why this is relevant to an incurred cost audit.

14. "A copy of the rental agreement in effect in FYs 2006 & 2007."

Presumably to look for related party transaction.

15. A copy of the insurance agreement for the Officers & Directors."

This potpourri of data requests will take some time and effort for the contractor to find, compile, and review. It will also take the audit a fair amount of time to review, organize, incorporate into working papers, and draw conclusions from.

All of this for a contract that is 90 percent labor/fringe and 10 percent indirect costs!

Compensation Caps in the President's 2014 Budget

It seems like the issue of compensation caps just will not go away. The President's 2014 budget includes caps on compensation for all employees, both for defense and civilian contracts that match the Vice President's salary, currently set at $230,700. It is uncertain whether this provision will get very far in the deliberative process but there it is, something to be considered.

Whereas the Senate last year capped salaries for defense contractors (the Senate's provision didn't survive the conference committee), the President's budget affects all contracts, defense, energy, NASA, commerce, education, etc.

The specific wording included in the budget follows:

Under current law, contractors that are paid based on their incurred costs may demand reimbursement for executive and employee salaries up to the level of the Nation's top private sector CEOs and other senior executives. These salaries and benefits have increased by more than 300 percent since the law was enacted in the mid 1990s. In 2011, when the cap reached $763,000, the President called on the Congress to establish a new, sensible limit that is on par with what the Government pays its own executives and employees. The Administration was encouraged by the proposal in the 2013 Senate's National Defense Authorization bill to cap reimbursement for defense contractors at the level of the Vice President's salary, which is currently $230,700. The Budget urges the Congress to expand the Senate's proposal to cover all contractor employees - both defense and civilian - and pass a law that allows agencies to pay above this cap on an exception basis only, when it is necessary to ensure the agency has continued access to the skills and capabilities of specialists to achieve mission outcomes.

What Are "Contract Briefs"?

We used the term "contract brief" in a conversation the other day and got a blank look from a Government contractor. Its a term we toss around so often that we assumed everyone knew and understood. Apparently not.

A contract brief is simply a summary of key portions of a contract. The purpose of a "contract brief" is to ensure that Government contractors fully understand the terms and conditions agreed to by the parties of the contract (the Government and the contractor). Contracts are usually very lengthy, complex to decipher, and cumbersome to read and understand. Contracts do not often contain the full text of all relevant terms and conditions but only references to clauses in FAR Part 52. To fully grasp everything in a contract, you need the FAR as your companion. Frankly, we doubt that very few contracts are ever read and studied - even by the Government folks that write them. The process of writing a contract is pretty much automated - the contracting officer answers a few questions and out pops a contract.

A contract brief is a summary of the contract - it cuts through all the clutter, extracts and organizes the most pertinent and relevant parts of a contract into one or two pages. Typically, contract briefs include

• A brief statement of work to be performed
• Contract funding, including limitations, ceilings and fees
• Special contract requirements
• Waivers of any regulations
• Contract administration information
• FAR (and Agency FAR Supplement) clauses that are relevant to Government oversight (e.g. whether the contract is CAS covered, subject to TINA, whether it has EVMS requirements, etc).

A sample contract brief can be found in DCAA's Information for Contractors starting on Page 95. An electronic copy is included in DCAA's ICE (Incurred Cost Electronically) Excel Model. Some accounting software designed specifically for Government contractors have an integrated contract briefing system.

Auditors consider the absence contract briefs to be some sort of deficiency - a contract briefing system enhances the overall management effectiveness of the organization - although we have never seen the lack of one called out in an audit report. We think briefing cards are most useful in ensuring that billings do not exceed the funding limitations of the contract and to alert contractors when to notify contracting officers when they've spent 75 or 85 percent of the funds available on the contract.

Market Planning and Economic Development Costs

There is and has been for many years, a focus by Government auditors on consulting costs. Consulting costs need to be supported with an agreement, a work product, and an invoice. That in itself doesn't make the costs allowable because the cost must also meet allocability, allowability, and general reasonableness criteria.

Small companies often do not have the resources in-house to provide some of the functions necessary to survive, grow, and comply with the daunting array of applicable rules and regulations (e.g. labor laws). So they outsource some of the functions.

One area that may be getting some increased focus is consulting firms hired to perform market planning and economic planning services. In two recent cases, auditors challenged such costs as either "unallocable" (i.e. those costs did not benefit the government contract) or unallowable selling or advertising costs. Let's see what the FAR says.

Market planning involves market research and analysis and general management planning concerned with development of the contractors business (FAR 31.205-38(b)(4). Long-range market planning costs are subject to the allowability provisions of FAR 31.205-12. All other market planning costs are allowable.

Long-range market planning costs (also called economic planning costs in FAR 31.205-12) are also allowable, for the most part. Economic planning costs are costs of general long-range management planning that is concerned with the future overall development of the contractor's business and that may take into account the eventual possibility of economic dislocations or fundamental alterations in those markets in which the contractor currently does business. These costs are allowable under Government contracts. Economic planning costs involving organization or reorganization however are unallowable.

Any market planning costs meeting these definitions are allowable costs under Government contracts, whether performed in-house or by consulting firms hired to provide the services.

Watch Your Dates - 90 Days is Not the Same as Three Months

EPSI (Executive Personnel Services, Inc.) had a contract with the Small Business Administration (SBA) to provide temporary clerical and administrative support services. The contract ended in April 2009 but in July 2011, the Department of Labor notified EPSI that it owed $94 thousand in back wages to its employees.

In April 2012, EPSI submitted a certified claim to the SBA contracting officer seeking to recover the back wages which represented increases in the minimum wage during the period of performance. On July 5, 2012, the contracting officer issued a final decision denying the claim.

On October 5, 2012, EPSI filed an appeal with the Civilian Board of Contract Appeals. The problem was, this appeal was filed 92 days after the contracting officer's final decision and not within the 90 days specified in the Contract Disputes Act.

Because of two days, the Civilian Board of Contract Appeals (CBCA) dismissed the appeal for lack of jurisdiction.

EPSI still has avenues available to it for appeal. It can appeal to United States Court of Federal Claims within 12 months of the contracting officer's final decision. That appeal process is significantly more costly and time consuming than a Board of Contract Appeals (BCA) appeal however and EPSI is going to have to weigh the cost/benefit of doing so.

By the way, there was no ruling on the merits of EPSI's appeal. Since the CBCA found a way to throw it out on a technicality, it didn't have to get in to the details of the appeal. That's one way to clear out your backlog.

Army, Navy, and Air Force Associations

The Association of the United States Army, Army Aviation Association of America, Navy League of the United States, Air Force Association, and other nonprofit associations with similar objectives have for many years offered memberships to Government contractors.

These associations are primarily concerned with fostering and preserving the images and efficiencies of the Army, Navy, and Air Force. They operate outside Government channels in an endeavor to preserve a spirit of fellowship among former and present Service members and to inform and arouse the interests of the public in activities and achievements of their respective military services.

Generally, memberships are offered to contractors that wish to support the objectives of these associations. The membership dues often include a subscription to publications issued periodically. For example, the Association of the United States Army publishes a monthly magazine entitled ARMY. In includes numerous articles primarily designed to enhance Army personnel programs and to promote manpower and combat readiness.

In addition, these organizations hold periodic conventions and meetings at which contractors frequently exhibit their products. Occasionally, these conventions or meetings will be sponsored by a contractor or group of contractors. These conventions or meetings are usually held to focus the attention of the public on the activities of a particular military service that contribute to national defense programs.

Sometimes, contractors have claimed costs associated with these organizations as allowable "Trade, Business, Technical, and Professional Activity Costs" as defined and discussed in FAR 31.205-43 because they consider these associations to be professional organizations. However, back in 1973, the ASBCA (Armed Services Board of Contract Appeals) ruled in an appeal by Boeing that membership dues paid to the Navy League, the Army Aviation Association of America, the Air Force Association and the Association of the U.S. Army were unallowable because the history of these organizations, their membership, their objectives and activities demonstrated that they are neither trade, business, technical or professional. Thus, Government auditors are certain to question such membership costs.

However, when these Army, Navy, and Air Force organizations hold conventions, conferences, and meetings where the principal purpose is the dissemination of trade, business, technical or professional information or the stimulation of production of improved productivity, costs of organizing, setting up, and sponsoring the gatherings, including rental of meeting facilities, transportation, subsistence, and incidental costs, are allowable.

The key to allowability is in documenting the purpose. If the gathering can be shown to be for dissemination of trade, business, technical, or professional information, contractors should not hesitate to claim the costs.

Recap:

• Membership fees - Unallowable
• Cost related to conventions and conferences - Allowable when purpose meets FAR 31.205-43 criteria.

If You're Going After a Government Contract, You'd Better Pay Your Back Taxes First

The Department of Defense just posted a new regulation that prevents any of its contracting officers from using Fiscal Year 2013 funds to award contracts to any corporation that owes Federal taxes. Specifically, the prohibition applies to firms that;

Has any unpaid Federal tax liability that has been assessed, for which all judicial and administrative remedies have been exhausted or have lapsed, and that is not being paid in a timely manner pursuant to an agreement with the authority responsible for collecting the tax liability, where the awarding agency is aware of the unpaid tax liability, unless the agency has considered suspension or debarment of the corporation and made a determination that this further action is not necessary to protect the interests of the Government.

This is almost identical to a January 2013 directive that applied to the use of continuing resolution funding that we reported on here. That one applied to funds made available by the 2013 Continuing Appropriations Resolution (Public Law 112-175) whereas this one applies to funds made available by the Consolidated and Further Continuing Appropriations Act (Public Law 113-6).

Here's where Government contractors and prospective Government contractors must be careful. It's unlikely that a contracting officer will know one way or another whether offerors owes back taxes. Therefore, DoD will require that any corporation pursuing contracts make an affirmative representation to the effect that it does not owe back taxes. Contracting officers will be including a provision in all solicitations that will require offerors to represent that they do or do not owe back taxes and this "representation" must be included in the proposal package.

Sequestration Adds Challenges to Meeting Audit Goals

The Bloomberg News is reporting that DCAA (Defense Contract Audit Agency) has frozen hiring and will lose about five percent of its workforce (about 250 employees) as a result of sequestration. The article quotes DCAA's Director (Patrick Fitzgerald) as stating that these reductions will make it more challenging for the Agency to reach its goal of eliminating a $400 billion backlog of unaudited incurred costs from 2009 and earlier by September 2014. Not mentioned in the article is the prospect that furloughs will further reduce Agency resources for incurred costs and other types of audits.

In order to achieve this goal, DCAA is concentrating on what it considers to be high risk contractors, those with more than $250 million of flexibly priced (e.g. cost-reimbursable) contracts, contractors who have not had a previous audit, and contractors where there have been previous significant audit findings. We discussed this new approach when it was first publicized. We've seen the results and benefits of this approach in practice. DCAA audits an initial year of incurred costs, finds no exceptions, and the contracting officer agrees to the proposed rates for all subsequent years. DCAA calls this the "IRS Model" - not every submission gets audited.

One thing is certain with this new model - the audits are much more thorough than they used to be. This has proven frustrating for many Government contractors who are accustomed to lesser scrutiny. However, its possible that on average, the amount of oversight is about the same as it has always been. An intense audit of one year that can be used to close out, say three years of incurred cost, could be about the same effort as performing less detailed auditing steps on each of those three years.

Another certainty is the payback on these audits. DCAA projects that it will uncover $4 billion in overcharges out of the $400 billion backlog. That's not chicken feed and exceeds by a huge margin the cost of the audits.

Health Benefits for Ineligible Employees

This is an update to previous posts on health care costs for ineligible dependents. It might be useful to read those before continuing. See Health Benefit Costs and Health Benefit Costs for Non-Eligible Dependents.

Costs for employee health care benefits, pursuant to FAR 31.205-6(m), must be reasonable and required by law, employer-employee agreement or an established policy of the contractor. Some Government contractors' employees claimed costs for health care benefits for dependents that were ineligible for those benefits. This has increased the costs claimed on cost-type contracts and perhaps fixed-priced contracts where histroy was used to project future costs.

Since 2009 at least, Government auditors have been scouring the countryside looking for unallowable health care benefit costs. Many contractors have been feeling the brunt of this audit emphasis. Typically in an audit, auditors will select a sample of transactions to test for allowability, allocability and reasonableness. No so with health benefit costs however. In many case, auditors are requiring that contractors prove to them that there are no health benefit costs paid to ineligible dependents. Contractors are spending significant amounts of money to comply. We know of several cases where contractors have paid tens of thousands of  dollars to outside consultants to review medical claims to ensure the propriety of costs and those outside consultants found no instances of payments made for health services to ineligible dependents.

One aspect of this affair has been DCAA's position that any health benefit costs paid to ineligible dependents are not only unallowable, but are expressly unallowable which means that any costs disclosed in an audit carry penalties  In a February 2012 memorandum to DCAA (Defense Contract Audit Agency) and DCMA (Defense Contract Management Agency), DoD's Director of Pricing told the Agencies to knock off the "expressly unallowable" recommendations. It informed the Agencies that the Department will not pursue application of penalties under FAR 42.709.

Although the DoD position was issued in February 2012, it took until March 2013 for DCAA to revise its audit guidance on the matter. In this new guidance, DCAA Headquarters instructed its auditors to cease the practice of citing "expressly unallowable" and computing penalties. Additionally, it instructed its auditors to inform any recipients of reports that contained penalty recommendations, to not relay on those reports any longer.

Allowability of Lodging, Meals and Incidental Expenses under the Travel Cost Principle

When it comes to determining the maximum allowable costs for lodging, meals, and incidental costs under the Travel cost principle, FAR 31.205-46, contractors are directed to base those ceilings on Government travel regulations; either the Joint Travel Regulations, the Federal Travel Regulations or the Department of State Standardized Regulations, depending upon the destination.

These Government travel regulations provide for two ceiling amounts, one for lodging and the other for meals and incidental expenses. Government employees cannot exceed the individual ceiling amounts. Contractors on the other hand are held to one ceiling amount, the combined amount for lodging, meals, and incidental expenses. This is clear from the plain reading of the regulations (FAR 31.205-46(a)(2)) and the regulatory intent of the provision.

Some auditors have been trying to apply the caps individually rather than combined. They do this of course, to find questioned costs. A traveler might have spent a little too much on the hotel but spent less on food when compared to individual caps but the combined expenditure did not exceed the combined cap. The auditor would question the overage but not offset the underage. The deviation from accepted practice has become so chronic that DCAA (Defense Contract Audit Agency) Headquarters was forced to issue an Audit Alert last month telling its auditors to cease the practice. The alert states:

The Government travel regulations provide for two ceiling amounts: one for lodging and one for meals and incidental expenses. However, as provided in CAM 7-1002.3c(2), contractors are subject to only one ceiling, a total of lodging plus meals and incidental expenses. This CAM guidance is consistent with the regulatory intent that the “maximum per diem” rates represent a single combined ceiling. (CAM is DCAA's Contract Audit Manual).

Was it Selling Expense or Lobbying Expense - We Still Don't Know

Back in 2011, a former employee of Fluor Corporation filed a whistleblower suit alleging that the company had used Government funds to lobby Congress. In 2012, the Government intervened in the case, presumably because it found some merit to the allegation. This week, Fluor and the Government settled the lawsuit for $1.1 million. The former employee whistleblower gets $200 thousand of the settlement - not a bad payday.

Fluor had a contract to operate a DOE training facility in Washington State. According to the whistleblower lawsuit, initial attempts by Fluor to "market" the training facility to regional first responders were not very successful. So, in 2005, Fluor hired a couple of consulting firms, using $675 thousand in DOE money, to market its training capabilities including overtures to Congress and federal agencies to include additional money to operate this training facility.

Fluor denied that the expenditures were lobbying costs (lobbying costs are unallowable under FAR 31.205-22). Fluor stated that it was required under the terms of the contract to increase utilization of the facility to promote "economies of scale" and "cost-effective operation and maintenance". Fluor also stated that it was prepared to prove that the use of consultants to cntact other government agencies to market the training facility was fully know to and overseen by high-level DOE officials who were also involved in meetings and communications with the consultants.

So the argument was settled out of court with neither side conceding anything. Fluor stated that it settled to avoid the expense and distraction of litigation. The Federal Government said that the settlement is not a concession that its claims were not well-founded.

So, we still don't know if the activities performed by the consultants were in fact, unallowable lobbying costs or were allowable under the Selling cost principle (FAR 31.205-38).

Are Auditors Really Looking for Fraud?

Yesterday, we discussed the requirement by all auditors, not just Government auditors, to plan and perform their audits to obtain reasonable assurance that material misstatements and noncompliance, whether caused by error or fraud, are detected. Historically, many audit firms and Agencies have not considered this step paramount in their overall planning and risk assessments but things are changing. Government contractors should expect inquiries as to whether they have any knowledge of fraud or suspected fraud affecting the entity. Don't take it personally - the auditors are just doing their jobs.

A recent DoD-IG report issued in February is one reason for the renewed emphasis on fraud.

The Institute of Defense Analysis (IDA) is a Federally Funded Research and Development Center (FFRDC) that provides objective analyses of national security issues. As a reciepent of federal funds, it was required to have an audit. In 2011, PriceWaterHouseCoopers (PwC) and the Defense Contract Audit Agency (DCAA) performed a joint audit of the costs expended by IDA. After the audit was completed, the DoD-IG performed a quality control review of the joint PwC/DCAA audit. Insofar as PwC's effort was concerned, the DoD-IG found that it met the standards. Not so for DCAA's portion. In fact, the DoD-IG concluded that more audit work was required before anyone could rely on the results of the audit.

Among the deficiencies found in DCAA's work was a failure to adequately plan, perform, and document the audit procedures to support their conclusions on whether IDA complied with the terms of its grants and contracts. They also found deficiencies in the performance of fraud risk assessment procedures. Specifically, the IG noted the following:

DCAA did not perform sufficient fraud risk assessment procedures during the planning and performance of the audit. The ... audit program procedures required the auditor to evaluate only the fraud risk indicators identified in the DoD IG, “Handbook on Fraud Indicators for Contract Auditors.” The working papers documented that the evaluation of fraud indicators was limited to a review of “Handbook on Fraud Indicators for Contract Auditors.” Based on this review, DCAA concluded that there were no identified fraud risks. 

... (However, auditing standards) ... requires the auditor to plan and perform the audit to obtain reasonable assurance that material misstatements and noncompliance, whether caused by error or fraud, are detected. Specifically, as a means of obtaining information needed to identify fraud risk areas, the standards require, among other procedures, inquiries of management during the planning process to determine if they have knowledge of any fraud or suspected fraud affecting the entity. 

As mentioned in yesterday's posting, since the IG report was issued, DCAA has been revising its audit programs and guidance to ensure compliance with auditing standards. Contractors should expect increased audit emphasis in this area.

Fraud Indicators

Government auditors are required, prion to commencing an audit, to sit down and discuss with their team member, supervisors, and managers, the risk of fraud and other noncompliances with applicable laws and regulations that could have a material effect on whatever it is they are auditing.

Although this requirement has been in place for many years, the 2011 revision of the GAO Yellow Book (a.k.a. Generally Accepted Government Auditing Standards or GAGAS) renewed its emphasis and now requires better documentation that the discussion took place.

DCAA has been quietly revising its audit programs to ensure compliance with the new Yellow Book, defining what should be discussed, the sources for fraud indicators and documentation requirements. The IG Handbook of Fraud Indicators is one source that auditors refer to when discussing the risks associated with fraudulent activity. This handbook is available as a download on the DoD Inspector General's  website  although it hasn't been updated in some time (the last update was twenty years ago).

Note: the Handbook is no longer available. DoD-IG removed it as being too "dated".

DCAA also lists examples of characteristics and types of activities associated with fraud. These can be found in the Agency's contract audit manual, Figure 4-7-5. These indicators include:

• Unexplained changes to timecards transferring hours from commercial firm-fixed-price contracts to Government cost-type contracts.
• Employee time charged differently from associated travel costs.
• Diverting labor from firm-fixed-price contract by reclassifying employees as indirect who provide direct labor to firm-fixed-price contracts.
• Significant material requirements charged to Government cost-type contracts where follow-up work shows that the material was not needed.
• Using inferior material on Government contracts that does not meet contract specifications.
• False certification of inspection test results.
• Intercompany profit claimed and billed for an intercompany affiliate that the contractor represented to the Government was an unrelated subcontractor.
• Cost Overrun contract costs charged to indirect expenses for allocation to other contracts.
• Expressly unallowable costs recorded in accounts that are generally allowable such as small tools and supplies.
• Improper transfers, or recording, of costs to indirect accounts for direct contract costs that are not allowed to be charged under the terms of the contract.
• Alterations to documents that would result in improper costs claimed for Government contracts.
• Evidence showing that payments were not actually made for the amounts shown on the document.

After an audit is completed, auditors hold another meeting to discuss the audit results and measure the impact of any findings on other past, current, and future audits. On occasion, auditors have had to rescind prior audit reports because of information that became available subsequent to that report's issuance that rendered the previous audit opinion indefensible.