New Minimum Wage is Here for Government Contractors

On June 25th, the GSA (General Services Administration) issued a "class deviation" to FAR that requires all Civilian Agencies (except NASA) to implement the President's minimum wage executive order effectively immediately. DoD followed suit the next day, June 26th. The class deviation applies to solicitations issued after these dates or after the date of the Executive Order (February 12, 2014), if feasible (such as where the solicitation is being otherwise amended). The class deviation also applies to subcontracts.

The new minimum wage beginning January 1, 2015 will be $10.10 per hour.

Under the class deviation, each service employee, laborer, or mechanic employed in the United States (the 50 states and the District of Columbia) in the performance of this contract by the prime Contractor or any subcontractor, regardless of any contractual relationship which may be alleged to exist between the Contractor and service employee, laborer, or mechanic, shall be paid not less than the applicable minimum wage under Executive Order 13658. The minimum wage required to be paid to each service employee, laborer, or mechanic performing work on this contract between January 1, 2015, and December 31, 2015, shall be $10.10 per hour.

That rate won't last. Contractors will be required to adjust the minimum wage each time the Secretary of Labor’s annual determination of the applicable minimum wage results in a higher minimum wage. The Secretary of Labor will publish annual determinations in the Federal Register no later than 90 days before such new wage is to take effect. The applicable published minimum wage is incorporated by reference into this contract.

Annual Incurred Cost Submissions are Due in a Three Days

Government contractors with cost-type contracts and whose accounting period is the calendar year, have just a couple of more days to submit their final incurred cost submissions for 2013. According to FAR 52.216-7(d)(2) contractors are required to submit their annual submissions within six months after year end. If you are uncertain as to whether the requirement applies to you, check your contract(s) to see if the aforementioned clause is included.

Many contractors are now in the position of needing an extension for submitting their final incurred cost rate proposals. Some have and will mistakenly make a request for an extension to DCAA (Defense Contract Audit Agency). That would be wrong. FAR 42.302 and FAR 42.705-1(b)(1)(ii) give that responsibility to the Administrative Contracting Officer (ACO). ACOs for DoD are typically part of DCMA (Defense Contract Management Agency). If you are uncertain who your ACO is, contact DCMA.

Any request for extension should include the rationale for requiring additional time. There is no guarantee that the ACO will accept the rationale or grant an extension. Based on our experience however, ACOs have routinely granted reasonable extensions of 30 or 60 days.

Even though the Government may not get around to auditing your incurred cost proposal for several years, the submission is still important from the Government's perspective to adjust provisional billing rates to the final rates. Differences should be reflected in the next billing cycle.

Contractors Should Love This Contracting Officer

Two days ago, we discussed a recently published report by the DoD Inspector General (DoD-IG) on its investigation of a hotline complaint alleging that high level management from DCAA (Defense Contract Audit Agency) and DCMA (Defense Contract Management Agency) had exerted undo influence in settling a case for $500 million less than the Government's estimate of damages. The charge was that the Government chose to settle for an amount that was agreeable to the contractor, not what was fair to the taxpayer. Click here if you missed that posting.

While we're on the subject of DoD-IG reports, the Agency issued another report last week involving DCAA and DCMA and a hotline complaint. In this case, the "large DoD contractor" was not named. Here's what happened.

The complainant alleged that the DCMA contracting officer did not take timely or appropriate action on several DCAA audit reports covering the business systems of a large DoD contractor. (any doubt that the complainant was a frustrated DCAA auditor?)

The hotline complaint was substantiated. Even though DFARS (DoD FAR Supplement) states that the contracting officer should make a final determination with 30 days, the contracting officer has so far take up to 1,373 days and still counting. As of the date of the report (June 20, 2014), the contracting officer had still not issued a final determination. Additionally, the DoD-IG investigation revealed that the contracting officer had not implemented withholdings for significant deficiencies. But DCAA also shared some blame. The DoD-IG reported that DCAA did not obtain sufficient evidence in support of a memorandum that stated the contractor "appeared" to have implemented adequate controls for the remaining estimating system deficiencies.

The DoD-IG recommended that the Director of DCMA instruct the contracting officer to make a final determination on the compensation system, ensure the contracting officer implements withholding for any disapproved business systems and develop a written corrective action plan for improving DCMA quality assurance procedures to help ensure timely final determinations and implementation of monetary withholds for significant deficiencies. DCMA agreed.

The DoD-IG recommended that the Director of DCAA rescind its "appearance" memorandum and initiate follow-up audits of the reported business system deficiencies. DCAA did not agree with most of the DoD-IG recommendations.

We've seen many cases like this. As former auditors ourselves, we were often frustrated by the contracting officer's lack of responsiveness in resolving audit issues and identified deficiencies. In most cases, that reluctance was primarily because the contracting officer remained unconvinced that the deficiencies were material or the deficiencies were backed up with adequate facts and data.

New FAR Interim Rule - Limitation on Allowability of Compensation

The compensation cap is now an official regulation, albeit an interim regulation. The FAR Councils yesterday issued an interim rule amending the FAR to implement Section 702 of the Bipartisan Budget Act of 2013. This interim rule revises the allowable cost limit relative to the compensation of contractor and subcontractor employees. Also, the interim rule implements the possible exception to this allowable cost limit for scientists, engineers, or other specialists upon an agency determination that such exceptions are needed to ensure that the executive agency has continued access to needed skills and capabilities.

The new act limits both contractor and subcontractor employee compensation. It changes the application of the cap, the amount of the cap, and the formula for adjusting the cap. Currently, the cap is set at $487 thousand for contracts awarded after June 24, 2014. The cap will be adjusted annually to reflect changes in the Employment Cost Index for all workers, as calculated by the Bureau of Labor Statistics.

The interim rule also authorizes the head of executive agencies to 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. We have no idea how that is going to work. Obviously, a contractor is going to have to propose an exception but the authority to grant the exception does not rest with the contracting officer but with heads of Executive agencies (or more likely, a designee). It seems like this process could get bogged down real quick. How is a contractor supposed to justify an exception to the rule? Perhaps compensation surveys would play a role but we all know that different compensation surveys produce wildly different results for similar positions within geographical areas. Seriously, does anyone want to leave it up to DCAA (Defense Contract Audit Agency) to perform some of their famous compensation reviews (e.g. see "fatally flawed" here and "inappropriate surveys" here)?

Contracts and subcontracts awarded before June 24, 2014 (yesterday) are still subject to the old cap which currently sits at $952 thousand.

One last comment, the Government is quick to point out that this interim rule doesn't limit what contractors can pay their employees. It only limits the amount that can be recovered under Government contracts.

This may not be the end of the compensation cap wars. There are still those in Congress who believe that the cap should be set at the President's salary and other who believe the cap should be set at the Vice President's salary. However, cutting the cap nearly in half from $952 thousand to $487 thousand should take a lot of pressure off the need to do more.

(p) Limitation on allowability of compensation. (1) Senior executive compensation limit for contracts awarded before June 24, 2014. (i) Applicability. This paragraph (p)(1) applies to the following:

(A) To all executive agencies, other than DoD, NASA, and the Coast Guard, for contracts awarded before June 24, 2014;

(B) To DoD, NASA, and the Coast Guard for contracts awarded before December 31, 2011;

(ii) Costs incurred after January 1, 1998. Costs incurred after January 1, 1998 for the compensation of a senior executive in excess of the benchmark compensation amount determined applicable for the contractor fiscal year by the Administrator, Office of Federal Procurement Policy (OFPP), under 41 U.S.C 1127 as in effect prior to June 24, 2014, are unallowable (10 U.S.C. 2324(e)(1)(P) and 41 U.S.C 4304(a)(16), as in effect prior to June 24, 2014). This limitation is the sole statutory limitation on allowable senior executive compensation costs incurred after January 1, 1998, under contracts awarded before June 24, 2014, and applies whether or not the affected contracts were previously subject to a statutory limitation on such costs. (Note that pursuant to section 804 of Pub. L. 105-261, the definition of “senior executive” in paragraph (p)(4) has been changed for compensation costs incurred after January 1, 1999.)

(2) All employee compensation limit for contracts awarded before June 24, 2014. (i)Applicability. This paragraph (p)(2) applies to DOD, NASA, and the Coast Guard for contracts awarded on or after December 31, 2011 and before June 24, 2014;

(ii) Costs incurred after January 1, 2012. Costs incurred after January 1, 2012, for the compensation of any contractor employee in excess of the benchmark compensation amount, determined applicable for the contractor fiscal year by the Administrator, Office of Federal Procurement Policy (OFPP) under 41 U.S.C 1127 are unallowable (10 U.S.C. 2324(e)(1)(P)).

(3) All employee compensation limit for contracts awarded on or after June 24, 2014. (i)Applicability. This paragraph (p)(3) applies to all executive agency contracts awarded on or after June 24, 2014, and any subcontracts thereunder;

(ii) Costs incurred on or after June 24, 2014. Costs incurred on or after June 24, 2014, for the compensation of all employees in excess of the benchmark compensation amount determined applicable for the contractor fiscal year by the Administrator of the Office of Federal Procurement Policy are unallowable. See http://www.whitehouse.gov/omb/procurement/cecp.

(iii) Exceptions. An agency head 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. In making such a determination, the agency shall consider, at a minimum, for each contractor employee in a narrowly targeted excepted position—

(A) The amount of taxpayer funded compensation to be received by each employee; and

(B) The duties and services performed by each employee.

Stonewall and earn $500 million

Back in 1996, based on a DCAA (Defense Contract Audit Agency) audit report, a DCMA (Defense Contract Management Agency) contracting officer determined that Pratt Whitney was in noncompliance with several CAS (Cost Accounting Standards) requirements. The impact of that noncompliance between 1984 and 1995 was $260 million. Essentially, the case dealt with the composition of costs in the indirect expense allocation base. The larger the allocation base, the lower the indirect rate.

Subsequently, the Government made a demand against Pratt Whitney for the increased costs. Pratt Whitney appealed the decision to the ASBCA (Armed Services Board of Contract Appeals). The ASBCA decided in favor of Pratt Whitney in 2001. The Government appealed the ASBCA decision to the U.S. Court of Appeals. In 2003, the court vacated the ASBCA decision and remanded the case back to ASBCA for a determination of damages.

In 2003, the Government updated its impact to include years up to 2002. The cost impact at that point had risen from $260 million to $755 million. In 2006, a contract management official from DCMA settled the whole mess for $283 million.

Then came the hotline call to the DoD Inspector General (DoD-IG). The complainant alleged that there was pressure from the highest levels of DCAA and DCMA to settle the litigation for an amount that was agreeable to the contractor (Pratt Whitney) rather than an amount that was fair to the taxpayers.

After an eight year investigation, the DoD-IG was unable to substantiate the allegation but it did find a host of other problems. The DoD-IG obtained and analyzed DCAA and DCMA legal, negotiation, and settlement files and documents, obtained and analyzed relevant e-mail communications relating to negotiation and settlement, reviewed applicable laws, regulations, DoD Instructions, DCMA instructions, and DCAA policies, and conducted interviews with DCAA and DCMA personnel. Even though the DoD-IG concluded that actions taken by various Government officials to explore the feasibility of an administrative settlement with Pratt Whitney in lieu of continued litigation did not constitute pressure to settle for $500 million less than what the Government determined had been overbilled, it found plenty of problems in the settlement process. Seems like the Government just wanted to settle, no matter the cost. It had people doing things they were not qualified to do - like DCAA weighing in on "litigative risks".

Don't like the Government's position on something? Just wait them out. Everyone vested in the dispute will leave/retire and their successors will not like their inheritance.

You can read the entire DoD-IG report here.

Plea Agreement in Timecard Fraud

The Tri-City Herald reported last week that a former DOE contractor employee has plead guilty to timecard fraud. That former employee, according to the plea agreement now faces four months in prison, three years of probation, a $20 thousand fine, and has agreed to cooperate with prosecutors in trials of other defendants in a huge timecard fraud scheme.

The timecard fraud is not a new story. We reported on it more than a year ago when the allegations were first reported. See here and here, for example. The contractor has already settled up with the Government on its role by paying back $18.5 million. However, the Justice Department is pursuing criminal fraud charges against 10 employees who also participated and personally benefited from the scheme.

This case involved payments of overtime for hours not worked. At the DOE site, overtime was voluntary but in order to get workers to volunteer for overtime, the contractor promised them eight hour shifts, regardless of how long it took to perform the actual work. In many cases. the work did not require the full eight hours so employees left their work sites early, while still charging the Government for eight hours of overtime work. Additionally, timecard fraud occurred during regular shifts when it was noted that a "steady stream of workers" began leaving work at 2:30 p.m. for shifts that should have lasted until 4:30 p.m.

One very interesting disclosure that wasn't reported earlier (or at least we didn't pick up on it from earlier news accounts and DOJ press releases), was the Government's use of GPS devises. The Tri-City Herald reported:

Global positioning system surveillance showed the workers were not at Hanford during those hours.

That can only mean one thing - Government investigators planted tracking devices on the individuals or their automobiles - most likely their automobiles. That, in our mind, is a little bit scary. There must have been probably cause for a judge to approve that tactic.

One of the failures in this case was the lack of effective oversight by contract auditors. DOE representatives told us that DCAA, who had been performing contract audits on behalf of DOE for many years, completely botched their risk assessment. Even at DOE's behest, DCAA would not focus on areas where DOE felt the highest risk. This was a contributing factor into DOE effectively firing DCAA for its contract audit effort. Instead, DOE now contracts primarily with commercial firms for its contract audit services.

Accounting Systems - Problematic Standards - Part 6

Today we conclude our discussion series on accounting system standards that many contractors have found challenging. According the the DoD FAR Supplement (DFARS), there are 18 accounting system criteria and we're only addressing six of those. That doesn't mean the other 12 are less important. It means that they are very basic and fundamentally easy to understand. We are reviewing the ones that, in our experience, cause contractors to trip when being audited or left scratching their heads when trying to understand the meaning and intent of the standard. Today, in conclusion, we are going to take a look at Standard No. 16 -  Billings that can be reconciled to the cost accounts for both current and cumulative amounts claimed and comply with contract terms.

Now obviously, this criteria applies to contracts where billings are based on costs such as cost reimbursable contracts and fixed price with progress payments based on cost. But its also important for T&M contracts where the "materials" costs much trace back to accounting records. Also, more recently, the Government has been checking out progress payments based on milestones to ensure that the amounts received don't exceed actual costs. We spent a great deal of time recently discussion performance based payments. For more on this last point, click here.

There are several problems that come up when contractors bill their actual costs. First, we've seen several cases where contractors bill what they negotiated, not what they've incurred. This usually happens at very small Government contractors who don't understand what kind of contract they've received. Most often, these are non-DoD contracts where billings do not go through the rigors of DCAA oversight. Secondly, some contractors like to include amounts in their billings that are not recorded in their accounting records. We've seen provisions for the business use of privately-owned vehicles and other "soft" costs that may have in some way benefited the contract.

Another problem with billing reconciliations is the capability of some accounting systems to record prior period adjustments. QuickBooks is guilty of this as is other software. These systems have no "hard close" dates so that prior period transactions can be edited at will. If a prior period is edited, suddenly the billings will no longer reconcile to the books. There is no definitive way to reconcile billings to accounting records at this point, other than to guess. Guessing does not typically satisfy auditors.Contractors should avoid editing prior period transactions. If adjustments are required, use journal entries and document the reason for the adjustment.

Reconciliations, in this context, are generally limited to direct costs. Indirect costs are typically billed at an approved provisional billing rate. However, as happens over and over, contractors sometimes try to bill indirect costs as direct. It may be a particular indirect cost that is specifically identifiable to a contract so the contractor rationalizes that it should be billed as direct. Doing so, is usually inappropriate and violates some FAR cost principles on direct and indirect costs.

The last issue we'll bring up today is the one where contractors try to bill certain costs at other than cost. A good example of this is company-owned equipment where a contractor charges the going market rate rather than its actual costs. There are situations where that would be acceptable however, generally, costs to the Government must be limited to the cost of ownership.

Deadline Approaching for Contractors to Enter Independent Research and Development Costs into Government Database

Back in January 2012, the Department of Defense amended its FAR Supplement (DFARS) to require "major" contractor to report their Independent Research and Development costs and information into a Government database, in order for those costs to be allowable. You can read about the change and who it affects by clicking here.

There was a lot of confusion over the implementation of the new rule so in February of this year, the Director of Defense Procurement and Acquisition Policy (DPAP), deferred reporting of 2012 and 2013 costs until the end of contractor fiscal year 2014. Read the DPAP deferral memo here. A key point of this memorandum is the communication that there is no expectation of reconciliation between the cost information in the database and the costs claimed in the incurred cost submission, only that the claimed project was in fact, entered into the database, updated annually, and updated when the project is completed.

DCAA (Defense Contract Audit Agency) recently issued its own guidance on the subject. The memorandum provides guidance to auditors on how they should handle various scenarios when contractors do not comply with the reporting requirement.

For audits of incurred cost, if the contractor fails to input its IR&D information into the Government database, the costs, according to DCAA, are expressly unallowable. Auditors should question whatever IR&D costs have been claimed and go so far as to recommend penalties. Further, if the costs are significant, the auditor should consider citing the contractor for noncompliance with CAS 405, Accounting for unallowable costs.

For internal control reviews such as an audit of the accounting system, the auditor should consider whether the contractor's failure to input IR&D data into the Government database, rises to the level of a system deficiency.

Either one of these possibilities should encourage contractors to comply with the regulations. Remember, contractors have until the end of their fiscal year 2014 to comply. For contractors whose fiscal years end on June 30th, the deadline is just a few days away.

Annual Performance Report on the Defense Acquisition System

Last week, the Department of Defense issued its 2014 annual report  on the performance of the Defense Acquisition System. For a full copy of the report, click here. The focus of this year's report was "incentives" - particularly those from contract types and profits (or fees). Ever wonder how the Government selects the type of contract to use in a given situation. Typically, its based on what the Government thinks will incentivize the contractor to perform effectively and economically. This well-written and informative report will provide some insights into the selection process. The conclusions are very interesting and for the most part, something we always knew intuitively but never had the facts and data to back it up. Here then are the report conclusions.

Not all incentives work. Contractual incentives are effective if (i) we use them, (ii) they are significant, stable, and predictable; and (iii) the are tied directly to our objectives.

Cost-plus versus fixed-price is a red herring. The distinction between cost-plus and fixed-price contracts is not the divide on effectiveness. Rather, the emphasis should be on matching incentives to the situation at hand instead of expecting fixed-price contracting to be a magic bullet. Fixed-price contract have lower costs because they are used in lower-risk situations, not because they control costs better. Moreover, prices on fixed-price contracts are only "fixed" if the contractual work content and deliverables remain fixed, which is often no the case. Our analysis showed that objectively determined incentives were the factors that controlled costs, not selecting cost-plus or fixed-price contract types.

CPIF and FPIF contracts perform well and share realized savings. These contract types control cost, price, and schedule as well as, or better than, other types - and with generally lower margins. We pay for the technical risks on our development systems - unlike the private sector, where companies pay for R&D on new products. This is partly due to the fact that we are, to some degree, the only customer for new military products . Thus it makes sense to use incentives that (i) link profit to performance, (ii) control price, and (iii) share in cost savings, especially in production when the risks are low. Specific incentive structures may not be appropriate in certain cases, so professional judgment is needed as always in matching contract type and incentives to the desired outcome.

FFP contracting requires knowledge of actual costs. FFP contracts provide vendors a strong incentive to control costs, especially in production, where they are most common. However, taxpayers do not share in those cost savings, unless the negotiated price took into account actual prior costs and margins, as well as the contractor's anticipated ability to continue cost reduction. Thus, to use FFP contracts effectively, we must fully understand actual costs when negotiating subsequent production lots.

Competition is effective - when viable. Competed contracts perform better on cost, price, and schedule growth than new sole-sourced or one-bidder contracts in development. Thus, we must continue our efforts to seek competitive environments in creative ways. Unfortunately, direct competition on some contracts is not viable - especially in production, where significant entry costs, technical data rights, or infrastructure may be barriers. In response, we are seeking ways in which competitive environments and open-system architectures will allow us to introduce competitive pressures.

Production margins may help minimize development time. Our analysis indicates that the prospect of high margins in production may motivate contractors to complete development as soon as possible. Unfortunately, this assertion is hard to test quantitatively given the predominance of higher margins in all production contracts. However, we did find significant examples where production margins were smaller when development schedules slipped despite an explicit policy to this effect.

Government Loses Another Statute of Limitations Case

There have been a number of notable contract appeals recently where the Government's case has been thrown out because it couldn't seem to act within the six-year statute of limitations imposed by the Contract Disputes Act (CDA). We've reported on a number of them on this blog including Raytheon Cost Accounting Changes case from last year. Bottom line, both the Government and a contractor have only six years for asserting a claim after the event that fixes a liability becomes known. The Government has been losing a lot of appeals lately (or choosing not to pursue the matter) because it cannot seem to complete audits in a timely manner, or, in the case of Laguna Construction, failed to act timely on an audit report that was issued.

Laguna Construction received an Air Force contract to perform various construction projects in Iraq. In due course, Laguna issued a couple of subcontracts whose prices were not adequately supported. The subcontracts were not awarded based on competition nor was there any documentation by Laguna to support the reasonableness of the subcontract prices.

In December 2005, DCAA (Defense Contract Audit Agency) issued an inter-agency audit report (that's an audit report issued from one DCAA office to another) citing Laguna for inadequate subcontract management practices. DCAA stated that Laguna's subcontract management policies, procedures, and practices could not be relied upon to ensure the reasonableness of subcontract prices. The receiving DCAA office forwarded the audit report to the ACO in February 2006.

Now here's where the Government's actions get lame. It took more than three years for the ACO (Administrative Contracting Officer) to notify Laguna of the deficiencies cited in the audit report and more than three more years after that for the ACO  to render a final decision. That's more than six years after the Government had knowledge of Laguna's (alleged) subcontract management deficiencies. The Government's claim totaled $3.8 million. Laguna appealed stating that the Government's claim was outside the six-year statute of limitations.

Under the CDA, a contract claim, whether that of the contractor or the government must be submitted with six years after the accrual of the claim. Accrual of a claim, according to FAR 33.201 means the date when all events, that fix the alleged liability of either the Government or the contractor and permit assertion of the claim, were known or should have been known. The Board (Armed Services Board of Contract Appeals) found that the Government was aware of the "injury" in February 2006 when DCAA issued its audit report to the ACO but the ACO did not file a claim until December 2012. December 2012 was beyond the six-year statute of limitations.

Based on the foregoing, the ASBCA ruled that the Government's monetary claim was barred under the CDA as untimely. Accordingly the ACO's decision was deemed null and void.

You can read the entire Board decision here.

New Regulations Posted on New Minimum Wage for Government Contracts

In this year's State of the Union Address, the President promised to increase the minimum wage for Government contractors (see previous coverage). A few weeks later, the President issued an Executive Order telling the Department of Labor to draft up regulations that would increase the minimum wage for Government contractors (see previous coverage). Last week, the Labor department did just that, it issued proposed regulations that will raise the minimum wage for workers on Government contracts to $10.10 per hour. The proposed regulations also carries an escalation clause that will increase the rate each year based on increases in the Consumer Price Index (CPI).

There will be cases where contractors will have "covered" and "non-covered" work. This is going to require some tricky record-keeping. The new regulations anticipate some issues here and provides the following:

...the hours worked by a worker generally include all periods in which the worker is suffered or permitted to work, whether or not required to do so, and all time during which the worker is required to be on duty or to be on the employer's premises or to be at a prescribed workplace. The hours worked which are subject to the minimum wage requirement ... are those in which the worker is engaged in performing work on or in connection with a contract subject to the Executive Order. However, unless such hours are adequately segregated or there is affirmative proof to the contrary that such work did not continue throughout the workweek ... compensation in accordance with the Executive Order will be required for all hours of work in any workweek in which the worker performs any work in connection with a contract covered by the Executive Order.

Later, in discussing the record keeping requirements that would satisfy the "adequately segregated" provision, the proposed regulations state that

...an arbitrary assignment of time on the basis of a formula, as between covered and non-covered work, is not sufficient.

Contractors who maintain adequate timekeeping systems (where labor hours are tracked by the contract, job, or task should have no difficulty in differentiating between covered and non-covered contracts. However, unless the contractors are geared up for performing cost-reimbursable contracts, they probably do not have systems sufficient to segregate covered and non-covered work. That might be incentive enough for some contractors to enhance their timekeeping systems.

Interested parties can submit comments to the proposed regulations for the next 30 days. The final rule is set to be published by October 1, 2014. Once enacted, the new minimum wage will become effective next January (January 1, 2015) on contracts that result from solicitations issued after that day or, for contracts awarded outside of the solicitation process (RFQs, RFPs, etc), January 1, 2015.

DCAA May Get Statutory Authority to Interview Contractor Employees

Back on May 30th, we reported that Senator McCaskill had introduced an amendment to the Senate version of the fiscal year 2015 NDAA (National Defense Authorization Act) that would grant specific authority to DCAA (Defense Contract Audit Agency) to interview contractor employees. The amendment made it through the Senate Committee on Armed Services and is now ready for full Senate consideration.

We've  now had a chance to review the specific wording of the amendment. It provides as follows:

Sec. 825. Authority for Defense Contract Audit Agency to Interview Contractor Employees in Connection With Examination of Records.
     (a) Authority. - Section 2313(a)(1) of title 10, United States Code, is amended by inserting ", interview employees," after "is authorized to inspect the plant".
     (b) Applicability. - The amendment made by subsection (a) shall apply with respect to contracts entered into after the date of the enactment of this Act.
     (c) Regulations. - Not later than 180 days after the date of the enactment of this Act, the Secretary of Defense shall revise the Department of Defense Supplement to the Federal Acquisition Regulation to implement the amendment made by sub section (a).

If passed, Section 2313(a)(1) would read: "The head of an agency, acting through an authorized representative, is authorized to inspect the plant, interview employees, and audit the records of - "

Although Sec 825 of the 2015 NDAA specifically mentions DCAA, the Code Section it modifies applies to any contract auditor, regardless of agency.

This amendment will give similar access to DCAA that the comptroller general (GAO) already enjoys under subsection (c)(1) of the same section.

As we mentioned before, the contractor employee interview battles have been fought and settled. There are very few cases where contractors try to prevent auditors from such employee interviews. Of course, buoyed with statutory authority, contract auditors might turn more aggressive in their interview techniques. Hopefully, they do not turn into interrogations.

Labor Qualifications for Time and Material Contracts

A couple of years ago, we reported an incident where auditors had questioned costs on a Time and Materials Contract (T&M) because the skills of the employees performing the work did not match the minimum skill set of the position contracted for. You can read it here. At the time, the issue remained unresolved so we never heard the end of the story. We still don't know what happened in that specific instance but DCAA (Defense Contract Audit Agency) recently issued guidance that speaks to the issue.

Fundamentally, the guidance requires that auditors coordinate with the contracting officer prior to questioning costs in circumstances where actual skills do not match contracted skills. The action to be taken by the auditor depends upon what the contracting officer tells them: authorization to use a lower skill set has been given, authorization to use a lower skill set will be given, or authorization to use a lower skill set is not given.

In our experience, contracting officer authorization to use a lower skill mix is not a given. Some contracting officers become incensed and demand a refund. Some are more matter-of-fact and simply ask for a price adjustment or other compensation. Others are more pragmatic and look at the overall performance rather than skills of the person performing the job. Regardless of contracting officer (CO) responses, contractors still have a responsibility and obligation to notify the CO whenever there is a difference between contracted skills and the skills of the person performing the work.

FAR 52.232-7(a)(3) states:

Labor hours incurred to perform tasks for which labor qualifications were specified in the contract will not be paid to the extent the work is performed by employees that do not meet the qualifications specified in the contract, unless specifically authorized by the Contracting Officer.

While FAR requires specific authorization, it does not require the contracting officer to provide that authorization prior to the delivery of the work. Sometimes, usually when brought to their attention, contracting officers will approve the use of lower skill employees after the fact.

Even when the contracting officer is not prone to approve the use of lower skill workers, he/she will rarely disallow all of the costs. After all, services were rendered. Instead, the contracting officer will seek a rate adjustment or sometimes add a new line item for the lower skilled category.

You can view the guidance on DCAA's website by clicking here.

Accounting Systems - Problematic Standards - Part 5

We're continuing our series on discussions of accounting system standards that many contractors have some difficulty meeting - or, at least meeting to the satisfaction of a Government auditor. As we began this series, we mentioned that there were two kinds of accounting system audits. There is the pre-award accounting system survey which is basically the SF 1408 (Preaward Survey of Prospective Contractor - Accounting System) and a post-award accounting system audit following the guidelines of DFARS 252.242-7006 (Accounting System Administration). The DFARS standards contain the same criteria found in the SF 1408, and then some. Most contractors naively believe that they have adequate accounting systems. Perhaps so but most auditors can find something wrong with the systems and the DoD standards make it much easier to find deficiencies.

Today we're going to look at Accounting System Criteria No. 8, Management reviews of internal audits of the system to ensure compliance with the contractors established policies, procedures, and accounting practices. Some of you might already be thinking that you don't have an internal audit department so this standard must be "n/a" or not applicable. Not so fast. The presumption here is that in order for an accounting system to be adequate, contractors will have policies, procedures, and practices over their accounting systems and that someone in the organization - it does not have to be a formal internal audit department -is going to conduct reviews (or audits) to ensure employees are complying with those policies and procedures.

Inherent in this standard are seven distinct requirements:

1. Contractors must have written policies and procedures
2. The policies and procedures must be disseminated to affected employees
3. Employees are expected to comply with those policies and procedures
4. There must be some form of oversight to ensure that employees are complying with those policies and procedures.
5. There must be some form of oversight to ensure that the policies are procedures are accomplishing what they were designed to do.
6. Management must be informed of the results of these oversight reviews.
7. Management must take action on any forthcoming recommendations.

An accounting system that misses the mark on any one of these items, is at risk for being labeled inadequate, or deficient, or needing improvement. Larger contractors are at risk for having some of their billings withheld until corrections are made.

Contractors that do not have internal reviews of internal control system adequacy and compliance should be thinking about ways to implement such a program.

Accounting Systems - Problematic Standards - Part 4

After a brief hiatus where we discussed a $570 thousand internal control deficiency, we return to our series on explaining the accounting system criteria that often cause problems for contractors. As we mentioned, many of DoD's criteria are fairly basic and hearken back to a day before personal computers. Today, if your running anything from QuickBooks on up, your software will automatically meet many of today's DoD standards; general ledger control, costs by contract, etc. That wasn't always the case with manual accounting systems.

Today we want to look at Criteria #7, Approval and documentation of adjusting journal entries. First, we will define "adjusting journal entries" by means of an illustration. When posting an invoice, it is necessary to assign the transaction a account number/description and a job number. So if you purchase material specifically for a contract, you would charge an account (Materials) and a job number that corresponds to the contract (Job 123). If later you find that the account number or job number is in error, you need to make an adjusting journal entry - move it from material to supplies, for example. Or, if you charged it to the wrong job, you need to make an adjusting journal entry to move the transaction from the incorrect job number to the correct job number.

A journal entry to move costs between two accounts is very simple. To use our illustration, moving a $100 purchase from "Materials" to "Supplies" would look like this.

That seems pretty straight-forward but for DoD purposes, the 'who, 'what, 'when, 'where, and 'why questions must be answered. DoD requires:

1. Written justification in sufficient detail to answer the who, what, when, where, and why questions.
2. Approval of the adjusting journal entry (although not stated, the approval must be from a position higher than the person making the adjustment).
3. Retention of the justification and approval documentation for the minimum record retention period.
4. Maintained where it is readily available and accessible.

There are very practical reason for requiring written justification and approval. First, its a good internal control step - there's someone watching. Secondly, humans forget things. It happens to us all of the time - we ask why such and such adjustment was made and even the person making the adjustment cannot remember. Thirdly, employees turn over. The person making the adjustment may have left the company or transferred to another division, or is otherwise nowhere to be found when the auditors come knocking and asking questions.

Poor Internal Controls Result in Half Million Dollar Embezzlement

Last week, the Department of Justice (DoJ) announced that a contractor employee had plead guilty to falsifying accounting records thereby over-billing the Government by at least $570 thousand. The scheme continued over a seven year period. The employee pocketed the amount of the over-billing and ostensibly, the contractor did not know about the scheme. It is not surprising that someone gets caught cooking the books or embezzling funds. That happens regularly. What is surprising to us however, is that it went on for seven years before someone caught on to the scheme. There was a serious internal control weakness here and probably a lack of Government oversight. We'll explain.

Matthews Media Group (MMG) had a NIH (National Institute of Health) contract to recruit, screen, and compensate participants in clinical research studies. The employee's job was to compensate study participants with cash or gift cards, obtain receipts from study participants, and keep a spreadsheet of participants' compensation with supporting documentation. The supporting documentation consisted primarily of signed receipts from study participants. The employees had access to the company bank account where he withdrew funds to pay participants. MMG invoiced NIH each month based on amounts taken directly from the employee-prepared spreadsheet. There was no evidence that MMG made any effort to audit or evaluate the data or trace the amounts to supporting data. They accepted the spreadsheet totals at face value.

There were a couple of ways that the employee perpetrated the fraud. In most cases, the employee paid study participants and obtained a receipt from them but logged a higher amount in his spreadsheet. He pocketed the difference between the two amounts. In other cases, the employee logged fictitious receipt numbers and amounts in his spreadsheet and pocketed all of the cash. In both cases, a periodic spot-check by management would have caught the scheme and the schemer early on. Some form of periodic review, oversight, or internal audit is internal control 101 and should have been implemented from contract inception. And too, where was the Government oversight in this process. The Government does have a role in ensuring the propriety of claimed costs.

Ultimately, the contractor, MMG, stumbled upon the fraud, not because of a systematic internal control process but by happen-stance when it was compiling some data for the Government. The employee will have to pay restitution and may face imprisonment and other fines.

MMG was lucky in this case. The employee will have to pay restitution, not the contractor. But that is somewhat unusual. Most of the time in Government contracting, the contractor has to repay the money and then somehow seek to recover it from the recalcitrant employee. Perhaps one reason the contractor was so negligent in setting up sound internal control systems is the perceived risk - everything it spends it simply passes on to the Government. Non-Government contractors and Government contractors with fixed price contracts would not be so lucky. The embezzlement would come straight out of its profits.

This illustrates one of the Government's perceived risk in flexibly priced contracts and is the primary reason why the Government is justified in increasing its oversight activities at those firms.

You can read DoJ's entire press release here.

Accounting Systems - Problematic Standards - Part 3

This is the third in our installment of DoD standards for contractor accounting systems that are often problematic for contractors. There are 18 standards in total - most are easily understood and can be implemented without too much pain. There are a few however that are difficult to comprehend or where applicability is not intuitive. In Part 1, we discussed the limitation of cost/limitation of funds clauses where these are compliance with contract terms issues, not accounting system issues. In Part 2, we looked at the control environment and determined what that means in the context of an accounting system. Today we will discuss Criterion No. 4 which requires adequate accounting systems to have a logical and consistent method for the accumulation and allocation of indirect costs to intermediate and final cost objectives.

You have probably already noticed the words "logical and consistent". Logical and consistent according to who? The Government? The contractor. Who's to decide? A method for allocating indirect costs may be logical to you, the contractor, but may seem not so logical to an auditor. We can't begin to count the number of times an auditor has decided based on two minutes of deep analytical thought and computation, that a contractor's rate structure is no good. And often, the pronouncement is made because your way is not what they've seen at other contractors. Or, they get some wild notion that if you use a value-added base for allocating G&A expenses, then you must also have a material handling indirect rate.

Here's what contractors need to know concerning indirect rate pools and allocation bases. It comes from FAR 31.203:

The contractor shall accumulate indirect costs by logical cost groupings with due consideration of the reasons for incurring such costs. The Contractor shall determine each grouping so as to permit use of an allocation base that is common to all cost objectives to which the grouping is to be allocated. The base selected shall allocate the grouping on the basis of the benefits accruing to intermediate and final cost objectives. When substantially the same results can be achieved through less precise methods, the number and composition of cost groupings should be governed by practical considerations and should not unduly complicate the allocation.

There's no hard and fast rules in the foregoing requirement. There is nothing that says you must use a total cost input (TCI) method when such and such is the case. Of course, if you have methods of allocating costs that result in egregious misallocations of indirect costs to final cost objectives (e.g. contracts), you deserve the audit attention.  That's not usually the case however. Disputes generally arise because an auditor usually thinks he/she has a better way.

Accounting Systems - Problematic Standards - Part 2

Last Tuesday, we identified the two types of accounting system audits/reviews that the Government might perform at a given contractor location (click here to read the posting) - a pre-award audit and a post-award audit. As we mentioned, the post-award accounting system audit is more robust than the pre-award and some contractors who have sailed through the pre-award audit, have been challenged over the adequacy of their accounting system during a post-award audit. There are 18 criteria that accounting systems must meet in order to be considered adequate. Yesterday, we began to look as ones that have been problematical for contractors with Criteria No. 15, accumulating costs that satisfy limitation of costs and limitation of funds.You can read that here.Today we will look at Criteria No. 1 which is vague and highly subjective.

DoD Criterion #1 requires contractor accounting systems to provide for a sound internal control environment and an appropriate accounting framework and organizational structure adequate for producing accounting data that is reliable and cost that are recorded, accumulated, and billed on Government contracts in accordance with contract terms (see DFARS 252.242-7009(c)(1)). Now there's a phrase that only an auditor would appreciate. To most folks, its a bunch of nonsense. What does "control environment" mean? What does "accounting framework" mean? What is an "adequate organizational structure".

Don't feel bad. You get a bunch of auditors in a room to discuss this and they won't even agree on what it means, and very few can articulate the meaning, when asked. Pity the contractor who finds out an auditor is coming to review its control environment. And because the meaning is so vague, trying to apply auditing procedures becomes very subjective and both contractors and auditors become frustrated. So, what is involved in satisfying this criteria? There are several professional resources one could consult but perhaps the most relevant is the DCAA (Defense Contract Audit Agency) guidance on how to audit a contractor's control environment. DCAA has divided its guidance into eight control objectives.

1. Integrity and ethical values: Management must convey the message that integrity and ethical values cannot be compromised, and employees must receive and understand that message through continuous demonstration of word, actions and commitment to high ethical standards (good luck proving that one). Sometimes this is referred to as "setting the tone at the top".
2. External auditor's report: Management should take timely corrective action on any deficiencies noted by the external auditor.
3. Board of directors/audit committee: The BofD and audit committee should be independent from management to constructively challenge management's decisions and act effectively on external audit communications.
4. Basic structural organization: The organization structure provides the overall framework for planning, directing and controlling operations.
5. Assignment of authority and responsibility: Management ensures that appropriate responsibility and delegation of authority is assigned to deal with goals and objectives, operating functions, regulatory requirements, information systems and authorization for changes. 
6. Financial capability: Management must ensure that the contractor has adequate financial resources to perform on Government contracts.
7. Accounting systems and controls: The accounting system is well-designed and is operating effectively to provide reliable accounting data and prevent misstatements that would otherwise occur.
8. Cost allocations: Management ensures that an item of cost or a group of items of cost are assigned to one or more cost objectives in accordance with rules, regulations, and standards for proper distribution of direct cost and allocation of indirect costs.

So, if you can do all this, your meet the first of 18 criteria for an adequate accounting system.

Accounting Systems - Problematic Standards - Part 1

Yesterday we identified the two types of accounting system audits/reviews that the Government might perform at a given contractor location (click here to read the posting). Essentially, you could categorize them as pre-award and post-award. The post-award accounting system audit is more robust than the pre-award and some contractors who have sailed through the pre-award audit, have been challenged over the adequacy of their accounting system during a post-award audit. We mentioned yesterday that among the eighteen criteria for an adequate accounting system, some seem to be more problematic than others. We are going to look at a few of those today and in the coming days. These criterion are found in the DoD FAR Supplement (DFARS 252.242-7006) so technically apply only to DoD contractors. However, other Agencies have been know to adopt the same standards for their contractors. While FAR requires contractors to maintain "adequate" accounting systems, only the DoD has attempted to define specific standards for adequacy.

Standard No. 15 requires accounting systems to be able to provide cost accounting information as required by contract clauses concerning limitation of cost (FAR 52.232-20), and limitation of funds (FAR 52.232-22). Essentially, these clauses require contractors to notify the Government whenever it is approaching estimated costs or funds allotted to the contract. In the -20 clause, contractors are required to notify the contracting officer whenever it has reason to believe that the cost it expects to incur under this contract in the next 60 days, when added to all costs previously incurred, will exceed 75 percent of the estimated cost specified in the schedule. In the -22 clause, contractors are required to notify the contracting officer whenever it has reason to believe that the cost it expects to incur under this contract in the next 60 days, when added to all costs previously incurred, will exceed 75 percent of the total amount so far allotted to the contract by the Government.

To meet these requirements, contractors will need to know two things; their historical costs and an estimate of the costs that it will incur in the next 60 days (often referred to as the "burn rate"). An accounting system records historical costs. It doesn't project future costs. Projections of future costs might be included in a budgeting system or some other kind of system but it is not found in a record of historical costs, i.e. an accounting system. Its possible that historical accounting data can be used to project costs to be incurred in the next 60 days, but not necessarily and that is not what accounting systems are designed to do.

Contractor accounting systems that meet the other adequacy criteria will automatically be able to produce historical costs. But what the auditors are looking for here is additional tracking and analysis apart from the accounting system. Auditors are looking to see if contractors have a system of estimating their burn rate by month, that they add these projections of future costs to historical costs and compare them with contractual cost estimates or fund limitations, and notify the Government when it hits the 75 percent threshold. Most auditors will ask for policies and procedures that apply to this requirement (most Government contractors do not have them). Then, the auditors will test for compliance with those policies and procedures (most Government contractors do not get concerned about these clauses until they get pretty far down the contract performance line). Realistically, its a meaningless exercise until expenditures approach the 75 percent of cost or amount funded levels. Many auditors don't deal in practicalities however - they want to see a system in place and actively monitored on day one.

Many contractors have successfully met this criteria with a simple written policy and Excel.

Two Kinds of Accounting System Audits

There are two types of accounting system reviews conducted by the Government. The first is a pre-award survey that essentially follows the SF 1408, Preaward Survey of Prospective Contractor - Accounting System. We've discussed this one several times and have alluded to it several more times. Its used primarily as a tool to assess whether a prospective contractor has an accounting system capable of meeting contractual requirements. These surveys are conducted by a contracting officer, a contract specialist, by DCMA (Defense Contract Management Agency) or by DCAA (Defense Contract Audit Agency). DCAA, hands down, does the best and most thorough review of anyone in assessing accounting system adequacy.

The other type of review is often referred to as a postaward accounting system review and is largely confined to Defense contractors. The policy is laid out in the DoD FAR Supplement (DFARS) at 242.7502.

Contractors receiving cost-reimbursement, incentive type, time-and-materials, or labor-hour contracts, or contracts which provide for progress payments based on costs or on a percentage or stage of completion, shall maintain an accounting system.

In evaluating the acceptability of a contractor's accounting system, the contracting officer, in consultation with the auditor or functional specialist, shall determine whether the contractor's accounting system complies with the system criteria for an acceptable accounting system as prescribed in ... (DFARS) 252.242-7006, Accounting System Administration.

Many of the same criteria found in the SF 1408 are contained in the DoD criteria, but the DoD criteria has about 5 or 6 additional criteria not contained in the SF 1408. The 18 DoD criteria includes the following. Not every criteria will apply to every contractor.

1. A sound internal control environment, accounting framework, and organizational structure.
2. Proper segregation of direct costs from indirect costs
3. Identification and accumulation of direct costs by contract
4. A logical and consistent method for the accumulation and allocation of indirect costs to intermediate and final cost objectives
5. Accumulation of costs under general ledger control
6. Reconciliation of subsidiary cost ledgers and cost objectives to general ledger
7. Approval and documentation of adjusting journal entries
8. Management reviews of internal audits of the system to ensure compliance with the Contractor's established policies, procedures, and accounting practices
9. A timekeeping system that identifies employees' labor by intermediate or final cost objectives
10. A labor distribution system that charges direct and indirect labor to the appropriate cost objectives
11. Interim (at least monthly) determination of costs charged to a contract through routine posting of books of account
12. Exclusion from costs charged to Government contracts of amounts which are not allowable in terms of FAR Part 31 cost principles and other contract provisions
13. Identification of costs by contract line item and by units (as if each unit or line item were a separate contract), if required by the contract
14. Segregation of pre-production costs from production costs, as applicable
15. Cost accounting information, as required by contract clauses for limitation of cost, limitation of funds, allowable cost and payment, and to readily calculate indirect cost rates from the books of accounts
16. Billings that can be reconciled to the cost accounts for both current and cumulative amounts claimed and comply with contract terms
17. Adequate, reliable data for use in pricing follow-on acquisitions
18. Accounting practices in accordance with standards promulgated by the Cost Accounting Standards Board, if applicable, otherwise, GAAP (Generally Accepted Accounting Principles).

There are several of these criteria that seem to be problematic to a lot of contractors. We will highlight those in tomorrow's post.

Lowered Compensation Cap - What's Included in Amount?

Last week we discussed the new compensation cap ($487 thousand) that goes into effect this month (for contracts awarded after June 24th) and the need for contractors to reflect the lowered cap in their proposals and in the forward pricing rates. If contractors don't, the Government will. You can read that posting here.

"Compensation", in the context of the new statute, is defined in the law and is different than what one might conclude if referring to FAR Part 31.205-6, Employee Compensation. But that's not the case. "Compensation" subject to the compensation cap includes the following:

1. Basic salary/wages
2. Bonuses/Incentive compensation (to the extent it is otherwise allowable)
3. Deferred compensation
4. Employer contributions to Employee Stock Ownership Plans (ESOPs)
5. Employer contributions to defined contribution pension plans

Notable exclusions from this listing include medical insurance, unemployment benefits, post-retirement benefits other than pensions, contributions to qualified pension plans, company furnished automobiles, and severance pay.

This new compensation cap applies to all Government contracts, not just DoD contracts. Each Agency however, is implementing it differently. DoD, for example will relay on DCMA and DCAA to ensure compliance. DOE (Energy) on the other hand, since it has a lot of M&O contracts (Management and Operating) and already has procedures in place to approve compensation levels, will require its contractors to submit information by January 15th of each year in order for the contracting officer to make a determination. We haven't surveyed all of the Agencies but contractors could expect to hear from their contracting officers regarding implementation.

We stated this in a previous post but it bears repeating. The Government is not responsible for ensuring that contractors' cost or pricing data is current, complete, and accurate. That is contractor responsibility. Failing to adjust proposals and indirect rates for the new, lowered compensation cap could leave contractors open to TINA (Truth-in-Negotiations Act) violations.