Interim FAR Rule Published Expanding Compensation Caps to All Employees

The National Defense Authorization Act for FY 2012 amended the standards for determining the individuals affected by the senior executive compensation benchmark amount. Specifically, section 803 expanded the applicability of the existing executive compensation cap so that it would apply to all employees of a contractor instead of just the five most highly compensated employees in management positions at each home office and each segment of the contractor. This NDAA provision applies to only DoD, NASA, and Coast Guard contracts and applies to compensation paid after January 2012. That cap for 2011 is $763 thousand. The cap for 2012 has not been announced but is rumored to be in the $900 thousand range.

There is a slight problem in implementing Section 803 - the retroactive nature of the legislation. Earlier this week, the FAR councils published an interim rule addressing contracts awarded after the the effective date of the law, which was December 31, 2011. It is also working on a case to address retroactive implementation. Back in 1998, Congress passed a similar law which imposed a cap on allowable senior executives that applied to contracts already in existence as of the date of enactment. General Dynamic took that one to court and won; the court ruled that the provision beached contracts awarded before the statutory date of enactment (General Dynamics Corp. v. U.S., 47 Fed.Cl 514 (2000).

To avoid a repeat of 1998, the new interim rule applies only to contracts awarded after December 31, 2011. The FAR councils are working on a companion rule that will address contracts awarded prior to December 31, 2011 (FAR Case 2012-025).

The interim rule's wording gets a bit convoluted because while FAR applies to all Government contracts, the statute only applies to DoD, NASA, and Coast Guard contracts. So FAR 31.205-6(p) was written to distinguish between the source of the award and the year in which the contract was awarded. You can read the interim rule here.

This is going to complicate estimating and billing practices at some contractors as well as the preparation of the annual incurred cost clims. Some contractors will need to develop two sets of direct and indirect rates, one for DoD, NASA, and Coast Guard contracts and the other for contracts with all other Government agencies.

New DoD Inspector General Nominated

Last Friday, the White House announced the nomination of Jon T. Rymer for the Inspector General, Department of Defense. Here is Mr. Rymer's bio that accompanied the announcement.

Jon T. Rymer is the Inspector General (IG) of the Federal Deposit Insurance Corporation, a position he has held since 2006. From May 2012 to January 2013, he was also the interim IG of the Securities and Exchange Commission. From 1997 to 2004, he was a Director at the accounting firm of KPMG LLP. He was executive Vice President at Boatman's Bank of Arkansas from 1992 to 1997, and Executive Vice President at First American National Bank of Tennessee from 1981 to 1992. Mr. Rymer is a 33 year veteran of the active and reserve components of the U.S. Army. He is a Command Sergeant Major in the U.S. Army Reserve. He serves on the Council of Inspectors General for Integrity and Efficiency as a Member of the Executive Council and as Audit Committee Chairman. Mr. Rymer received a B.A. from the University of Tennessee and an M.B.A. from the University of Arkansas at Little Rock.

The nomination is currently under consideration by the Senate Committee on Armed Services.

This is an important position as the IG sets the organization's agenda and sets the tone at the top. A lot of folks are wondering whether under new leadership, the DoD-IG will continue its bitter internecine feud with DCAA (Defense Contract Audit Agency). The IG has been extremely and exuberantly critical of DCAA in general and the quality of its audits in particular.

Comments we've seen on this nomination have been mostly postive. His tenure at FDIC and SEC garnered much praise.

More on DCAA's Subpoena Authority

Much ado has been made of DCAA's (Defense Contract Audit Agency's) subpoena authority. We've been in meetings where auditors threatened to subpoena records. However, DCAA has been very reluctant to use its subpoena authority and as far as we know, DCAA has never been successful in issuing a subpoena. We could be wrong but it seems we would have heard about it if the Agency was successful.

DCAA tried once. DCAA issued a subpoena to force Newport News Shipbuilding to turn over internal audits and other records of management "reviews". Newport News appealed and in 1988, the United States Court of Appeals, Fourth Circuit shot the Agency down on the basis that the records it sought were not those covered by the statute that authorizes DCAA's subpoena authority.

So, what is the extent of DCAA's subpoena authority?

Public Law 99-145 (codified into 10 USC Section 2313) authorizes the Director of DCAA to issue subpoenas when a contractor refuses to grant DCAA access to records relating to negotiations, pricing, or performance of a particular contract. DCAA takes a very broad view of what records relate to negotiation, pricing and performance. Insofar as internal audit reports are concerned, an identified internal control deficiency could impact the propriety of costs charged to Government contracts. Identified internal control deficiencies could help the auditor perform better risk assessments when auditing incurred costs. The Court however, took a much narrower view. The Court could not find a nexus between negotiations, pricing, and performance of a contract and internal audit reports. That case was pretty substantial as contractors have used it over and over again to deny access to whatever it is they don't want the auditors to see.

Records in the context of 10 USC 2313 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 any other form. Those records however must pertain to the negotiations, pricing, and performance of a contract. Obviously, certified cost or pricing data submitted in response to a solicitation would meet this definition. Also, historical costs upon which billings or progress payments are based would fall into this category. There is usually no reluctance among contractors to provide this information. After all, there is an incentive; contractors want the contract and they want to be paid. Controversies arises when the auditors begin to request documentation that does not bear directly on pricing or billings. Internal audits are one example. Other examples might include audit reports from the independent public accountants, internal control reviews and reports required by the Sarbanes-Oxley Act, investigative reports, profitability information, data related solely to commercial sales, and cash flow forecasts, to name a few.

DCAA is seeking to broaden its subpoena authority. It has a powerful ally in GAO (Government Accountability Office). Should their efforts fail, DCAA may take another run at a court to see if they can elicit a more favorable ruling than the Newport News case.

Record Imaging

We've discussed record retention requirements from time to time, most recently here. Contractors should become intimately familiar with FAR 4.7 because that section lays out in detail the time periods for which various types of records must be retained and made available for Government review.

Frequently, questions arise about whether those records may be imaged and stored electronically. Auditors routinely ask for "original" documents and there is good reason for that. They want to insure that they are not reviewing "altered" documentation. But sometimes, their insistence goes beyond what is legally required. Lets take a look.

10 USC Section 2313 is the statute that gives the Government the authority to examine contractor records. Paragraphs (g) and (h) of that section discusses the medium used to store records.

Paragraph (g) unequivocally authorizes contractors to storing "original" records in electronic form.

(g) Forms of Original Record Storage. - Nothing in this section shall be construed to preclude a contractor from duplicating or storing original records in electronic form.

Paragraph (h) then sets forth a few conditions/requirements.

(h) Use of Images of Original Records. - The head of an agency shall not require a contractor or subcontractor to provide original records in an audit carried out pursuant to this section if the contractor or subcontractor provides photographic or electronic images of the original records and meets the following requirements:

(1) The contractor or subcontractor has established procedures to ensure that the imaging process preserves the integrity, reliability, and security of the original records
(2) The contractor or subcontractor maintains an effective indexing system to permit timely and convenient access to the imaged records
(3) The contractor or subcontractor retains the original records for a minimum of one year after imaging to permit periodic validation of the imaging systems.

By the way, most modern accounting software allows users to attach or link electronic copies of invoices or other documentation directly to the transaction. So, for example, if you're paying an invoice for Rent, you can attach a PDF copy of the invoice to the transaction. If you want to retrieve or view a copy of the bill later on, you click on an icon and the copy opens up. That meets criteria No. 2 above.

The next time auditors give you grief over having to view scanned copies of documents, you might want to refer them to 10 USC Section 2313.

What Does the ACO (Administrative Contracting Officer) Do?

People that are new to Government contracting (and we were there once) are often perplexed by similar sounding, yet very different roles and responsibilities among Government contracting professionals; contracting officer (CO), procurement contracting officer (PCO), administrative contracting officer (ACO), termination contracting officer (TCO), contracting officer's representative (COR), contracting officer technical representative (COTR), for example.

The contracting officer is the main person with authority to enter into, administer, and/or terminate contracts and make related determinations and findings. That person then, may or may not delegate some of their authority to authorized representatives to assist in certain matters. Usually, but not always, the contracting officer will delegate contract administration functions to an ACO (Administrative Contracting Officer). The ACO function within DoD is the Defense Contract Management Agency (DCMA).

The administrative functions that are normally delegated to an ACO are listed in FAR 42.302. There are 81 of them so we're not going to list them all. You can refer to the complete listing here. Of the 81 administrative tasks, 78 are optional in that the CO may delegate the functions or, in a rare case, choose to retain the functions in-house. The three administrative functions that are reserved for the ACO specifically are:

1. Negotiating forward pricing rate agreements
2. Establishing final indirect cost rates and billing rates
3. Anything dealing with Cost Accounting Standards (CAS)

The ACO's organization (sometimes referred to as CAO, Contract Administration Office) are the ones responsible for CIPRs (Contractor Insurance/Pension Reviews), CPSR (Contractor Purchasing System Reviews), and EVMS (Earned-Value Management Systems) oversight.

The ACO is the person contractors usually start with when there are any billing issues (though DCAA plays a role in that process as well). The ACO can negotiate advance agreements applicable to the treatment of costs, issue notices of intent to disallow costs, and levy penalties for unallowable costs.

For contractors, the ACO is arguably your most important contact, once your contract has been negotiated. Get to know him or her.

Don't know who your ACO is? Just click here and enter a Contract Number (or your CAGE Code)

GAO Review of Employee Compensation Paid by Defense Contractors

Since the mid 1990s, federal law has placed limitations or caps on the amount of employee compensation that contractors can charge to federal contracts. This cap, based on a complex formula, has outstripped inflation by 63 percent. For compensation paid in 2012, the cap is $763,029.

The 2013 National Defense Authorization Act (NDAA) directed GAO (Government Accountability Office) to provide information on the effect of reducing the amount of employee compensation that contractors can charge to federal contracts. Specifically, GAO was tasked to provide information on the effect of reducing the cap to the salary of the U.S. President and Vice President and to obtain the views of government and contractor representatives on potential effects of a reduction in the cap.

GAO collected data from 30 randomly selected contractors from 3 strata; 10 from large-tier, 10 from mid-tier, and 10 from small-tier populations. Data was received from 27 of the 30 contractors sampled. The three contractors that refused to provide data incidentally, were the three largest contractors in GAO's sample. GAO used the data as voluntarily submitted and made no attempt to validate or substantiate the information provided.

GAO reported that reducing the cap to the President's salary ($400 thousand) or the Vice President's salary ($230,700) would significantly increase the number of employees exceeding the cap. That's hardly surprising.  The interesting information here is the impact to taxpayers. For just the 27 companies reporting data, contractors reported over $180 million per year in compensation costs that would have exceeded a cap set at the President's salary. That number rises to $440 million per year if the cap were set at the Vice President's salary. GAO made no attempt to project these results but one can see that the real impact is significantly more than the reported amounts.

Government representatives generally supported reducing the cap as a means of reducing the costs of DoD contracts (again, hardly surprising). Contractor representatives however identified negative effects that could result from reducing the cap. These include

• reduced profits (amounts paid over the cap would come from company profits
• challenges in attracting capital from the financial markets
• negative impact on company's ability to attract and retain top talent
• over the long term, lead companies to reassess their business and staffing models
• shift work or personnel from government business to their commercial sector

This report is certain to gain a lot of attention as Congress gets to work on the 2014 NDAA. As reported here in this blog, the 2014 NDAA that came out of the House Armed Services Committee includes a $400 thousand cap on the top five executives.

You can read the entire GAO report here.

Proposed Expansion of DCAA's Subpoena Authority

Every year, the Department of Defense packages up a bunch of legislative proposals and sends them over to Congress for consideration and hopeful inclusion in the National Defense Authorization Act. Some make the bill, some don't. Some make it but are are almost unrecognizable in the final bill. For example, last year, one of DoD's proposals was to require contractors to give the auditors unfettered access to internal audit reports. This proposal proved to be very controversial and the provision that finally made it into law was so wattered down as to be inconsequential - it didn't require contractors to turn over internal audit reports - it merely required the auditors to document contractor responses to requests for internal audit reports.

So, with that background, we peruse DoD legislative proposals as they become available to look for issues and areas of concern for Government contractors. One of the proposals sent to the Legislature this year is for an expansion of DCAA's subpoena authority.

Currently, DCAA's subpoena authority, contained in 10 U.S.C. 2313 permits DCAA both access to and the authority to subpoena certified cost or pricing data, but it does not specifically provide similar authority for "data other than certified cost or pricing data" as defined in FAR 2.101. When a contracting officer determines that historical data is insufficient to determine the reasonableness of prices in fixed-price contract for commercial items, FAR 15.403-3 permits the Government to obtain "data other than certified cost or pricing data" to assist in making the determination. Contractors have been reluctant to provide this information. While the FAR allows contracting officers to request data, there is currently no authority to compel production of that data.

The legislative proposal submitted by DoD would amend 10 U.S.C. 2313 to provide DCAA (Defense Contract Audit Agency) the authority to evaluate data other than certified cost or pricing data and would expand DCAA subpoena authority to include such data.

In justifying this enhanced access, DoD reported that in the past 12 months, at least two major contractors have refused to provide the data requested. Because DCAA's subpoena authority includes only certified cost or pricing data, DCAA was unable to compel the production of data other than certified cost or pricing data to determine whether proposed price increases on commercial parts were fair and reasonable. As a result, the contracting officers were left with a decision to withhold award of the contract and develop a second source for a weapon system (impractical in most cases) or negotiate with less than optimal data.  It also significantly delayed the acquisition  process. Additionally, DoD noted that some contractors have also refused to provide data that substantiates sufficient commercial sales to support pricing based on the commercial sales price.

Senator Barry Goldwater said in 1958, "This bill and the foregoing remarks of the majority remind me of an old Arabian proverb. If the camel once gets his nose in the tent, his body will soon follow." DCAA has another proposal in the works that would expand its subpoena authority even more, by compelling contractors to turn over their internal audit reports.

Entertainment Costs - Part 3

Today we finish off our short series on entertainment costs. In Part 1, we discussed the essence of the cost principle. In Part 2, we discussed some of the Board decisions (Boards of Contract Appeals) concerning entertainment costs. In this final part, we will take a look at some of the things that DCAA tells its auditors to be alert for when reviewing entertainment costs. Most of the following is found in DCAA Contract Audit Manual Section 7-1100.

In its guidance, the Agency repeatedly states that entertainment costs are expressly unallowable and auditors should never be dissuaded into believing that such costs might be allowable under competing cost principles. Contractors always have the obligation to adequately support all costs but in this case, DCAA emphasizes the requirement. If the Government challenges the allowability of claimed costs, it is the contractor's responsibility to establish that the cost is for an allowable activity.

Entertainment costs are expressly unallowable, without exception. Therefore, even if the principal purpose for incurring an entertainment is other than for entertainment, the entertainment cost is unallowable. For example, while the cost of a contractor open house for employee families is generally allowable, the cost of entertainment provided as part of the open house is unallowable. In this example, contractors would be expected to analyze cost and exclude unallowable costs from any proposal or claim to the Government.

The statutes and cost principles at 31.205-13 (Employee Morale) and 31.205-14 (Entertainment) are closely related. Taken together, the cost principles expressly disallow costs which some conntractors may have considered reasonable and allowable prior to the 1995 effective date of the current rule. Examples of such costs include, but are not limited to:

• Entertainment provided as part of public relations, employee relations, or corporate celebrations;
• Gifts to anyone who is not an employee;
• Gifts to employees which are not for performance or achievement or are not made according to an established plan or policy;
• Compensation awards of entertainment, including tickets to shows or sports events, or travel; and
• Recreational trips, shows, picnics, or parties.

Finally, auditors are specifically guided to look for entertainment costs that might be buried in other accounts. Accounts that are considered high risk for inclusion of potentially unallowable entertainment costs include:

• Public relations costs
• Business meetings

Entertainment Costs - Part 2

Yesterday, we introduced the FAR (Federal Acquisition Regulations) cost principle governing the allowability of entertainment costs. Entertainment is not allowable under Government contracts and entertainment by any other name is still unallowable. Thus, you cannot argue that some example of entertainment is good for employee morale and therefore is allowable under the employee morale cost principle (FAR 31.205-13).

Most forms of entertainment are obvious and Government contractors by and large do a pretty good job of identifying and excluding such costs from proposals and billings. However, there have been a number of board cases (Boards of Contract Appeals) that have had to decide whether a certain cost is a form of amusement, diversion, or social activity.

In one case, the city of Seattle wanted to honor Boeing's 50th anniversary with a banquet. Boeing paid for printing and mailing invitations. When the event was to take place, there was an airline strike so Boeing chartered an aircraft to bring important guests to the banquet. The Government took the position that the banquet was entertainment and therefore the cost of the invitations and mailings and the charter aircraft were directly associated to entertainment activities and therefore unallowable. The Board did not agree. The Board stated that Boeing did not plan the banquet but stepped in and did what a prudent businessman would do in the circumstances, considering the responsibilities to the owners of the business, his employees, his customers, the Government and public at large.

In another case, the Board sustained the Government's position that a luncheon for visiting businessmen and Government employees were unallowable entertainment expenses because the luncheons were not for dissemination of technical information or stimulating production.

In contrast to the previous ruling, the Board ruled in 1990 that the cost of luncheons and dinner meetings were allowable. The contractor had demonstrated that they had discussed business matters. Moreover, the amounts involved were modest, the meetings were not excessive in number and were reasonable in nature and amount.

Finally, in a case from 1991, the Board ruled that a company holiday party was unallowable entertainment because clients were invited and the primary purpose of the event was entertainment. The Board stated that "To be an allowable cost, it must be clearly documented that an event's purpose was to improve employee morale, that the event benefited employees and not outside participants (such as spouses or other non-government clients), and that the costs were reasonable".

The key point from these cases is that documentation is absolutely critical to fending off challenges to allowability. Secondarily, be careful who you invite to your business luncheons and dinners.  Contemporaneous records are the best evidence but, as illustrated in one of the cases described above, affidavits were used to prove that the luncheon served a business purpose.

Click here to go to Part 3

Entertainment Costs

Today we'r going to tackle a discussion on the "entertainment" cost principle. A few weeks ago, we looked at employee morale and identified some of the challenges in deciding whether particular costs should be classified as employee morale or entertainment. Its an important distinction because while employee morale costs (however narrowly defined) are generally allowable under Government contracts, entertainment costs are not.

The entertainment cost principle found in FAR 31.205-14 is rather brief. It states:

Costs of amusement, diversions, social activities, and any directly associated costs such as tickets to shows or sports events, meals, lodging, rentals, transportation, and gratuities are unallowable. Costs made specifically unallowable under this cost principle are not allowable under any other cost principle. Costs of memberships in social, dining, or country clubs or other organizations having the same purposes are also unallowable, regardless of whether the cost is reported as taxable income to the employees.

The middle sentence, "Costs made specifically unallowable under this cost principle are not allowable under any other cost principle" was added in 1995 to prevent just such arguments. Auditors might questions costs as unallowable entertainment but contracting officers were often persuaded to give those costs back because they would arguably meet the definition of one or more other cost principles. Congress had to act to tighten things up.

Auditors are ever on the alert for entertainment type activities. It could be entertainment that is part of a company's open house (the open house should be allowable but the entertainment portion is not) or entertainment that is part of a business meeting (business meetings are allowable with restrictions but a business meeting at an expensive resort is going to open up a line of inquiry.

Tomorrow, we will look at a few Board cases that help us define what is and is not allowable under this cost principle. Click here to go to Part 2.

Incurred Cost Proposal Adequacy Checklist

We wouldn't want to let a week go by without telling you about another Government checklist. As we approach the due date for submitting incurred cost proposals (June 30th for calendar year contractors) it is important to remember that incurred cost proposal submissions passing DCAA Incurred Cost Adequacy Checklist, have reduced likelihoods of being audited. For proposals under $15 million, and assuming no history of "significant" questioned costs, that likelihood is only five percent. See our previous coverage on this topic. Now, that's incentive for getting it right the first time.

The latest version of the incurred cost adequacy checklist, Version 2.2 from April 2012 can be downloaded here.

The checklist steps through each of the required schedules, 'A through 'O and asks a series of questions for each schedule. These schedules correlate to the final incurred cost proposal requirements of FAR 52.216-7(d)(1)(iii). Many of the questions deal with internal consistencies within the proposal itself. For example,one of the questions pertaining to Schedule A is whether amounts shown on that Schedule can be traced to the corresponding amounts on Schedules B, C, D, F, and H.

We believe that this checklist should be part of each contractor's proposal preparation process. It has the potential for saving a lot of time in the long run.

If you're frustrated with the complexities of DCAA's ICE package (Incurred Cost Electronically), you might want to look into our significantly improved and fully compliant version of the model. We call it SPICE and its available for $250 which includes one hour of technical support. Call David Koeltzow ('Kelso') 866-849-4887 Ext. 5 for more information.

Be Careful to Comply with Solicitation Requirements

Last December, the Department of Homeland Security (DHS) issued a solicitation for repair and maintenance work along the U.S. southwest boarder. The work included (i) fencing and gates, (ii) roads and bridges, (iii) drainage and grate systems, (iv)lighting and electrical systems and (v) vegetation control and debris removal.

The RFP instructed offerors to submit their proposals electronically, and on paper and to provide all required information in the format specified. With regard to the electronic version, the RFP required that it be submitted in "XLS" file format with all formulas and calculations. This requirement was necessary to "ensure submission of information essential to the understanding and comprehensive evaluation of the offeror's proposal. Offerors were specifically warned that a failure to comply with the RFP's proposal submission requirements would result in rejection of the firm's proposal.

Nineteen proposals were submitted in response to the solicitation. Based on an initial review, DHS rejected six of them for failing to comply with the RFP's requirement for submission of the price proposal in Excel file format. One of those six firms, Herman Construction appealed the Agency's rejection of its proposal to the Comptroller General. Herman, you see, had submitted its electronic proposal in PDF format rather than XLS format.

Herman argued that it had complied with the solicitation's submission requirements and that DHS had improperly rejected its proposal. Herman contended that its PDF files should have been acceptable to the Agency because they were based on the cost template guide provided in the RFP. DHS argued that the solicitation specifically required offerors to submit their price proposal spreadsheets as Microsoft Excel files.

The Comptroller General sided with the Government. The CG ruled that DHS properly rejected Herman's proposal for failing to comply with the RFP's mandatory proposal submission format requirement. An agency is not require to adapt its evaluation to comply with an offeror's submission. The question is not what the agency could possibly do to cure a noncompliant submission but rather, what it was required to do. Where proposal submission requirements are clear, an agency is not required to assume the risks of potential disruption to its procurement in order to permit an offeror to cure a defective proposal submission initiated by its failure to comply with mandatory solicitation requirements.

Here is yet another illustration of the importance of complying with specific solicitation requirements. All that work to prepare a proposal was for naught because of a simple formatting mistake.

Contractors to Share DoD Furlough Burdens

Yesterday, when testifying before the Defense Subcommittee of the Senate Appropriations Committee, Secretary of Defense Chuck Hagel told Senators that DoD contractors will share the burden of spending cuts, including the furloughs facing the Department's civilian workforce.

The DoD Comptroller, Robert Hale who testified at the same hearing told the Senators that the 700 thousand defense contractors who work throughout the Department "...are in for some changes".

The Department of Defense is taking a $37 billion sequestration spending cut this fiscal year. While about $2 billion is coming out of furloughs for civilian workers, the majority of that cut will be coming out of contracts. That means a "sharp drop" in the number of contracts in the department.

The hearing also touched on the high cost of contract employees in general. One Senator cited a recent study that concluded contractors, on average, were twice as expensive as civilian employees. Contractor employees make up 22 percent of DoD's workforce but represent 50 percent of its personnel related costs. Evidence of a problem in this area comes from Edward Snowden's (the NSA employee who leaked classified information) revelations that was making $200 thousand per year, living in Hawaii, while performing relatively little work (his employer said he was making $122 thousand, not $200 thousand).

Government contractors, and Defense contractors in particular, have already been feeling the effects of sequestration because a lot of contracting actions are suspended or cancelled. We've had contractors tell us about specific cases where solicitations have been cancelled because of sequestration. If the Secretary's testimony comes to fruition, the impact will be felt even more directly as existing contracts are terminated in whole or in part due to funding limits.

Impairments to Independence

A number of years ago, DCAA assigned a supervisor to audit a particular contractor. The supervisor informed the Agency that he had a brother who worked for the contractor. Upon review, it was determined that there was no real or perceived conflict of interest - the brother worked for a commercial division in another city. Later, the brother was reassigned to the same division being audited by the supervisor. The contractor cam forth and challenged the propriety of the supervisor's involvement in the audit.

The first reaction was that the contractor transferred the brother purposefully as part of a scheme to have a particularly effective supervisor transferred away from his current engagement. DCAA even suggested that the contractor re-reassign the brother. Ultimately, the Agency blinked first and had to reassign its supervisor.

This is not a particularly isolated incident. Spouses, children, and other family members need jobs too and often times, find employment with government contractors. DCAA has quite a rigorous program to avoid even the appearance of a lack of independence. Auditors are required to self-disclose any real or perceived conflicts.

The Agency recently issued guidance on how to proceed when contractors lodge complaints about circumstances or behavior that indicate, or appear to indicate, auditor bias, which in turn may indicate a threat to independence.

First, the Agency must determine the credibility of the complaint. Disagreements between auditors and contractor personnel over audit issues can and do occur during audits. Such disagreements do not indicate bias or lack of objectivity. However, if the complaint is about inappropriate behavior, close relationships with contractor employees, or any of the other myriad ways in which independence could be impaired, the Agency will make an "inquiry". If, based on the inquiry there is some merit to the complaint, the Agency will initiate an investigation and temporarily, at least, remove the auditor from the affected audits.

If no significant threat to independence exists, the auditor will be returned to his/her position. If independence is impaired, either actual or in appearance, management will eliminate the threat - most likely by reassigning the auditor to another engagement.

Contractors should never hesitate to bring up potential impairments to independence to DCAA or DCMA or any other type of Government oversight to appropriate levels. Ultimately, it will help these Agencies perform their jobs efficiently and effectively.

Payment Recapture Audits - Progress So Far

In July 2010, the President signed the Improper Payments Elimination and Recovery Act (IPERA) which was intended to help achieve a reduction in wasteful, improper payments by $50 billion between then and 2012. According to a White House press release at the time, the federal government wastes billions of American taxpayers' dollars on improper payments to individuals, organizations, and contractors. These are payments made in the wrong amount, to the wrong person, or for the wrong reason.

There were a number of provisions to IPERA. The law requires agencies to conduct annual risk assessments, and if a program is found to be susceptible to significant improper payments, then agencies must measure improper payments in that program. It requires agencies to conduct payment recapture audits. As an incentive for agencies to get with the program , it authorizes agencies to use recovered funds for additional uses than currently allowed, including to improve their financial management.

In fiscal year 2011, the first year of IPERA implementation, DoD reported $1.1 billion in improper payments. GAO (Government Accountability Office) was asked to review the progress DoD has made to identify, estimate, and reduce improper payments. GAO's objective was to review the extent to which DoD has implemented key provisions of the Act.

GAO's report, issued last month, found that DoD did not adequately implement key provisions of the IPERA. It also found that the $1.1 billion reported savings was neither a reliable nor a statistically valid estimate because of long-standing and pervasive financial management weaknesses and significant deficiencies in the department's procedures to estimate improper payments. In fact, there is no way of knowing whether the estimate is realistic, overstated or understated.

DoD does not perform required risk assessments, have procedures to identify root causes of improper payments and develop corrective action plans, conduct recovery audits for any of its programs, or have procedures to ensure that its annual improper payment and recovery audit reporting is complete, accurate, and in compliance with IPERA.

GAO made about 10 recommendations and DoD more or less agreed with them. Contractors should be expecting increased oversight as a result of this program.

Compensation Caps - House Armed Services Committee's Markup

The House Armed Services Committee (HASC) passed the 2014 NDAA (National Defense Authorization Act) by a vote of 59-2 yesterday. The Bill, as it comes out of committee rejects the President's proposal to cap executive compensation at $400 thousand (the President's salary). Instead, the Committee wants to set up a formula that doesn't reduce the current compensation cap but will stem the growth of what is allowable under Defense contracts.

Here's what the HASC fact sheet states:

Executive Compensation Reform: The White House’s formula for calculating allowable private sector compensation on DOD contracts has become dysfunctional and no longer meets the needs of industry or the taxpayer. The FY14 NDAA excludes the salaries of large contractors’ top five earners from allowable expenses on federal contracts and freeze the current employee compensation baseline, only adjusting for the economic cost index going forward. The Chairman’s mark rejects calls by some to cap individual industry salaries at the President or Vice President’s salary level. The Chairman believes this is an inappropriate and arbitrary comparison that will drive talent from the nation’s defense industrial base. Instead reform should focus on reasonable expenses given the market conditions that determine what a contractor needs to pay to recruit and retain talent.

Did we read that right? The 2014 NDAA, if passed as is, would disallow all compensation for the top five earners? We did. That's what it states and that's what others have reported. Certainly a lower cap is better than this draconian provision. The actual wording reads as follows:

Section 812—Limitations on Allowable Costs for Contractor Compensation 

This section would amend section 2324(e)(1)(P) of title 10, United States Code, to replace the current statutory benchmark compensation formula used to determine the amount of contractor compensation that is considered an allowable cost on a Department of Defense contract. This section would limit additional changes to the current compensation baseline to the U.S. Bureau of Labor Statistics Employment Cost Index (ECI). The Administrator for Federal Procurement Policy has previously set the adjusted compensation benchmark amount for fiscal year 2013 at $763,209. This section would also make unallowable the entire cost of compensation for the five most-highly compensated employees of a contractor that meets statutory requirements for compliance with cost accounting standards on a Department of Defense contract. This section would exempt small business concerns from such limitation.  

The committee believes application of the current formula by Office of Federal Procurement Policy is flawed, as it has resulted in an escalation of $422,559, or nearly 225 percent, in the 15 years since the compensation cap was established in law. The committee does not believe this escalation reflects the actual adjustments in compensation for defense contractors over this same period due to inflation and other market factors. The committee notes that section 1127 of title 41, United States Code, directs the Administrator for Federal Procurement Policy to "review commercially available surveys of executive compensation and, on the basis
of the results of the review, determine a benchmark compensation amount to apply for each fiscal year." The Administrator is also directed to consult with the Director of the Defense Contract Audit Agency and other officials of executive agencies in making the determination. However, rather than using all available data and input from appropriate officials to inform decision-making, it appears that the Administrator has interpreted the requirements of section 1127 to require that the benchmark compensation amount be established at an amount equal to the median amount of the total compensation (total amount of wages, salary, bonuses and deferred compensation) accrued over a 12-month period for the top five highest paid employees in management positions at each home office and each segment of publicly traded U.S. companies with annual sales over $50.0 million. According to the Congressional Budget Office, if the current approach remains in place the compensation cap could be raised to as high as $1.6 million by fiscal year 2020. 

The OMB (Office of Management and Budget) is already on record as saying their proposal (the $400 thousand cap) is better than HASCs. Something is bound to happen this year concerning compensation. It will be a long process before a bill is signed by the President.

The Government's Initiative to Improve Contractor Proposals

In the past few months, the FAR Councils issued two proposal related checklists, one as a final rule (Proposal Adequacy Checklist) and the other as a proposed rule (Forward Pricing Rate Proposal Adequacy Checklist). We reported on those checklists here and here. Variations of these checklists have been around for some time, notably on DCMA (Defense Contract Management Agency) and DCAA (Defense Contract Audit Agency) websites but never required from contractors. Now, they are or will soon be part of the acquisition regulations and contractors will be required to complete these and submit them with proposals when certified cost or pricing data is required.

Inadequate contractor proposals have always been barriers to performing effective, and especially timely audits and reviews. Inadequate proposals are certainly not new. They existed in the early 70s when we were cutting our government contracting teeth and they continue to this day. Of course, sometimes "adequacy" is a matter of judgment - the Government often wants more than contractors believe is required by regulation. Many contractors are fond of scrimping on support and writing something like "data available upon request". Well, usually data available upon requires is not so readily available when requested.

The Government could return inadequate proposals to contractors to be fixed but that's not always practical. The exigencies of getting something under contract make that impractical if not impossible. Almost every auditor has heard the contracting officer; referring to an inadequate proposal, say something like "yeah, I know, but do what you can in the time you have". Well, when dealing with a finite amount of hours, time spent trying to understand or "fix" an inadequate proposal is time not spent elsewhere - like performing actual audit testing.

Some of the more common proposal deficiencies identified by the Government include:

• Variances between proposed amounts and basis of estimate/supporting documentation. This should be obvious - there has to be a direct link.
• Variances between prior buy actual cost data and proposed amounts without supporting justification/explanation. If the history is not applicable, explain why.
• Lack of consolidated bills of materials. 
• Unsupported additive factors applied to various elements of costs often leading to duplicate costs proposed.
• Rates not based on contractor budgetary and/or trend data
• Proposal does not reflect anticipated cost accounting changes
• Subcontract proposal deficiencies including inadequate prime contractor cost or price analysis and inadequate support to demonstrate fair and reasonable commercial pricing.

The new checklists should set out clear expectations to contractors on required components for contract proposals. These checklists are based on FAR Part 15.40-8, Table 15-2 requirements so they do not represent anything that hasn't been required all along. The difference now is that contractors must complete the checklist and document that it has satisfied all items.

DCAA's Second Annual Report to Congress

DCAA's Second Annual Report to Congress, dated 29 March 2013 was recently posted on DCAA's website. This annual report is a product of the National Defense Authorization Act for Fiscal Year 2012 (now codified at 10 U.S.C. 2313a) and provides an overview of DCAA's mission, audit performance and recommendations to address significant deficiencies identified by DCAA during the conduct of its audits.

The report includes a lot of data, charts and narrative to explain why the Agency feels that fiscal year 2012 "...was a very successful year for DCAA." Among its accomplishments were (i) recommended cost reductions of $12.4 billion and (ii) a return on taxpayer's investments of $6.70 for each dollar spent by the Agency.

From a contractor's perspective, the most interesting thing in the report is Section 4,Significant Deficiencies and Recommended Actions to Improve the Audit Process. In this section, DCAA tells Congress what statutes or regulations need changing in order for them to do their job better. Here are some of those.

1. DCAA continues to face insufficient commercial pricing documentation and the lack of express authority to review "data other than certified cost or pricing data". DCAA wants contracting officers to become better trained on commercial item determinations. DCAA also want authority to review and subpoena "data other than certified cost or pricing data".
2. Access to contractor internal audit reports continues to pose significant challenges to DCAA auditors. DCAA acknowledges that the 2013 NDAA falls short of requiring contractors to fork over their internal audit report. Look for renewed attempts to force contractors to provide them.
3. The lack of access to contractor online data is another area of growing concern to DCAA. Read-only access would greatly assist DCAA to effectively plan and perform its audits. Some contractors have denied such access so DCAA is contemplating a legislative proposal that would require contractors to provide online access to electronic data.
4. DCAA strongly believes that having access to contractor employees to conduct interviews and observations is critical to ensure compliance with GAGAS (Generally Accepted Government Auditing Standards). Because some contractors have denied such access, DCAA believes that changes to FAR (Federal Acquisition Regulations) is necessary to ensure that auditors have timely access to contractor employees. Because there is no specific language in FAR stating DCAA has access to interview employees, DCAA plans to submit a legislative proposal to support DCAA’s right of access to contractor employees and to avoid future confusion on DCAA’s ability to interview employees. 

We might see some of these proposals submitted in connection with the 2014 NDAA (National Defense Authorization Act). 

Government Loses Another Appeal Based on Statute of Limitations

The Government has lost a number of notable appeals lately because of the six year statute of limitations. The latest is a case involving Raytheon and Cost Accounting Standards. In a case decided on April 22, 2013 but apparently just published, the ASBCA (Armed Services Board of Contract Appeals) ruled that the Government's claims against Raytheon for increased costs resulting from cost accounting practice changes were beyond the statute of limitations.

The six-year statute of limitations was a provision included in the Federal Acquisition Streamlining Act of 1994. It requires each claim by a contractor against the Federal Government relating to a contract and each claim by the Federal Government against a contractor relating to a contract shall be submitted with 6 years after the accrual of the claim. It works both ways, Government claims against the contractor and contractor claims against the Government.

FAR 33.201 defines the "accrual of the claim" as

The date when all events, that fix the alleged liability of either the Government or the contractor and permit assertion of the claim where known or should have been known. For liability to be fixed, some injury must have occurred. However, monetary damages need not have been incurred.

In the latest Raytheon case, the Government's claims arose for cost accounting changes that the contractor made in 2004 and 2005. Raytheon notified the Government of the pending changes in 2004 and also notified the Government that the accounting changes would result in increased costs to the Government.

In 2011, the contracting officer (DCMA in this case) issued final decisions which demanded that Raytheon refund the Government for increased costs that resulted from the accounting changes. Raytheon appealed on the basis that the Government's claim was beyond six years from the "accrual of the claim".

Raytheon's position was based on the date that it notified the Government of the accounting practice changes and the "potential" for there to be increased costs. The Government argued that Raytheon did not provide "auditable" cost impacts until much later (and within the statute of limitations).

The ASBCA sided with Raytheon. The Board stated that the initial notification was sufficient to trigger the statute of limitations. It stated:

Claim accrual does not depend on the degree of detail provided, whether the contractor revises the calculations later, or whether the contractor characterizes the impact as "immaterial". It is enough that the government knows, or has reason to know ...

Contractor Employees Under DoD Contracts

Did you ever wonder the number of contractor employees working for DoD? Well, no one has a very accurate count. And that's somewhat understandable. Its a moving target. Contracts are awarded, they are completed, wars come and go, the Government goes back and forth on what work should be done with their own civilian workforce or contracted out. Budget shortages and priorities cause some projects to lose funding.

The DoD has been trying since at least 2009 to come up with an accurate count. The GAO (Government Accountability Office) recently looked at DoD's counting efforts and found that while the accuracy is improving, the number is probably understated. The GAO concluded that more work needs to be done to come up with a reasonable count. So, what is the current number? In fiscal year 2011, DoD reported that there were 710,000 full time equivalent (FTEs) contractor employees working on DoD contracts, led by the Army with 250,000 of those. Now that's a lot of people.

By comparison, there are about 800,000 DoD (Department of Defense) civilian employees. That's almost a one-to-one ratio of contractor employee to civilian employee.

Right now, the competition between contracting for services versus in-house hiring is favoring the in-sourcing crowd. Usually the decision to in-source is made for one of two reasons. First, someone has determined that its cheaper to hire than to contract for the same services. Or secondly, the service is "inherently governmental" and should never have been contracted out int he first place.

The arguments over which method is cheaper is on-going and will never be resolved. Contractors have a profit motive so that tips the scale on the side of Government employment. Contractors often argue that a contracted workforce is more efficient, thus tipping the scale back to the contractor side. We've looked at audits performed by the Government and audits performed by non-Governmental entities. There is no doubt that non-Governmental organizations take less time to do similar audits. On the other hand, those audits are not nearly as comprehensive or in-depth as those performed by Governmental agencies. Whether the added assurance the taxpayer receives from a Government agency performed audit is worth the additional cost, is left for the policy makers.
___________________________________

See related article in Government Executive. Interesting comment that during the last drawdown, DoD shed 200,000 civilians but then, hired that many more contractor employees.