Gains and Losses on Disposition of Assets - Part I

Depreciable assets don't last forever. At some point, assets wear out and need to be replaced or become obsolete having outlived their usefulness. If assets have been depreciated down to zero dollars and the asset is dumped in a landfill, there is no gain or loss on the disposition of that asset. The book value is zero dollars and the market value (or real value) is zero dollars.

What happens though when the asset has not been fully depreciated and it is dumped? There is a loss on the disposition of that asset. Or what happens when it is sold for more than the book value? There is a gain on the disposition of that asset. There is a FAR cost principle (FAR 31.205-16) that deals with how gains and losses should be accounted for under Government contracts.

In short, the Government is going to share in either the gain or the loss when assets are disposed of. If there's a gain, the gain reduces the indirect expense pool for the year of disposal. If there's a loss, the loss increases the indirect expense pool for that year. Paragraph (a) of FAR 31.205-16 states:

Gains and losses from the sale, retirement, or other disposition of depreciable property shall be included in the year in which they occur as credits or charges to the cost grouping(s) in which the depreciation or amortization applicable to those assets was included. 

There are exceptions to this rule however. In the case of a business combination, no gain or loss shall be recognized as a result of the transfer of assets (more about this in FAR 31.205-52). Also, in the case of sales and leasebacks, there are some special rules that prevent the Government from paying more than they should - they'll accept the gain but won't absorb any of the loss:

• when costs of depreciable property are subject to the sale and leaseback limitation in 31.205-11(h)1) or 31.205-38(b)(2)
• The gain or loss is the difference between the net amount realized and the undepreciated balance of the asset on the date the contractor becomes a lessee, and
• When the application of (b)(1) of this subsection results in a loss
• The allowable portion of the loss is zero if the fair market value exceeds the undepreciated balance on the asset on the date the contractor becomes a lessee; and
• The allowable portion of the loss is limited to the difference between the fair market value and the undepreciated balance of the asset on the date the contractor becomes a lessee if the fair market value is less than the undepreciated balance of the asset on the date the contractor becomes a lessee.

The FAR cost principle also includes guidance for calculating and applying gains and losses:

Gains and losses on disposition of tangible capital assets, including those acquired under capital leases shall be considered as adjustments of depreciation costs previously recognized. The gain or loss for each asset disposed of is the difference between the net amount realized, including insurance proceeds from involuntary conversions, and its undepreciated balance. The gain recognized for contract costing purposes shall be limited to the difference between the acquisition cost (or for assets acquired under a capital lease, the value at which the leased asset is capitalized) of the asset and its undepreciated balance (except see subdivision (c)(2)(i) of this section).

The gain recognized for contract costing purposes shall be limited to the difference between the acquisition costs (or for assets acquired under a capital lease, the value at which the leased asset is capitalized) of the asset and its undepreciated balance 

Tomorrow we will look at a special kind of asset disposition, involuntary conversions.

Fines and Penalties - Part II

This is our second and final part in discussing FAR 31.205-15, Fines, Penalties and Mischarging Costs. Yesterday we discussed the "fines and penalties" section and today we will discuss the "mischarging costs" section.

Actually, this cost principle covers a whole lot more than just "msicharging". The entire section reads:

Costs incurred in connection with, or related to, the mischarging of costs on Government contracts are unallowable when the costs are caused by, or result from, alteration or destruction of records, or other false or improper charging or recording of costs. Such costs include those incurred to measure or otherwise determine the magnitude of the improper charging, and costs incurred to remedy or correct the mischarging, such as costs to re-screen and reconstruct records.

This section has caused a fair amount of confusion over the years. For one, the term "mischarging" is not defined in FAR. Second, is the question as to whether the mischarging is deliberate or inadvertent. The Government says both, contractors like to limit the applicability to "deliberate". This question has not been tested through the appeal process that we know of.

But the phrase that has caused a lot of ruckus over the years is "costs to re-screen and reconstruct records". A number of years back when the requirement to "certify" incurred cost submissions was instituted, many contractors withdrew their incurred cost claims and "scrubbed" them to ensure that all unallowable costs were identified and excluded. The Government took exception to these scrubbing costs. The Government reasoned that it had already paid for that service so why should they pay a second time. Additionally, contractors should have adequate systems in place to identify and exclude unallowable costs from their books and records used to support pricing and billings. Having to scrub those records a second time was tantamount to admitting that the accounting system was not adequate.

The auditors got aggressive and began to question "scrubbing" costs and any directly associated costs they could think of. Some contracting officers went along with the auditors but some did not. In order to ensure consistency, the Government added this provision in 1989.

These potentially unallowable activities still go on today but not nearly to the degree that they did back in the 1980s. Also, auditors have moved on to new hot-button issue and don't have time for this one. Thirdly, its difficult to compute a defensible cost impact as scrubbing activities are typically performed by indirect personnel who most likely, don't keep track of their time at this level of detail. Finally, contractors have made significant improvements in their systems for identifying and excluding unallowable costs from Government contracts.

Fines and Penalties - Part I

There is a FAR cost principle that addresses fines, penalties, and mischarging costs (see FAR 31.205-15). The "fines and penalties" part of this cost principle goes way back to 1940 and the "mischarging costs" portion was added in 1989.

The "fines and penalties" section of this cost principle provides that cost of fines and penalties resulting from violations of, or failure of the contractor to comply with Federal, State, local, or foreign laws and regulations, are unallowable except

• when incurred as a result of compliance with specific terms and conditions of the contract or 
• written instructions from the contracting officer. 

One would think that is fairly straight-forward however there have been a number of appeals over the years. Often times, the Government takes a position that any costs resulting from a contractor's violation of a law or regulation are in the nature of a fine or penalty. Is a payment made to an employee to settle an EEO claim a fine or penalty, or something else? The Government will usually argue that it is in the nature of a fine or penalty. But not necessarily.

There was a board case back in 1968 that illustrates this distinction. McDonnell Douglas had to pay additional workers compensation to the family of a worker killed on the job. California levied the additional workers compensation payments in order to penalize the employer for serious and willful misconduct.

The Board of Contract Appeals decided that the payments were awarded as the result of the serious and willful misconduct of the employer but not because of the violation of any law or regulation. Therefore, this cost principle was not applicable and the Government lost.

In another case, the Government used this cost principle to question payments that a contractor made to two job applicants who the EEOC (Equal Employee Opportunity Commission) found reasonable cause to believe that they had been discriminated against. The ASBCA found the cost allowable because the Government had not proved that the contractor had, in fact, discriminated against the applicants or otherwise violated any laws.

Tomorrow we will look at the "mischarging" element of this cost principle.

"Compensation" in the House Passed 2014 Defense Authorization Act

The House passed the 2014 National Defense Authorization Act earlier this month. Now its on to the Senate for consideration. This is a good time to take a look at what they've done with employee compensation recoverable by contractors under Government contracts.

First, it should be noted that the new coverage applies to all contractors, not just Defense contractors. Right now, there are different limits set on Defense, NASA, and Coast Guard contracts than for civilian agency contractors. That's confusing because contractors, with both Defense and non-Defense contracts must account for those difference when estimating and billing.

Secondly, there is a new definition for "senior executive". Currently it includes the five most highly compensated employees within each contractor component (e.g. division, subsidiary). Under the House version, it will apply to the five most highly compensated employees contractor-wide. Those five individuals will continue to be subject to the compensation cap methodologies that have been in place for some time. For fiscal year 2011, that cap is $763 thousand. The cap for 2012 has not yet been announced but is expected to top $900 thousand.

New to the compensation discussion is a cap on all contractor employees (except for the top five executives). The House NDAA would cap compensation for everybody at the $763 level and adjust that cap each year based on the U.S. Bureau of Labor Statistics Employment Cost Index for total compensation for private industry workers. The DoD or executive agency would be able to establish exceptions to those caps for positions in the science, technology, engineering, mathematics, medical and manufacturing fields upon a determination that such exceptions are needed to ensure that they have continued access to needed skills and capabilities.

The effective date for this proposed legislation would be 180 days after enactment. It seems to us that this provision, if enacted, is unlikely to impact a significant number of contractors. There doesn't seem to be that many contract employees whose compensation comes anywhere near that limit.

Proposal Adequacy - What Can Happen if You Don't Comply with Instructions

Last week we posted a four part series on the importance of ensuring that proposals comply with solicitation requirements, Table 15-2 of FAR 15.403, and other instructions. These are important issues and failure to comply can and probably will affect your chances of winning whatever contract you're bidding on. Lest you under-estimate the importance of complying, consider these recent appeal cases decided by the Comptroller General.

1. Compuline claimed that the Government did not reasonably evaluate its proposal. The Government argued that Compuline's proposal was appropriately rejected because it did not include some of the most basic information required by the RFP.

The Comptroller General (CG) evaluated the evidence and denied Compuline's appeal. The CG found that the Government appropriately rejected the proposal. Among other omissions, Compuline did not provide a required management or staffing plan, key personnel, past performance references, nor a cost proposal. In addition, the proposal did not follow the format required by the RFP.

2. Herman Construction submitted a proposal in PDF format when the solicitation very clearly required Excel format. Herman argued that PDF was an acceptable substitute for Excel. The CG did not sustain Herman's appeal because it deviated from clearly written solicitation instructions.

3. SMI challenged the Government's determination that its proposal was technically unacceptable. The CG looked at the evidence supporting the Government's action and sided with the Government. It found that SMI failed to provide a complete and realistic plan for satisfying performance objectives and that its proposal did not identify a plan and otherwise failed to address most of the requirements.

4. LC objected to the Government's evaluation of its proposal arguing that its proposal provided the Government with sufficient data and detail to demonstrate that it was technically capable of performing the contract. The CG looked at the evidence and found that LC had failed to demonstrate an acceptable technical approach in its proposal. LC insinuated that the Government was pretty dumb for not knowing the latest technology for producing the product. Had the Government understood, it would have properly evaluated the proposal (good way to win friends).

The CG sided with the Government stating, in effect, that LC's failure to comply with the requirements of the solicitation was reasonable grounds for rejecting the proposal.

These are just a few recent examples of cases where contractors failed to comply with the regulations and requirements and where their appeals were not sustained. It pays to follow instructions.

Department of Justice Settles Conflict of Interest Case

Here's an update to our post from March 4th of this year. In that post, we reported that the Department of Justice had indicted a former DCAA auditor for violating conflict of interest laws. According to the Department of Justice, this auditor left DCAA and went to work for Alaska Aerospace. While with Alaska Aerospace, she represented the company in a matter that she was personally involved in as a Government auditor.

Yesterday, the Alaska Daily News reported on how the case was settled.  The news article states:

An Anchorage woman, who is a former auditor for the Defense Department, was sentenced to two years' probation and ordered to pay a $5,000 fine for violating conflict of interest laws.

Jodi Ann Andres, 48, was sentenced in federal court on Monday, according to a media release from U.S. Attorney Karen L. Loeffler.

Andres broke a federal law by representing a contractor on issues she previously handled for the government.

Officials say Andres was an auditor with the Department of Defense from January 2003 to September 2006. She was the primary auditor of cost proposals, labor rates and claims for the Missile Defense Agency. But in September 2006, Andres left the DCAA to work for Alaska Aerospace as its controller.

In July 2008, Andres represented Alaska Aerospace during communications and negotiations with the DCAA about the same Missile Defense Agency contract she had previously audited. Prosecutors say this was a violation of a lifetime restriction that barred such communications.

Sounds to us like both sides of the issue wanted to close this case as quickly as possible. Two years probation and a $5 thousand fine is not all that significant, in the scheme of things.

Accounting System Adequacy - Canadian Company

The DoD-IG (Inspector General) issued a report last week that disclosed deficiencies in a contractor's accounting system that led to over-billings on cost-type contracts.

The contractor was General Dynamics Land Systems (GDLS) - Canada and the Government oversight organizations were DCMA (Defense Contract Management Agency) - Detroit and the Project Management Office Stryker Brigade Combat Team (PMO-Stryker). Because this was a Canadian company, Canada's Public Works and Government Services (PWGSC), not the Defense Contract Audit Agency (DCAA) was the responsible "audit" organization.

The DoD-IG found deficiencies in the way the contract was administered. They found that DCMA and PMO-Stryker officials did not verify that General Dynamics' accounting system was adequate to properly account for costs on a cost-type contract. In fact, the DoD-IG laid the blame on Government officials, not the contractor because the Government officials should have performed some minimal effort to ascertain that GD had a lousy accounting system. The DoD-IG also criticized DCMA for not coordinating with Canada's contract auditors to determine the sufficiency of GD's accounting system.

As a result of the deficiencies noted, GD charged $867 million to the wrong contract line item (and to the wrong fiscal appropriation). This caused violations to the Anti-Deficiency Act (ADA). Moreover, the DoD-IG found that no one in the Government had a clue as to whether $1.5 billion charged to the contract were allowable costs under the contract.

The DoD-IG recommended that the Director of Defense Procurement and Acquisition Policy get on the stick and make sure that Canada's contract auditing arm, the PWGSC, start auditing in a manner that complies with U.S. fiscal laws and auditing standards. Additionally, PWGSC needs to assess whether GD's accounting system is adequate for Government contracting purposes. Finally, the DoD-IG wants the Army to determine whether the extent of ADA violations and report those up the chain.

There is a lesson here for contractors who have or are considering subcontracts with foreign companies. If those subcontract costs require audit or oversight, don't assume that other countries have the same rigorous contracting and accounting standards that we have here. You might need to take a few extra steps to ensure the propriety of their costs and their cost allocation systems.

Commonsense Contractor Compensation Act of 2013

Its about time for our periodic update on contractor compensation. Our last update was on June 7 where the 2014 NDAA (National Defense Authorization Act) had come out of committee with a formula that would freeze the current cap except for a cost of living adjustment.We don't know whether that proposal will get too far, probably not.

There's a new bill that was simultaneously introduced in the Senate (S. 1192) and the House of Representatives (HR 2444) on June 19, 2013 that, if enacted, will cap everybody's salaries at the level of the Vice President's (currently $230,700). The purpose of the Act is " to implement common sense controls on taxpayer-funded salaries of government contractors by limiting reimbursement for excessive compensation.". The bill, which would apply to both Defense and civilian contracts reads:

Costs of compensation of contractor and subcontractor employees for a fiscal year, regardless of the contract funding source, to the extent that such compensation exceeds the rate payable for the Vice President under section 104 of title 3, United States Code, except that the head of an executive agency may establish one or more narrowly targeted exceptions for scientists, engineers, or other specialists upon a determination that such exceptions are needed to ensure that the executive agency has continued access to needed skills and capabilities.’

The bill also includes a reporting requirement for those "narrowly targeted" exceptions to the compensation caps. Within 90 days after the end of the fiscal year, agencies must report to Congress;

• the total number of contractor employees, by executive agency, in the narrowly targeted exception positions described under subsection (a) during the preceding fiscal year;
• the taxpayer-funded compensation amounts received by each contractor employee in a narrowly targeted exception position during such fiscal year; and
• the duties and services performed by contractor employees in the narrowly targeted exception positions during such fiscal year.

Seems like there might be some privacy issues in such reports. In any event, this seems to be another Congressional posturing event as GovTrack.us give the bill a 7 percent chance of getting out of the Senate Homeland Security and Governmental Affairs Committee and a 2 percent chance of ever getting out of House Armed Services Committee. 

By the way, the President's budget sets the cap at $400 thousand.

Proposal Adequacy - Table 15-2 - Formats

We are going to conclude our four part series on what constitutes an adequate forward pricing submission according to FAR (Federal Acquisition Regulations). Table 15-2 of FAR 15.804 lays out very specific requirements for prospective contractors to follow when submitting price proposals. These requirements have been in FAR for a long time but DoD has recently begun to enforce them and to reject proposals that are not compliant. In some cases, a proposal rejection could end a contractor's quest to bid on a particular solicitation.

Part 1 - Background
Part 2 - General Instructions
Part 3 - Cost Elements

Section III of Table 15-2 specifies how submissions should be arranged. There are three examples provided, one for new contracts, one for change orders, modifications, and claims and the third for price revision/redetermination. We will focus on just the first one - New Contracts (including letter contracts).

The format for new contracts looks like this:

(1) This column lists the various proposed cost elements (e.g. materials, subcontracts, labor, other direct costs, fringe, overhead, general and administrative, FCCM, etc).

(2) The instructions in this column require contractors to enter those costs necessary and reasonable that, in their judgment, will properly be incurred in efficient contract performance.

(3) This column is optional, unless required by the Contracting Officer. Note, many proposals do not lend themselves to unit costing.

(4) This column is a reference to information supporting the specific cost elements. Many rejected proposals do not include adequate supporting data.

Many contractors have pricing applications, either commercially available or self-developed. Some that are designed specifically for Government contracting include summary level information that complies with the requirements of Table 15-2. If your system does not, or if you use Excel and Word to prepare your proposals, just be certain to add a section that summarizes the proposal in a manner that complies with Government expectations.

Proposal Adequacy - Table 15-2 - Cost Elements

We're continuing our series on how to ensure your pricing proposal is adequate before submitting it to the Government. It wasn't that long ago when proposal adequacy was not such a big deal. It was always a big deal with the auditors, but complaints to contracting officers were often met with something akin to "Well, do the best you can". Recently however, contracting agencies, and especially the Department of Defense, have come to realize that poorly prepared and supported proposals really do cause delays in negotiating contracts, not to mention an expenditure of more human resources than the Department is willing to squander. This realization led to two new checklists incorporated into the DoD FAR Supplement; one for pricing proposals and the other for forward pricing rate proposals (the latter is still a proposed regulation but we expect it to become final very shortly). The regulations accompanying these checklists require that contractors complete and submit them with their proposals.

Today we want to briefly discuss the basic requirements for the various cost elements that typically comprise a prospective contractor's proposal. You can refer to Table 15-2 for more detailed information. You can also refer to the DoD checklists to see how the Government "interprets" some of these requirements.

Materials. Contractors are required to provide a consolidated priced summary of individual material quantities included in the various tasks, orders, or contract line items being proposed and the basis for pricing (e.g. vendor quotes, invoice prices, inventory, etc). This includes raw materials, parts, components, assemblies and services to be produced or performed by others.

For all proposed items, the regulations require that you identify the item and show the source, quantity, and price. Contractors are also required to conduct cost or price analyses of all subcontractor proposals, as appropriate and include the results of those reviews as part of their own proposal.

Labor. Contractors (or prospective contractors) are required to provide a time-phased (e.g. monthly, quarterly, etc) breakdown of labor hours, rates, and cost by appropriate category and furnish bases for estimates of both required hours and hourly rates.

Other costs. Contractors must list all other costs not otherwise included in other categories. These would include special tooling and test equipment, travel, computer and consultant services, preservation, packaging and packing.

Indirect costs. Contractors must indicate how they computed and applied indirect costs, including cost breakdowns. They must show trends and budgetary data to provide a basis for evaluating the reasonableness of proposed rates. They must indicate the rates used and provide an appropriate explanation.

FCCM (Facilities Capital Cost of Money). When contractors elect to claim facilities capital cost of money as an allowable cost, they must also submit Form CASB-CMF and show the calculation of the proposed amount. We often see instances where contractors do not propose FCCM. Those that don't, are leaving money on the table.

Recently, we've seen a significant increase in the number of proposals rejected because they did not meet one or more of these requirements. Don't give the Government an excuse for rejecting one of yours.

Proposal Adequacy - Table 15-2 - General Instructions

This is the second in our series on pricing proposal adequacy. Table 15-2 of FAR 15.804 contains detailed instructions to prospective contractors on how to prepare and submit adequate proposals. These requirements are more than guidance or mere formality. Failure to comply with with the regulations risks the Government rejecting your proposal as inadequate. Although Table 15-2 applies to solicitations that require the submission of certified cost or pricing data, it has been called out by contracting officers for other types of procurements as well (e.g. data other than certified cost or pricing data).

The first general instruction requires the following information to be included on the first page of your pricing proposal. This might seem linke a somewhat mundane requirement but it is a requirement and it is the Number 1 item on DoD's adequacy checklist.

• Solicitation, contract, and/or modification number
• Name and address of offeror
• Name and telephone number of point of contract
• Name of contract administration office (if available)
• Type of contract action (i.e. new contract, change order, price revision, letter contract, etc)
• Proposed cost, profit or fee and total
• Whether you will require the use of Government property in the performance of the contract, and if so, what property
• Whether your organization is subject to CAS, has submitted a CAS Disclosure Statement, whether it has been determined adequate, and whether you have been notified that you are or may be in noncompliance
• The following statement

This proposal reflects our estimates and/or actual costs as of this date and conforms with the instructions in FAR 15.403-5(b)(1) and Table 15-2. By submitting this proposal, we grant the Contracting Officer and authorized representative(s) the right to examine, at any time before award, those records, which include books, documents, accounting procedures and practices, and other data, regardless of type and form or whether such supporting information is specifically referenced or included in the proposal as the basis for pricing, that will permit an adequate evaluation of the proposed price.

• Date of submission
• Name, title, and signature of authorized representative.

The second general instruction is a requirement to include an index, appropriately referenced, of all the certified cost or pricing data and information accompanying or identified in the proposal. In addition, you must annotate any future additions and/or revisions, up to the date of agreement on price, or an earlier date agreed upon by the parties, on a supplemental index (Item #3 on the DoD Adequacy Checklist).

Solicitations generally require specific information that must be included in the proposal. Often this information is unique to each solicitation. In addition to these specific requirements, the third general instruction requires an explanation of your estimating process including

1. The judgmental factors applied and the mathematical or other methods used in the estimate, including those used in projecting from known data; and
2. The nature and amount of contingencies included in the proposed price.

There are a few other general requirements to keep in mind; costs by contract line item (and a total of all line items), incurred costs, if any, and whether you have an FPRA (Forward Pricing Rate Agreement)

Don't take these requirements lightly. As we stated earlier, the Government, especially DoD, has been requiring a much higher level of compliance with these requirements. Save yourself time and grief by getting it right the first time.

Proposal Adequacy - Table 15-2

We're going to spend the next few posts discussing Table 15-2 under FAR 15-804. Table 15-2 is the instructions for submitting cost/price proposals when certified cost or pricing data are required. Some solicitations that require data other than certified cost or pricing data will specify the use of Table 15-2.

There is a very strong emphasis by the Government these days on ensuring that proposals and rate proposals are adequate. These are not new requirements - they've been around since the inception of the FAR in 1984. What is new about this requirement is the increased emphasis on compliance. According to DoD, adequate and well-supported proposals will

• facilitate the timely and efficient completion of the audit,
• reduce contractor effort needed to support an audit, and
• facilitate the negotiation process. 

DCAA (Defense Contract Audit Agency) and DCMA (Defense Contract Management Agency) as well as procurement contracting officers will often cite Table 15-2 as an authoritative source when commenting on a proposal's inadequacy. If deficiencies are significant enough, the forward pricing proposal or forward pricing rate proposal may even be rejected as inadequate.

The new DFARS checklist for Proposal Adequacy and the proposed DFARS checklist for Forward Pricing Rate Proposal Adequacy both source Table 15-2 as the basis for most of the checklist items.

The first section of Table 15-2 is a reminder of contractor's obligation to submit rather than make available. It states:

There is a clear distinction between submitting certified cost or pricing data and merely making available books, records, and other documents without identification. The requirement for submission of certified cost or pricing data is met when all accurate certified cost or pricing data reasonably available to the offeror have been submitted, either actually or by specific identification, to the Contracting Officer or an authorized representative. As later data come into your possession, it should be submitted promptly to the Contracting Officer in a manner that clearly shows how the data relate to the offeror's price proposal. The requirement for submission of certified cost or pricing data continues up to the time of agreement on price, or an earlier date agreed upon between the parties if applicable.

This is pretty straight-forward but the many defective pricing cases have been lost because contractors failed to "submit" data. It's not a defense to suggest that if the Government wanted something, all they had to do was ask.

The next section of Table 15-2 is a reminder that by submitting the proposal, the contractor is giving the Government access to its books and records.

By submitting your proposal, you grant the Contracting Officer or an authorized representative the right to examine records that formed the basis for the pricing proposal. That examination can take place at any time before award. It may include those books, records, documents, and other types of factual data (regardless of form or whether the data are specifically referenced or included in the proposal as the basis for pricing) that will permit an adequate evaluation of the proposed price.

Companies that cannot abide by the access to records requirement should probably not be bidding on Government contracts that require the submission of cost or pricing data.

Tomorrow we will look at the information required to be included on the first page of the proposal.

Access to Records - Requirement up for Renewal

The Paperwork Reduction Act requires that the regulatory agencies periodically submit for OMB's (Office of Management and Budget) review and approval, previously approved information collection requirements. This is one mechanism for ferreting out and eliminating outdated and no longer necessary regulations. This process also provides the public with the opportunity to "weigh in" and comment on the regulations. Most of the time however, these requests are approved with little or no public comment. After all, who wants to waste their time bashing (or suggesting improvements to) regulations when for the most part, those regulations are based on statutory requirements. You're not going to eliminate the regulation unless you first change the law.

So it is today where we see that the FAR councils have requested OMB to review and approve an extension of information collection requirements concerning the examination of records by comptroller general and contract audit.

Government contractors are required to maintain certain records and to ensure the Comptroller General and/or agency have access to, and the right to, examine and audit records, which includes: books documents, accounting procedures and practices, and other data, regardless of type and regardless of whether such items are in written form, in the form of computer data, or in any other form, for a period of three years after final payment. This requirement is necessary for examination and audit of contract surveillance, and verification of contract pricing, and to provide reimbursement of contractor costs, where applicable.

The records retention period is required by the statutory authorities at 10 USC 2313.41, 41 USC 254, and 10 USC 2306. These statutory provisions are implements through the following FAR clauses:

• 52.215-2, Audit and Records - Negotiation
• 52.212-5, Contract Terms and Conditions Required to Implement Statutes or Executive Orders
• 52.214-26, Audit and Records - Sealed Bidding

(By the way, none of these clauses require contractors to create or maintain any records that the contractor does not normally maintain in its usual course of business. That is a discussion for another day).

What's interesting about this request is the FAR council's estimate of hours required to comply with this regulation. They have estimated a total burden to Government contractors (and subcontractors) of 153 thousand hours per year or about 75 FTEs (full-time equivalents). That's based on contractors having to provide access to its books and records 10 times a year and taking one hour for each incident. That, to us, is a scoffingly low estimate.

Accelerating Payments to Small Business Subcontractors - Policy Extended

About a year ago, we reported on OMB's initiative to accelerate payments to small business subcontractors. The initial program was set to expire this month (July 11th). OMB just announced at extension of the policy for another year. Essentially, this directive encouraged expedited payments to prime contractors so that those contractors, in turn, could expedite payments to its subcontractors, especially its small business subcontractors.

According to the OMB (Office of Management and Budget) "... this initiative is part of the Administration's ongoing commitment to supporting small business growth and prosperity, as an engine to drive economic activity and job creation". Under the policy all Executive Branch agencies (including the Department of Defense) should, to the full extent permitted by law, temporarily accelerate payments to all prime contractors - with a goal of paying them within 15 days of receipt of "proper invoices" in order to allow them to provide prompt payments to small business subcontractors.

Some agencies have incorporated clauses in their prime contracts that require contractors to accelerate payments to their small business subcontractors when they receive accelerated payments from the government. However, small business subcontractors we've talked to have not yet seen any accelerated payments as a result of this policy. For them, its business as usual.

From a Government oversight perspective, this is one of those provisions that would be nearly impossible to monitor. Contract administrators are not staffed to go out looking for compliance. DCMA is not going to send someone out to ensure a contractor, who has benefited from accelerated payments, is, in turn, accelerating payments to its subcontractors.

From a contractor's perspective, this policy would require significant changes to its business systems. It would need to set up some kind of exception system to identify contracts subject to accelerated payments and then, if it received an accelerated payment from the Government, it could, it turn, accelerate payments to small business subcontractors. The transient nature of this policy (one year but now extended for one more year) makes it unlikely that contractors could justify the cost required to modify existing systems.

As part of this policy, OMB is asking agencies to provide bi-annual reports on their progress in making accelerated payments "...including steps the agency has undertaken to ensure that small business subcontractors are paid in a prompt manner. Good luck getting meaningful data on that.

GSA Announces New Reverse-Auction Platform

GSA (General Services Administration) announced Tuesday the launch of a government-managed reverse auction program. GSA expects the new program will deliver savings for federal agencies on everything from office products, equipment and services. The GSA estimates that agencies will save about 17 percent on their purchases. The GSA also believes that the program will make it easier for small businesses to compete for the Government's business.

In a reverse auction, sellers compete to win business from various Government agencies. Prices will typically decrease as the competitive auction progresses. The reverse auction concept has a number of anticipated benefits including;

• Shorter processing times
• Driving prices down
• Improves transparency and collection of data
• Allows for small business set-asides

Reverse auctions have been used for a number of years now by a lot of companies including Fortune 500 companies. The success has been somewhat limited for many companies. One company complained that its purchasing team was not fully engaged in the process. Others blamed supplies for not buying in to the concept. That's understandable we guess. If reverse auctions work well, supplies are going to find increased competition and lower costs.

From an internal control standpoint, it should be easier to design protections against supplier kickbacks and other forms of improper activities with reverse auctions than with traditional procurement. The "human" factor in deciding who to buy from is replaced by very objective criteria - lowest price wins.

You can learn more about GSA's reverse auction process here.

UPDATE (July 15, 2013):

Does the Government compete in reverse auctions? We came across this posting:

I recently heard from a contractor regarding an experience he had with reverse auctions. A federal agency was conducting a reverse auction using FedBid and he decided to compete (FedBid, Inc., provides a service whereby federal agencies can conduct reverse auctions). Although he submitted several bids, he ultimately lost the reverse auction. When he checked to see who had won, he was surprised to see that the federal agency that was in need of the required items was the low bidder. In other words, the federal agency was submitting bogus bids in an effort to get the contractor to reduce his bid price. The federal agency then contacted him and offered to purchase the items from the contractor at his lowest bid price. Feeling that he had been duped, he told them to get lost.

The tactic employed by the federal agency, called phantom bidding, is not new. Many view the practice as unethical while others see it as a legitimate tactic. In regular auctions, the legality of seller participation in bidding varies from state to state. For those states that allow it, sellers typically must disclose that they reserve the right to participate in the bidding. 

In any case, should the Federal Government be allowed to place phantom bids in reverse auctions? Would your answer be different if the disclosure of the practice was required prior to the reverse auction?

You can read the entire posting and the comments here.

DoD Civilian Furloughs Have Begun

Starting this week, about 650 thousand Defense Department civilians are taking their furlough days. At one time, DoD projected that its employees would have to take 22 furlough days. Now, its down to 11 days; one day a week for the next eleven weeks. DoD estimates that this will save almost $2 billion between now and the end of the fiscal year (September 30th).

There are a lot of stories, articles and blogs warning of dire consequences resulting from these furloughs. With respect to Government procurement, companies might see delays in contract negotiations and contract awards. Contractors might get slower responses (it that's possible) from their contract administrators (DCMA). The auditors will still prioritize demand work (e.g. proposal evaluations) and that means that they'll slip that much further behind in beating down their incurred cost audit backlog. Billings should not be significantly affected because of the prompt payment act but you might see payments pushed back closer to the 30 day maximum instead of the customary 15 or 20 days.

We think that the impact on performance will be much greater than the eleven furlough days. We've gone through these before. The memos, staff meetings, and water cooler discussions that precede furlough days eat into productive time. Feeling overworked yet very under-appreciated wears on ones psyche. You don't really want to start something when you come back from a furlough day because you know the next one is coming up.

Last month, DoD issued a memo warning against "borrowing" military manpower to perform civilian duties. The memo also warned against using contractors to fill civilian roles.

Unless Congress acts to remove the sequestration, future years will be similarly impacted. Already DoD is warning Congress of the impact on the fiscal year 2014 budget. Additional furlough days in fiscal year 2014 is already being touted as a way of dealing with sequestration-based shortfalls.

Once Section 8(a), Always Section 8(a)

Section 8(a) of the Small Business Act (15 USC Sec 637(a)), authorizes the SBA to enter into contracts with Government agencies and to arrange for performance through subcontracts with socially and economically disadvantaged small business concerns. The Act affords the SBA and contracting agencies broad discretion in selecting procurements for the 8(a) program.

In a recent appeal, a contractor argues that a particular solicitation was improperly set aside as an 8(a) competition because the SBA failed to perform an adverse impact analysis as required by 13 CFR Section 124.504(c). The contractor claimed that it was adversely impacted by the decision to set aside the solicitation as an 8(a) award, given that it is a small business, but no longer a certified 8(a) contractor.

The SBA contended that no adverse analysis was required because the work solicited was a follow-on shuttle bus service contract performed by the appellant when it was still an 8(a) contractor. The SBA further contended that the requirement is, therefore subject to the "once 8(a), always 8(a)" rule set forth at 13 CFR 124.504(d), which precludes removing follow-on requirements from the 8(a) program unless they are specifically released by the SBA from the program for non-8(a) competition.

The Comptroller General sided with SBA. It concluded:

Under the circumstances, and, given the deference we accord the SBA’s interpretation of its regulations, we find the SBA’s determination--i.e., that the current solicitation is a follow-on to the previous contracts to obtain these services under the 8(a) program, and, is thus subject to the “once 8(a), always 8(a)” rule--is not inconsistent with applicable SBA regulations. In this regard, the pertinent regulation provides, “where a procurement is awarded as an 8(a) contract, its follow-on or renewable acquisition must remain in the 8(a) . . . program unless the SBA agrees to release it for non-8(a) competition.” 13 C.F.R. § 124.504(d)(1). For procurements covered by this regulation, no adverse impact analysis is required. We cannot find the SBA’s position in this regard to be inconsistent with applicable regulations.

You can read the entire decision here.

Purchase Card Transaction Fees

We noted a cases recently where contractors voluntarily deleted the fees it pays to banks for processing credit card charges on the basis that they represent interest expense. We are also aware of a case in the not too distant past where an auditor questioned these fees as unallowable interest.

Most likely, these fees are allowable.

Many contractors allow purchasers, including the Government, to pay for purchases through the use of a purchase card (P-Card, credit card, etc.) When a contractor accepts a purchase card for payment of goods and services, the contractor is charged for transaction costs, generally referred to as "merchant fees". Merchant fees include fees paid by the contractor for processing payment through the credit card network for:

• the contractor's bank,
• the credit card company (e.g. VISA or MasterCard), and 
• the card-issuing bank 

Auditors sometimes take the position that these fees represent unallowable interest costs because the fees are expressed as a percentage of the amount of the transaction. However, the transaction fees associated with the use of the purchase card represent a charge for administrative processing and do not represent interest on borrowings.

While these fees are not unallowable under the "Interest" cost principle (FAR 31.205-20), there could still be an "allocability" issue. For example, if commercial customers pay using a credit card but the Government customers do not, its likely that an auditor will say that the Government does not benefit from the fees and those fees should be excluded for indirect costs allocated to Government contracts. On the other hand, there could be similar "processing" costs that benefit the Government in greater proportion than commercial customers.

Contractors that have been questioned in this area may benefit from outside help.

Service Contracts and Incumbent Employees

This is an update to our posting of May 3, 2012 wherein we described the proposed regulations to implement Executive Order (EO) 13495, "Non-displacement of Qualified Workers Under Service Contracts", issued by the President back in January 2009. Those regulations were finalized and became effective on solicitations issued after January 18, 2013. The regulations require that workers on a federal service contract who would otherwise lose their jobs as a result of the completion or expiration of a contract be given the right of first refusal for employment with the successor contractor. The regulations apply to all service contracts (both prime contracts and subcontracts) above the simplified acquisition threshold (currently $150,000) that succeed contracts for the same or similar services at the same location.

Virginia thinks this new rule is a good one. She was 62 years old and described herself as an excellent worker with good appraisals and extremely reliable. She and everyone else over 60 years old were not offered their jobs by a successor contractor. Stan thinks its a bad rule. Stan says that this rule denies companies who have full responsibility for performance under the contract, their ability to select a worforce they believe is best suited to meeting the contract requirements.

According to the Department of Labor, the Federal Government's procurement interests in economy and efficiency are served when the successor contractor hires the predecessor's employees. A carryover work force reduces disruption to the delivery of services during the period of transition between contractors and provides the Federal Government the benefits of an experienced and trained work force that is familiar with the Federal Government's personnel, facilities, and requirements. The EO recognizes that successor contractors or subcontractors already often hire the majority of the predecessor's employees when a service contract expires and follow-on contract is awarded for the same or similar services at the same location. Sometimes, however, a successor contractor or subcontractor displaces the predecessor's employees and hires a new workforce.

Contracts under the $150,000 simplified acquisition threshold are exempt from this EO. So are contracts awarded for services produced or provided by persons who are blind or have severe disabilities. Agency can also exclude contracts and subcontracts if the head of a contracting department or agency finds that the application of any of its requirements would not serve the purposes of the EO or would impair the ability of the Federal Government to procure services on an economical and efficient basis (the so-called "union-busting" provision). Any such decision must be made no later than the contract solicitation date, and incumbent workers and their collective bargaining representatives are to be notified in writing of the agency determination no later than 5 business days after the solicitation date.

Service employees must be advised of their right of first refusal by either a poster or individual notice. DOL has a poster here. The predecessor contractor must provide the contracting officer a list of all service employees working under the contract (and subcontracts) within 30 days before the end of the contract. The contracting officer will furnish the list to the successor contractor. The successor contractor is required to offer the right of first refusal of employment to all qualified employees whose names appear on the predecessor's list except that the successor contractor may employ on the contract employees who worked for that contractor for at least three months immediately preceding commencement of the contract and who would otherwise face lay-off or discharge.

Successor contractors have the discretion to determine how many employees are needed for efficient performance of the contract. They may employ fewer employees than the predecessor contract. Also, offers made to employees of predecessor contractors must be "bona fide" offers. There is nothing in the regulation that requires successor contractors to match the pay or benefits of the predecessor contractors but contractors won't be permitted to "low-ball" employment offers simply to discourage incumbents from accepting positions (more on what constitutes "bona fide" offers of employment in 29 CFR 9.12).

The Importance of Data Entry Accuracy

Everyone has heard the axiom, "garbage in, garbage out" (GIGO). The term originated and is still mostly associated with the field of information technology. It refers to the fact that computers will unquestioningly process the most nonsensical of input data (garbage in) and produce nonsensical output (garbage out).

This illustrates why auditors of all stripes, financial auditors, internal auditors, Sarbanes-Oxley auditors, and government auditors, are profoundly concerned with "data input controls". We are not yet "paperless" and much of the data that goes into computers, originates with paper. Someone has to glean data from paper and enter it into the computer.

Take a simple purchase, for example. The purchase might originate with a purchase request which goes to a "buyer" who initiates a purchase order. The purchase order goes to a vendor who fills the order, issues an invoice, a picking slip, and perhaps a packing slip. The customer receives the invoice which must be entered into a computer. The shipping/receiving department receives the merchandise, verifies receipt (kinds and quantities) and probably enters that into a computer. Consider the potential for data to get messed up along the way. A simple date slip up could mean the difference between getting and losing an early payment discount. An address mistake might send the product to the wrong company. A coding error could send the cost to the wrong account, or the wrong project.

All companies, and Government contractors in particular need internal controls in place to help ensure that all input data are authorized and complete, and data are consistently recorded, accumulated, processed, and reported in a controlled environment to produce timely and accurate information. These controls normally include written procedures for originating, authorizing, collecting, preparing, and approving input transactions to the contractor's accounting system.

When auditors begin their work, they first assess the adequacy of internal controls. Strong controls typically mean that auditors can scale back the number of transactions they need to review. Concerning data entry controls, the auditors might look to see if the company has implemented the following:

• Documentation exists to identify all input data and/or files
• There are established authorization procedures for all source documents feeding the system.
• The functions of originating, approving, and converting source documents into computer data are adequately segregated. If anyone in the data input area performs more than one of the operations related to the origination, entering, processing, or distribution of data, there should be compensating controls for the lack of segregation of duties.
• All input data is properly authorized, validated, and recorded
• All authorized data remains complete, accurate, and valid through the source document origination process.
• All input data is transmitted in a timely manner.
• Source documents are periodically reviewed for proper completion and approval
• Erroneous source documents are handled appropriately and are not entered into the system.
• An audit trail is maintained during and after data input.

It might be useful to self-assess how your internal controls stack up against these attributes.

Whistleblower Protections for Subcontractor Employees

Contracts awarded after July 1, 2013 have enhanced whistleblower protection provisions. Based on a provision of the 2013 NDAA (National Defense Authorization Act) signed into law last January, subcontractor employees have some new protections when blowing the whistle on fraud, waste and abuse. See our previous posting on this subject for details of the provision. Essentially, the new law gives subcontractor employees the same protections against reprisals that are now afforded to employees of prime contractors.

This provision is not retroactive to contracts (or subcontracts) awarded prior to July 1, 2013 which may discourage some subcontractor employees from reporting instances of fraud, waste, and abuse in the near term. The DoD-IG (Inspector General) however expects more calls to its hotline as a result of this new law. In 2006, it received 16 calls to its hotline. By 2012, the number had increased to 85 reports. To handle the projected increase, the DoD-IG has increased its staff by 30 percent.

According to the DoD-IG, past whistleblower allegations have included

• Equipment being thrown out when it is perfectly good
• Billing against one contract for work performed on another
• Swapping in personnel that don't have the requisite expertise to perform the work.

On a related note, to contractors and subcontractors alike, don't forget to display a hotline poster.

On a cautionary note to potential whistleblowers, not every disclosure is protected. Know the rules on who you can report you concerns without fearing reprisal.

Proposed FAR Rule Wants to Retroactively Cap Compensation Caps

Last Friday we discussed the interim FAR provision that limits compensation that can be recovered under Government contracts. This compensation cap has been applied to top executives for a number of years but beginning in 2012, it applies to all employees. That cap is set pretty high, currently $763 thousand (set to increase for 2012) and so most Government contractors will not be impacted. However, Congress is right now, considering lowering that cap to $400 thousand (the President's salary) or $230 thousand (the Vice President's salary). Either of those caps will impact many more contractors than the one currently in place.

There's a companion rule published in the form of a Proposed Rule (not to be confused with an Interim Rule) that would extend this provision to contracts that were in existence at the time the 2012 NDAA was signed into law, December 31, 2011.this Section 803 of the 2012 NDAA retroactively.  This proposed rule and the interim rule we reported on last Friday arise from the same NDAA provision. However, the FAR councils bifurcated the provision because of what happened last time Congress passed legislation that applied retroactively to existing contracts.

On 18 November 1997, the National Defense Authorization Act for Fiscal Year 1998 (NDAA or Act), Pub. L. No. 105-85, 111 Stat. 1629 (1997), was enacted. Section 808 of the Act, 111 Stat. at 1836, effective 90 days after the date of enactment, imposed a fixed cap on allowable executive compensation costs, making unallowable all such costs that exceeded a benchmark compensation amount to be determined annually by the Administrator for Federal Procurement Policy. It is undisputed and we find that the Section 808 cap covered cost reimbursable or fixed-price incentive contracts in excess of $500,000, and applied to all executive compensation costs incurred after 1 January 1998, whether the contracts were awarded on, before or after the date of enactment of the Act. 

In essence, the contractors argument is based on the allowable cost and payment provisions that provides that costs will be determined based on the FAR cost principles in effect as of the date of contract award.

After the Government attempted to apply that provision, a number of contractors appealed. The courts and boards ruled that imposing that provision retroactively was tantamount to a breach of contract. In order to avoid a costly repeat, the FAR Councils have made this part of the Legislation a "proposed rule" and have asked for public comment. Frankly, we don't see how anyone is going to come up with a solution that satisfies both the intent of the legislation and complies with Government contracting principles. If you do want to weigh in on the issue, public comments are due by August 26th.