Contractor Pleads Guilty for Falsifying Small Business Status

It may be just that our awareness has been piqued by so many recent Department of Justice's press releases or there has actually been an increase in the number of Government contractors charged (and convicted) for obtaining contracts set aside for small businesses, women-owned businesses, or small disadvantaged businesses under false pretense. Another case was reported this week.

In this latest announcement, a construction contractor used a fronting company to secure 45 contracts totaling $23 million that were set aside to be awarded to Service-Disabled Veteran-Owned Small Businesses (SDVOSB). The Government's investigation revealed that the one company had set up a second company and found a service disabled veteran to act as a figurehead. (Justice used the term "rent-a-vet"). Evidence showed that the primary company controlled the second company and even set up all its CCR and ORCA (now SAM) certifications and representations. As a result of the misrepresentation, the company received at least 45 contracts that should have been awarded to SDVOSB contractors.

The principle behind the scheme plead guilty with sentencing scheduled for later. He could face jail time but he will definitely forfeit the profits he earned on those contracts and his compnaies (both the primary and sham corporation) have been suspended (and will probably be debarred) from obtaining future Government contracts.

It seems to us that this kind of fraud is not particularly sophisticated in that it can be easily investigated and proven. Perhaps the perpetrators believed they can somehow avoid detection with clever planning and careful implementation. That might work for awhile but even the most clueless COR (contracting officer representative) is going to figure out after awhile that something is not right and will probably report it. Or, a disgruntled employee could become a whistle-blower.

The DoJ press release did not state how the scheme was uncovered. These press releases never disclose that kind of information. However, since the Inspector General (IG) was involved in the investigation, it suggests that the accusation might have come through a "Hot Line" call.

Are Your Internal Controls Working as Designed?

We recall the time a contractor put a lot of effort into developing its estimating system. It created sound, well thought out polices and procedures, developed a manual for its estimators, produced forms for documentation purposes, and provided training to all of its employees involved in the estimating process. It was a great product, the contractor was appropriately proud of it and the contract auditors found no deficiencies with the new system.

However, within a year, pretty much everyone involved in the estimating process had come to ignore the new system and had gone back to the way things were done before the roll-out of the heralded new estimating system. What happened? What went wrong? Did the new system only look good on paper but was unworkable? Those are the kinds of questions that should have been considered and answered through the monitoring process.

One of the elements of an adequate estimating system (and any internal control system for that matter) is the need to provide for internal review of, and accountability for, the acceptability of the estimating system, including the budgetary data supporting indirect cost estimates and comparisons of projected results to actual results, and an analysis of any differences (DFARS 252.215-7002(d)(4)(xii)). So what does this really mean? It means that someone in the organization - management, internal auditors, peers - must perform some level of oversight to determine whether the controls put in place (e.g. the estimating system policies, procedures, and manual) are operating as intended. If they're not, the monitoring activity should also figure out how those control activities should be modified to make them work.

All contractors need to monitor their internal control systems. The sufficiency of the monitoring activity will depend upon a number of factors including the size and complexity of the contractor's operations. One would not expect an SBA 8(a) contractor to have the same controls as a Lockheed or Boeing or Northrup. In small or mid-sized companies, ongoing monitoring activities are likely to be informal, but there still needs to be some form of monitoring.

Here's a self-assessment that contractors can undertake to see if they might pass the the "monitoring" test.

1. Do you have policies and procedures that require periodic monitoring (e.g. management reviews) of your estimating system?
2. Do the timeframes and/or guidelines appear sufficient given the complexity and size of your operations to determine that controls are operating as intended and that they are modified as appropriate?
3. Are you actually performing reviews in accordance with time frames and guidelines established in the policies and procedures?
4. Is there documentation to support your internal reviews of, and accountability for, the acceptability of the estimating system, including comparisons of projected results to actual results, and an analysis of any differences.

If you have trouble answering these questions, you might need to assess the adequacy of your monitoring program.

DCAA to Get New Leadership

It doesn't seem that long ago that Patrick Fitzgerald moved over from Army Audit to sit in the Director's chair at the Defense Contract Audit Agency. Yet, its been about five years already. Now he's retiring at the end of the August (this week) after 35 years of Government service. He was brought in to DCAA at a particularly stormy period of the Agency's existence where everyone - Congress, the GAO, the Inspector General, a number of so-called "watch-dog" organizations, and the press - were piling on stories of inadequate audits, internal strife, and whistle-blower retaliation. One thing Fitzgerald did was calm the waters a bit - you don't hear or read much about DCAA's ills these days. But this came at a cost - DCAA jettisoned a significant amount of its work - audits of proposals under $100 million, most incurred cost audits, contractor financial viability, many internal control audits, to name a few. At the same time, the Agency became less responsive and failed to meet contracting officer needs and expectations. As a result, the Agency which was once the go-to guys for financial advisory services has become the millstone of the procurement community. The latest External Peer Review of the Agency's work, issued earlier this month, downgraded DCAA's work from "Pass" in 2006 to "Pass with Deficiency" in 2014. So it seems that there will be something for Fitzgerald's successor to work on.

A replacement for Fitzgerald has not yet been named.

Rights to Organize and Bargain Collectively

Back in 2009, the President issued Executive Order (EO) 13494 requiring a change to the FAR Cost Principle on Labor Relations (FAR 31.205-21). The EO makes costs of activities by contractors for the purpose of persuading employees (regardless of whether those employees work for the contractor or work for another company) to exercise the right to bargain collectively through representation of the employees' own choosing. The EO also provided that contracting officers must treat as allowable, any cost incurred in maintaining satisfactory relations between the contractor and its employees, including the costs of

• labor management committees,
• employee publications, and
• other related activities.

As a result of this EO, FAR 31.205-21 was revised effective December 2011 to implement these new prohibitions. We wrote about the changes at the time (see Labor Relations Costs - Revised Cost Principle). Briefly, the revised cost principle wants employers (Government contractors) to act neutral when employees decide whether to organize and bargain collectively. It then gives some examples of unallowable activities including (i) preparing and distributing materials, (ii) hiring or consulting legal counsel or consultants, (iii) meetings, and (iv) planning or conducting activities by managers, supervisors, or union representatives during work hours.

 We've seen a case recently where the auditors have inappropriately questioned costs related to labor relations and suspect there are other cases as well. The specific case dealt with legal costs related to labor relations and the auditor questioned it because it was one of the costs specifically called out. However, the auditor focused on the cost rather than the activity. Before considering cost, one needs to determine whether the activity is allowable, or not. The unallowable activity is one that is designed to persuade employees to exercise or not exercise their right to organize and bargain collectively. If that is the nature of the activity, the associated costs are unallowable. If the activity does not meet that definition, the costs are not unallowable based on this Cost Principle. 

Contractors need to evaluate the "activities" before addressing the associated costs. Auditors need to do the same.

DoD's Decreasing Number of Contracts Based on Competition

The Department of Defense (DoD) is very concerned about the diminishing use of full and open competition for awarding contracts. Over the past four years, DoD did not meet its competition goals, and in fact, has experienced a declining competition rate. According to DoD, a competitive environment;

• spurs innovation
• improves quality and performance, and
• lowers costs for the supplies and services we acquire

Last week, the Under Secretary of Defense for Acquisition, Technology, and Logistics, signed out a memorandum bemoaning the failure to achieve its competition goals, and announcing a new five-part program to improve the Departments performance.

Its first order of business is to form a committee and hold meetings (that should really help). The committee will identify best practices and deploy business intelligence tools (can't wait to look into that toolbox).

Each quarter we will address progress to expand and improve our use of competition at the Business Senior Integration Group meetings. We will collaborate to understand best practices that have successfully employed to either achieve direct competition or realize the benefits and efficts of indirect competition. To facilitate our analysis we will be deploying business intelligence tools that enable us to use data to identify opportunities for improvement.

The second action is to issue new guidelines to "provoke thought" (like anyone has time to read more guidelines and mull things over). You can read those guidelines here.

These guidelines are intended to provoke thought about the various approaches that may be used to competitively fulfill DoD requirements. The techniques and examples should be considered in developing acquisition strategies to tailor an approach that creates and maintains a competitive environment throughout the life cycle of a given product or service.  

Thirdly, DoD wants to compile feedback from companies who expressed interest in bidding but ultimately chose not to bid.

...the contracting officer will seek feedback from those companies who originally expressed interest to understand why they did not submit an offer. We will use this feedback to consider how we might overcome barriers to competition for future requirements. 

Fourth, DoD in trying to limit the use of non-competitive actions, will require contracting officers to use RFIs (Requests for Information) or SS (Sources Sought) before soliciting a sole source. Who knows, mayber there are sources out there that the Government is unaware of.

This technique is already used in many instances, but expanded use will inform our ability to maximize use of competitive procedures. In certain limited circumstances, it may be inappropriate or unnecessary to use an RFI or SS notice as a market research method for a particular acquisition; therefore, waivers to this requirement are permitted.  

Finally, the Department wants to make sure that contracting officers follow up on things they have promised to do. The J&As (Justification and Approvals) for sole-source procurements must describe actions to take to remove or overcome barriers to competition for subsequent acquisition of the same supplies or services.
Current policy makes certain that these action plans go to the dead letter file. There's never any followup. Now however, those plans must accompany the follow-on procurements and the contracting officer will need to justify why it didn't follow through.

To address these missed opportunities, we will require follow-on acquisitions of the same supply or service to include the previous J&A as part of the approval package. To the extent the planned actions cited in the prior J&A were not completed, the subsequent J&A must be approved at one level above the prior J&A. The approving official has the discretion to determine if the planned actions were completed, and J&As approved at the Senior Procurement Executive level will remain at that level. 

The thing that's missing in this course of action is any detailed comprehensive analysis as to why the number of competitive procurements is decreasing. It may be for reason(s) that have nothing to do with this new DoD program.

Annual Incurred Cost Submissions - Optional Items - Part 5

We've now come to the last of our five-part series on information considered supplemental to the annual incurred cost submission. FAR 52.216-7(b)(2)(iii) contains the 15 items that comprise an adequate incurred cost submission. The next section, 7(b)(2)(iv), contains 15 additional items that are not critical to the adequacy of the submission but may be required during the audit. We are often critical, and have been throughout this series, about the propensity of the auditors to insist on many of these optional items in order to perform an adequacy determination. DCAA is not consistent from office to office. Some have a good understanding of what the FAR requires while others seem to, almost haphazardly, demand more information than is necessary to determine adequacy.

Today we come to the last of the fifteen optional items: director minutes, claims, and contract briefings.

Minutes from board of directors meetings. When we were auditors, we dutifully requested to review director meeting minutes because there was a step in the audit program that required us to. However, sitting here today, we cannot think of a single instance where those meeting minutes yielded any information useful to our review of incurred costs. Perhaps somewhere in the annals of DCAA history they did. Sole proprietors probably wouldn't have any and even small companies (corporations, S-corps, and LLCs) wouldn't have anything more than perfunctory information (e.g. election of officers, selection of the IPA (Independent Public Accountant). If a contractor refused to provide minutes, we didn't really care because we didn't expect they would be useful in the first place. We simply documented our files and moved on.

Listing of delay claims and termination claims submitted which contain costs relating to the subject fiscal year. In certain claims and terminations, the contractor is permitted to claim settlement expenses. Settlement expenses are a special class of costs covered in FAR 31.205-42 that permit normally indirect costs to be claimed as direct costs. Therefore, the auditor wants to assure themselves that settlement expenses have been excluded from the indirect expense pools from where they were initially recorded. That's a legitimate audit step but one which will rarely be applicable since terminations and claims are relatively rare.

Contract briefings, which generally include a synopsis of all pertinent contract provisions, such as contract type, contract amount, product or services to be provided, contract performance period, rate ceilings, advance approval requirements, pre-contract cost allowability limitations, and billing instructions. When we prepare incurred cost submissions, we typically include contract briefs along with the required information. This is the only optional item we treat this way. The reason we do this is because we rely on contract briefs to prepare some of the required schedules. For example, it would be difficult to prepare Schedules I and O (following DCAA's standard labeling format) without contract briefs. Since we're already prepared them, its a simple matter to include them in the submission.

If you've missed any of the previous postings in this series, you can read them by clicking on the following links:

Part 1 - Comparative analysis and organizational information
Part 2 - Subcontracts, Accounting System Description, Procedures for Unallowables
Part 3 - Financial Statements, Management Letters, and Corrective Actions
Part 4 - Internal Audits, Audit Plans, Tax Returns, and SEC Filings

Annual Incurred Cost Submissions - Optional Items - Part 4

Today we present Part 4 in our discussion of the optional items that may be requested in connection with the audit of annual incurred cost submissions. This listing is found in FAR 52.216-7(d)(2)(iv) and are identified as items not necessary to support a submission's adequacy but items that may be required during an audit of the incurred costs. Today we look at internal audits, tax returns and SEC filings.

List of all internal audit reports issued since the last disclosure of internal audit reports to the Government. We don't know what benefit a listing of internal audits will contribute to an audit of incurred costs. Perhaps in reviewing the listing, an auditor might spot something that speaks to incurred costs. But a listing is not the audit itself and contractors should know that there is nothing in FAR that requires them to furnish internal audits to the Government. In fact, this all played out in the 2013 NDAA (National Defense Authorization Act) where the Government made a concerted effort to require contractors to provide their internal audits to Government auditors. It didn't happen. What did happen is DCAA was told to go back and document contractor responses to requests for internal audits - this many contractors said "yes" and this many said "no". You can read more about that circus here.

DCAA is going to conduct the audits that, based on risk assessments, need to be conducted to protect the Government's interests. In theory, if the contractor has already audited the systems that DCAA plans to audit, DCAA could review those audits and rely on some or parts of the work, thereby reducing the level of testing it needs to perform. Sounds good in theory but in practice, it doesn't work. When we were auditors, some contractors routinely provided their internal audit reports and accompanying workpapers. We don't recall a single instance where those reports were helpful in the audits we needed to accomplish. Part of the reason was because the contractors were not about to spend time auditing areas that they knew that DCAA was going to audit. And DCAA was not going to audit areas that were of no consequence to Government contracting (like internal controls over the petty cash fund).

Bottom line here is that contractors are not required by contract or FAR to provide the Government access to their internal audit reports. They can if they want but its not mandatory. Contractors shouldn't be too skittish about doing so however. In most cases, such reports are benign from a contract auditors perspective. In a perverse thought, giving the auditors access to internal audits will waste their time and take away from the hours they have to do real auditing.

Annual internal audit plan of scheduled audits to be performed int he fiscal year when the final indirect cost rate submission is made. This relates somewhat to the discussion above on internal audits and it is not clear as to the purpose of such a listing as it pertains to audits of historical costs. We could probably make some kind of nexus if we tried but from a practical sense, we just don't see how future internal audits will impact the propriety of historical costs.

Federal and state income tax returns. If contractors claim state income tax as an expense item (allowable under FAR 31.205-41), they're going to have to provide a state tax return to support the costs. Beyond that, there is great angst among contractors in releasing tax returns. Some do willingly while others are very reluctant to do so. One major contractor allows auditors to view and take notes but not to make copies (DCAA grudgingly accepted this restriction). Sole proprietors don't want to show their entire tax return but may be willing to extract the Schedule C from the return and give it to the auditors.

Years ago, an auditor was reviewing a tax return and noted that Research and Development costs for R&D tax credit was much lower than the amount claimed under Government contracts. The Government opened a fraud case but closed it quickly when they realized the definitions of R&D for tax purposes were different than they were under the FAR. That illustrates one of the problems with allowing auditors unfettered access to not only tax returns but other information where they may jump to the wrong conclusions.

Securities and Exchange Commission (SEC) 10-K annual report. This qualifies as the dumbest item on the list and shows how out of touch these folks are. The 10-K reports (and a lot of other information) are available on SEC's EDGAR (Electronic Data Gathering, Analysis and Retrieval System) website for anyone in the world to download.

Tomorrow, the conclusion of this series.

Annual Incurred Cost Submissions - Optional Items - Part 3

Today we present the third installment in our five part series on "optional items" related to annual incurred cost submissions. Sometimes DCAA will pretend that these (or some of these) items are necessary in order to assess the adequacy of the incurred cost submission. We frequently encounter situations where the auditor is requesting the trial balance as part of their "adequacy" determination. The trial balance is an optional item and is not necessary for an "adequate" submission. These items are found in FAR 52.216-7(d)(2)(iv).

Although these considered "optional" items that may be requested at the time of the audit, we have some reservations about whether some of these items should be made available at all. We explain those reservations throughout this series.If you missed parts 1 and 2, you can catch up by going here and here.

Certified financial statements and other financial data (e.g. trial balance, compilation, review, etc). More imprecise terminology. Perhaps "certified" financial statements means "audited" financial statements prepared by a Certified Public Accountant. Perhaps it means something else. Who knows? If it means "audited" financial statements, most small businesses and many medium-sized businesses do not have "audited" financial statements. They might have a "review" (limited assurance) or a "compilation" (no assurance), or none of those. Maybe the best they can do is print out a Profit and Loss Statement and a Balance Sheet Statement from QuickBooks. The requirement is vague and very open ended and we've seen cases where auditors have used this provision to request all kinds of financial data that were not germane to their audit of incurred costs. Push back on their requests a little bit and you'll get a retort along the lines of "who are you to tell me what I need or don't need to conduct my audit. I'm the independent auditor and will make that determination on my own". Not necessarily. The auditor still needs to establish a nexus between the audit objectives and the data requested. Its certainly appropriate for contractors to inquire as to what any requested information will be used for, or what the auditor is trying to establish by requesting the data (if not obvious).

That being said, the contract auditor will need to reconcile the incurred cost submission back to back to the financial statement or perhaps the trial balance. This is a legitimate audit step. Be careful however about providing too much information or data that has no relevance to the audit of costs charged to Government contracts.

Management letter from outside CPAs concerning any internal control weaknesses. As we stated earlier, most small businesses do not have audited financial statements. Only audited financial statements will have such a letter, and may not even have that if the auditor didn't find any internal control weaknesses. In an audit, the auditor must concern himself with the adequacy and sufficiency of internal control systems. That is not the case in a "review" or a "compilation". Even if a contractor has undergone an audit and has received a management letter from their IPA (Independent Public Accountant) concerning internal control deficiencies, there is no requirement in FAR that requires contractors to furnish these letters to the Government. In fact, we would resist turning over such documentation. First of all, those internal control deficiencies probably have nothing to do with how costs are accumulated and charged to Government contracts (cost accounting or job costing). Usually such reports address the safeguarding assets or something totally unrelated to Government contracting. A financial "audit" looks at the financial statements as a whole. It is not concerned with job costing or how indirect costs are accumulated and allocated to Government contracts, or whether the contractor has good policies for identifying FAR unallowalbles and for excluding such unallowable costs from billings to the Government.

Actions that have been and/or will be implemented to correct the weaknesses described in the management letter from outside CPAs. This is related to the paragraph immediately above. Whenever an internal control weakness is identified, there is a corresponding action plan to fix it. Obviously, if a contractor is not going to provide "management letters" to the auditor, its not going to provide any corresponding corrective action plans either.

Continue on to Part 4 - Internal Audits, Audit Plans, Tax Returns, and SEC Filings

Annual Incurred Cost Submissions - Optional Items - Part 2

We're back for the second part of our series on the optional items to send along with your annual incurred cost submissions.These are the fifteen items listed in FAR 52.216-7(d)(2)(iv) that are not necessary to determine whether the incurred cost submission is adequate but "may be" required during the audit process. "May be required" also means "may not be required" so we are of the opinion that contractors should just wait until the information is requested during the audit and not waste time during the preparation of the claim to generate these items. There is one or two exceptions to this advice which we will discuss in due course. In this series of blogs, we're giving you a big dose of our opinions and commentary which differs from our usual Joe Friday format ("...just the facts, mam").

Identification of prime contracts under which the contractor performs as a subcontractor. Not even contracting officers nor contract auditors will agree among themselves what this encompasses. Does it mean all subcontracts or "auditable" subcontracts? If read by itself, it definitely implies all contracts. But that really makes no sense. What would the identification of prime contracts for fixed price subcontracts contribute to the audit objectives (i.e. to determine the allowability, allocability, and reasonableness of claimed costs" under flexibly priced contracts and subcontracts). What would be useful to an auditor is to find out who the prime contractors are for cost-reimbursable subcontracts so that the auditors at the subcontractor can send a copy of the audit report to the auditors at the prime contractors so that the auditors at the prime contractor has some audit evidence as to the propriety of claimed subcontract costs. That's the only thing that makes sense. However, we've seen cases where auditors have demanded that contractors identify all prime contractors because "that's what it says". Many auditors don't think, they just like to check off little boxes.

Description of accounting system (excludes contractors to submit a CAS Disclosure Statement or contractors where the description of the accounting system has not changed from previous year's submission). This is another one of those optional requirements where there's no consensus on what constitutes a description of the accounting system. If you want to determine whether an auditor or contracting officer can think fast on their feet, ask them what they mean by description or can they be more specific. If they say they want to see a listing of accounts that comprise the indirect expense pools and their allocation bases, point them to the incurred cost submission. Its all there. It is not necessary for contractors to generate something here just because an auditor asks. If there's not a contractual requirement, there is no obligation to generate something. Let the auditor ask the questions through inquiry. You can show him how the accounting system works, but its the auditors responsibility to document his understanding the the system and the associated risks.

Procedures for identifying and excluding unallowable costs from the costs claimed and billed. If the contractor has a contract, there's a high probability that someone from the Government has come in and assessed the adequacy of its accounting system. Inherent in an accounting system for Government contracts is the ability to identify and exclude costs that are unallowable under FAR Part 31 cost principles and contract terms. Therefore, the contractor has already demonstrated to the Government's satisfaction that it can identify and exclude unallowable costs.  A contractor's first response to this question should be to tell the auditor to go back and check his perm files. Or, its always satisfying to pull out an accounting system audit report that an auditor performed previously and announce that they've already got that information.

Continue on to Part 3 - Financial Statements, Management Letters, and Corrective Actions

Annual Incurred Cost Submissions - Optional Items - Part 1

Every contractor (with a cost-type contract) is well aware of the requirement to submit annual incurred cost submissions. The requirement to submit is found in FAR 52.216-7(d)(2)(iii) which lists 15 schedules that must be included in the submission to make it adequate. There are 15 additional items listed in FAR 52.216-7(d)(2)(iv) which, although not required to determine if a proposal is adequate, may be required during the audit process. We call these the optional items.

Unfortunately, for contractors that use DCAA's (Defense Contract Audit Agency) ICE (Incurred Cost Electronically) - basically some Excel sheets with a few links) - the model does not list these as optional. Similarly, many DCAA offices have requested this "optional" information in order to determine whether the contractor's submission is adequate. According to FAR, these optional items are not required for an adequacy determination. Over the next few days, we will discuss each of the 15 optional items and give you our opinion of whether they should be provided.

Comparative analysis of indirect expense pools detailed by account to prior fiscal year and budgetary data. When we were auditors, comparative analysis was always an auditor's task and we never had any expectations that contractors would do it for us. The comparative analysis is used primarily to identify accounts that change significantly from one year to another (either up or down). Significant changes then can be used to identify potential risk areas to be further investigated. If contractors already have this information, it should not be a problem to provide it. However, it does require extra work to compile and is not necessary to the preparation of an adequate submission. So we say, let the auditors do it.

Many small companies do not prepare budgets so the comparison of budget with actual is not possible. Don't try to make up a budget just to comply. There is no FAR requirement that contractors prepare budgets (though it is probably a good idea). If you have a budget that allows for a ready comparison with actual costs, its fine to provide it. However, like the comparison of actuals between years, let the auditor do the analysis.

General organizational information and limitation on allowability of compensation for certain contractor personnel. Don't waste your time here. The auditor is going to request you to complete its "Internal Control Questionnaire" (ICQ) when he begins his audit and that will give him all the organizational information he needs. If you decide to do one at the time of submission, the auditor will also request that you submit another one three or four or five years later whenever he gets around to auditing the submission. If you want to see what an ICQ looks like, send us an email and we'll send you a copy.

As far as compensation goes, the contract auditor (especially DCAA) is going to do what they want to do concerning executive compensation. You may have the greatest justification to support the reasonableness of your executive compensation but DCAA is going to send the data off to their Mid-Atlantic Region experts so they can compare it with the average of two or three (sometimes four) commercial benchmarking surveys that no small contractor can afford to purchase.

As a precaution, just make certain that the compensation amounts do not exceed the statutory maximums according to FAR 31.205-6(p). For a listing of these statutory maximums, see the OFPP website. Most small businesses do not come anywhere near these maximums.

Continue on to Part 2 - Subcontracts, Accounting System Description, Procedures for Unallowables

What are "Operations Audits"?

Operations audits are those reviews designed to assess the efficiency or economy of contractors' operations. At one time (back in the 1980s and 1990s), operations audits were a significant program area of DCAA (Defense Contract Audit Agency). The Agency programmed up to 5 percent of its staffing to perform operations audits. That worked out to a couple of hundred auditors nationwide. Today however, operations audits are very low on DCAA's priority list. In the past five years, very few operations audit reports have been issued.

From the very beginning, operations audits have focused on major contractors with a significant percentage of their work under cost-reimbursable contracts. The feeling within the Government is, and has always been that cost-reimbursable contracts do not inspire contractors to be "lean and mean" or efficient, effective, and economical in their operations. Fixed price contractors on the other hand are motivated to minimize costs in order to maximize profits.

In planning for operations audits, the auditor will "seek out and identify those areas where the contractor's practices are wasteful, careless, inefficient and result in or may result in unreasonable costs and unsatisfactory conditions in performing Government contracts ..." (see CAM 14-503). The presumption that a contract auditor can identify waste and careless practices better than the contractor boarders on arrogance and has resulted in some unusual reports over the years.

For example, one auditor noticed that a contractor was using a five part form. The original would go somewhere, one copy would go elsewhere and a second copy would go to yet another location. The final two copies were discarded. The auditor recommended the contractor convert from buying five-part forms to buying three-part forms, thereby saving a lot of money each year. In another case, an auditor noted that employees were not regularly turning off lights when they left the room. The auditor recommended training for recalcitrant employees which would result in saving a lot of money toward electricity. In another case, an auditor calculated that software engineers were writing only 12 lines of code per day when the industry average was more than that. The auditor determined that more training was needed so that contractor employees could code with the best. Once that happened, the contractor could lay off a bunch of engineers and save a ton of money. In one of the most presumptuous operations audits in memory, a contractor was holding on to some employees pending notification that it had won or lost a particular contract. The auditor wrote a report stating that if the contractor lost the particular contract, it should lay off  'x' number of employees, something the contractor had planned to do anyway. When the contract was awarded to a competitor, the contractor laid off those employees. The auditor however, took credit for the cost savings.

Thinking back, we can't thing of a single situation where a operations audit truly saved the Government any significant amount of money. If an auditor comes to you with promises of making you more efficient, economical, or effective, run away as fast as you can - or at least do your best to discourage the auditor from wasting his time.

See our posting from 2012 for additional coverage of operations audits.

Billing System Adequacy - Part 4

This is our final posting on the attributes that comprise, from the Government's perspective, an adequate billing system. The specific requirements will vary depending upon type of contract but the fundamental requirements are the same, regardless of type of contract. If you missed our other postings on billing systems, it would be useful to read from the start:

• Part 1
• Part 2
• Part 3

Today's postings will cover billing withholds and the necessity for accuracy.

Procedures to ensure that vouchers include appropriate "withholds". There are a number of clauses that may require contractors to voluntarily withhold some of their billings until certain conditions are met. Perhaps the most common one is the 15 percent withhold of fixed fee (up to $100 thousand). The FAR citation for that is found in 52.216-8 which reads:

Payment of the fixed fee shall be made as specified in the Schedule; provided that the Contracting Officer withholds a reserve not to exceed 15 percent of the total fixed fee or $100,000, whichever is less, to protect the Government's interest. The Contracting Officer shall release 75 percent of all fee withholds under this contract after receipt of an adequate certified final indirect cost rate proposal covering the year of physical completion of this contract, provided the contractor has satisfied all other contract terms and conditions, including the submission of the final patent and royalty reports, and is not delinquent in submitting final vouchers on prior years' settlements. The Contracting Officer may release up to 90 percent of the fee withholds under this contract based on the Contractor's past performance related to the submission and settlement of final indirect cost rate proposals.

The key point here in a billing system review is to determine whether a contractor has processes in place to ensure that only 85 percent of fee is claimed (up to the $100 thousand). In practice, most contractors who submit vouchers through DCAA (Defense Contract Audit Agency) are well aware of this requirement because DCAA is well aware of this requirement and will reject any billing that does not factor in the withhold. But, DCAA is not going to know when the $100 thousand cap is reached nor will they voluntarily release 75 or 90 percent of the withholds once the incurred cost submission for the final year of contract has been submitted. For those things to happen, contractors need to establish policies and procedures.

Another common withhold is the 5 percent of billings not to exceed $50 thousand applicable to T&M and labor hour contracts. That clause, found in FAR 52.237.a.(7) reads:

Unless otherwise prescribed in the Schedule (i.e. the Schedule included in the contract), the Contracting Officer may unilaterally issue a contract modification requiring the Contractor to withhold amounts from its billings until a reserve is set aside in an amount that the Contracting Officer considers necessary to protect the Government's interests. The Contracting Officer may require a withhold of 5 percent of the amounts due ... but the total amount withheld for the contract shall not exceed $50,000. The amounts withheld shall be retained until the Contractor executes and delivers the release required by ... this clause.

This clause is different than the withholding clause for cost-type contracts in that it requires an affirmative action by the contracting officer before any withholds are made - a unilateral contract modification. The fee withhold on cost-type contracts is automatic. In practice, this T&M contract withholding clause is used frequently but by no means universally.

For contractors to which this clause applies, policies and procedures to ensure proper withholds are made from billings, is essential to an adequate billing system.

Mathematical accuracy and error free. As a final check of a contractors billing system, the auditor will determine whether the billings are mathematically correct and error free. This would include quantity time price extensions, proper billing rates or T&M rates, proper dates, voucher numbers in sequence, etc. One would think that with modern spreadsheets and other reporting tools that error rates would be insignificant but they're not. This is still a problem area for small contractors especially.

A billing system with reported inadequacies could render a contractor's accounting system inadequate as well and jeopardize its chances of winning contracts. But it doesn't have to come to that. A little thought and attention now can ensure that billings meet the Government's desired attributes.

Billing System Adequacy - Part 3

Today we will resume our series on the attributes of billing systems for small and medium-sized Government contractors and subcontractors. These attributes would also apply to large (major) contractors but the Government's expectations for such contractors are much more involved and detailed than those for non-major contractors. If you missed Parts 1 and 2, click here and here, respectively.

Billings can be reconciled to cost accounting records for both current and cumulative amounts. This requirement should be obvious but surprisingly, many contractors (and subcontractors) have been known to base their billings on something other than incurred costs. Also, some accounting software applications (such as QuickBooks) allow changes to prior periods with little or no documentation to explain the debits and credits. When that happens, cumulative costs will no longer reconcile with cumulative billings.

Subcontractor invoices are included only if payments are made in accordance with subcontract terms and conditions. The idea here is that contractors must develop and maintain procedures to ensure that subcontractor and vendor costs are only included in billings if payments to the subcontractor or vendor will be made in accordance with the terms and conditions of the subcontract or invoice and ordinarily within 30 days of the contractor's payment request to the Government. Auditors will often request Accounts Payable aging schedules to help with this analysis. Also, while the actual contract provision  uses the term "ordinarily within 30 days", the Government tends to overlook the significance of the word "ordinarily" and hold out 30 days as firm.

Billings are consistent with contract terms. Sometimes contractors (and subcontractors) forget to consider the terms of the contract when preparing billings. It is imperative that contractors develop and maintain a robust contract briefing system. Amounts billed cannot exceed any contract, work order, funding ceiling, or any other contract ceiling amount. For example, almost every cost-reimbursement contract contains the provision at FAR 52.222-2, Payment for Overtime Premium. This provision limits the amount of overtime a contractor may charge to the contract. Usually, the amount is zero. Other provisions often overlooked include:

1. Restrictions on billing frequency
2. Special withholding provisions
3. Contractual unallowable costs

Contractors that don't read their contracts are at risk for billing system deficiencies.

Click here for the concluding part in this brief series on billing system attributes.

Proposal to Require Contractors to Report Compensation by Sex, Race, Ethnicity, and Job Categories

CORRECTED: Aug 12, 2014

Here's a proposed rule that should get a lot of contractors excited, not only because of the onerous nature of the data collection, but also for the time and effort required to comply.

The Office of Federal Contract Compliance Programs (OFCCP) is proposing to amend one of its regulations (based on Executive Order 11246), by adding a requirement that certain Federal contractors and subcontractors supplement their EEO reports with summary information on compensation paid to employees by sex, race, ethnicity, and specified job categories, as well as other relevant data points such as hours worked and the number of employees.

This information according to the OFCCP will become a critical tool for eradicating compensation discrimination. It would enable OFCCP to direct its enforcement resources toward entities for which reported data suggest potential pay violations, and not toward entities for which there is no evidence of potential pay violations. It would also enhance two enforcement objectives: greater voluntary compliance and greater deterrence of noncompliant behaviors by contractors and subcontractors.

This proposed reporting requirement will apply to contractors and subcontractors with (i) more than 100 employees (ii) a contract or subcontract in excess of $50 thousand, and (iii) a period of performance of at least 30 days. The OFCCP estimates that somewhere between 21 thousand and 68 thousand contractors and subcontractors will be subject to these reporting requirements and will collectively cost contractors $34 million to implement and $12 million per year thereafter to update. Most likely, this burden is understated.

Under the proposed rule, Federal contractors will have the opportunity to conduct meaningful self-assessments of their compensation practices and policies, and make any necessary pay adjustments or other compensation modifications prior to an OFCCP compliance evaluation.

According to the OFCCP, data collection and analysis of data are likely to serve as a disincentive for noncompliance, and are therefore, effective deterrents. One recent report found that deterring violations before they occur is one part of an overall enforcement policy.

This notice of proposed rule making is lengthy and should be studied by contractors affected by it. You can read the entire notice here.

Contractor Performance Assessment Reporting (CPARS)

In the process of selecting contractors, the FAR (Federal Acquisition Regulations) require agencies to consider past performance as a factor in competitive procurements exceeding the simplified acquisition threshold (currently $150 thousand). That makes sense. Why would the Government want to award contracts to companies that don't perform? Contracting officers have more work than they can do right now - why add to the burden with contracting issues that just chew up time. Of course, to be in a position to "consider" past performance, contracting officers need relevant past performance data. FAR provides for that by requiring agencies to evaluate contractor performance at least yearly and also, at the time the work is completed. That requirement is well and good but years ago, the GAO found that very few agencies were bothering to write up past performance reports and even those few that were written up, were dropped off in some dead letter office never to be seen again.

In 2004, the DoD developed and began using CPARS (Contractor Performance Assessment Reporting System) and by 2010, all Government agencies were tied into the system. In theory, a contracting officer from NASA could review past performance data from a prospective contractor who worked for DoD or Energy, or any other agency. The centralized database was a good idea, however several GAO (Government Accountability Office) reviews determined that there was still a low compliance rate in writing up past performance information and therefore, incomplete past performance information loaded up into the CPARS.

The 2013 NDAA (National Defense Authorization Act) included a requirement to develop a strategy to ensure that evaluations in past performance databases. In response to this requirement, the Government established some strategies to improve compliance including (i) increase emphasis through memos to agency officials, (ii) self-assessing compliance, (iii) more training, (iv) setting performance targets, and (v) developing content guidelines. The last strategy was considered high risk because with the increased emphasis on past performance evaluations and the push on contracting officers to complete them, the quality of those evaluations suffered considerably. Some evaluations were simply check boxes where contractors were rated highly and no narrative accompanied the score. Some contracting officers simply doled out the highest score possible because (i) they either had no information to the contrary or (ii) they didn't want to deal with the inevitable contractor disagreement process that would ensue for any evaluation less than perfect.

Last week, the GAO issued a report that assessed agency compliance with the CPARS reporting requirement. Notably, the study did not assess the completeness, timeliness, or accuracy of those evaluations - only whether the evaluations were uploaded into CPARS. Overall, Government agencies are making improvements in complying with the past performance requirements. Overall, the compliance rate for the year ended April 2014 was 49 percent. Although not great, it represents a significant increase over the 32 percent from the previous year. DoD is doing the best at 83 percent compliance. GSA had the lowest compliance rate at 13 percent.

You can read the entire GAO report here.

Billing System Adequacy - Part 2

The billing system is often considered part of the accounting system. After all, any billing based on incurred costs is derived from the accounting records. The Government usually disaggregates the two systems when reviewing large contractors but reviews them as one system for smaller contractors and for preaward accounting system surveys.

Yesterday, we began a discussion on billing system attributes that the Government considers necessary in order for a billing system to be considered adequate. In Part 1, we discussed the requirements for monitoring actual costs against contract ceilings and for ensuring annual incurred cost submissions are timely submitted. If you missed Part 1 of this series, click here. Today we're going to pick off a few more system attributes.

Billings are submitted using "approved" billing rates and the "approved" billing rates are reasonable. Most contractors know and understand that if the contract auditor will be provisionally approving cost reimbursement vouchers, he will also expect that the contractor submit provisional billing rates for review and approval and once approved, will consistently use the approved rates until circumstances require that they be adjusted (either up or down). One key aspect of this requirement is the need for contractors to monitor their billing rates against the year-to-date rates and their expected or anticipate final year-end rates and adjust them if differences become too great. Sometimes, contractors just assume that once they have approved billing rates, they are free to use those rates for the entire year, regardless of what happens. Failing to monitor rates and/or ignoring significant differences will likely be considered a billing system deficiency.

Billings are reconcilable to accounting records. This should really go without saying but we've seen numerous examples where contractor are preparing billings based on something other then their accounting records. For example, one common deficiency is where billings are based on negotiated labor rates rather than actual labor charged to the contract.

For cost-reimbursable costs, billings are submitted only for paid costs. In cost-type contracts, there is an expectation that the contractor pays employee salaries and pays vendor invoices prior to requesting reimbursement from the Government. There are some exceptions to this. The applicable contract clause, FAR 52.216-7(b)(1) provides the following:

For the purpose of reimbursing allowable costs, the term "costs" include only those recorded costs that, at the time of the request for reimbursement, the Contractor has paid by cash, check, or other form of actual payment for items or services purchased directly for the contract. When the Contractor is not delinquent in paying costs of contract performance in the ordinary course of business, costs incurred, but not necessarily paid for supplies and services purchased directly for the contract and associated financing payments to subcontractors, provided payments determined due will be made in accordance with the terms and conditions of a subcontract or invoice, and ordinarily within 30 days of the submission of the Contractor's payment request to the Government.

We have seen situations where auditors will closely scrutinize vendor payment information to determine whether a contractor has been delinquent in paying for supplies and services. Contractors may be requested to provide an Accounts Payable aging schedule in connection with this audit step.

Next week we will continue our discussion on billing system attributes. Go read Part 3.

Billing System Adequacy

Its been awhile since we specifically addressed billing systems and the criteria that the Government uses to determine whether a particular billing system is adequate for the determining the proper reimbursement amounts for cost-type contracts. We've discussed it in connection with requirements for accounting systems. Recently DCAA (Defense Contract Audit Agency) revised its audit procedures for determining accounting system adequacy and has enhanced the audit requirements specific to billing systems.

By way of background, DFARS (DoD FAR Supplement) 242-7503 requires the contracting officer to include the clause at DFARS 252.242-7006, Accounting System Administration, in solicitations and contracts for cost reimbursement, incentive type, time-and-materials, labor-hour contract or a fixed-price contract with progress payments made on the basis of costs incurred by the contractor or on a percentage or stage of completion. Contracting Officers are required to determine if contractors with the accounting system clause comply with the DFARS accounting system criteria. Contracting officers use this determination to assess whether a contractor is a responsible prospective contractor, as required by FAR Part 9. The contracting officer will base this determination, in part, on advice from DCAA.

The first thing an auditor is directed to assess is whether the contractor monitors contract expenditures against contract limitations on price. This is a requirement of the various limitation of costs clauses at FAR 52.216-5, -6, -7, etc.

Limitation of costs applies to fully funded cost reimbursement contracts. The clause requires a contractor to notify the Government when it expects in the next 60 days to have spent 75 percent of the estimated cost, or expect expenses to be greater or substantially less than previously estimated. The clause allows variations in the number of days, between 30 and 90 days and variations in the percentage between 75 and 85 percent.

This is a process that is fairly simple to set up but surprisingly, many contractors fail to do so. Some high-end government-centric accounting software programs have integrated this capability but even with QuickBooks and Excel, its easy to implement. Contractors just have to make a practice of doing it. Now if you are a very small contractor with one or two contracts, you probably know - you intuitively know how your expenditure burn rate is stacking up against contract ceilings. That's not good enough for the auditors - they want to see a written policy and adherence to that policy.

The next thing the auditor will assess when reviewing a contractor's billing system is to determine whether the contractor is up to date in submitting its annual incurred cost proposals. This is important because the indirect rates used for billing purposes must be adjusted to reflect the final rates from the incurred cost submission. If the final rates are lower than the provisional billing rates, the Government is harmed. If final rates are higher than billing rates, the contractor is harmed. You might think that the Government wouldn't care too much if the contractor were harmed but those rates do impact the limitation of cost monitoring requirements discussed above. The Government really wants to know its true exposure under cost type contracts.

Tomorrow, we will continue our discussion on the criteria that make up an adequate billing system for Government contracts.

Go on to Part 2.

Independent Audits of Contractor Business Systems - Part 7

We recently finished up a six-part series discussing the DoD's new proposal for ensuring the adequacy of certain contractor business systems; namely the estimating system, the MMAS (material management and accounting system), and the accounting system. If you missed it, you can read them through by starting with Part 1. In short, DoD's proposal, if adopted, will require contractors to self-assess three of their business systems and engage an independent CPA firm to audit those systems every three years.

We haven't been the only one writing about the proposal. There have been numerous published blogs and articles on the subject. Today, we want to recap some of the concerns and insights expressed by various authors and organizations. Some of these comments express concerns and offer insights that we hadn't considered as we were reviewing and writing about DoD's proposed regulation.

In its Federal Register Roundup Blog, SheppardMullin looks at the rule with a "legal" spin. Contractors will be offered no favorable credit or "safe harbor" for disclosures made in their reports. That's true. Under current rules, system deficiencies will result in billing withholds until the deficiencies are corrected. That doesn't change under the new rule. It doesn't matter whether the deficiencies are disclosed by the Government or by the contractor's independent CPA firm. Withholds will still result.

SheppardMullin further writes that the new rule places a substantial administrative and monetary burden on contractors (which we previously discussed) but because the Government won't conduct any audits until the contractor and/or its CPA has completed their own audits, the statute of limitations on Government claims will begin to run at a much later point in time then would be the case if the audit process were initiated by the Government. They also expressed concerns that DCAA criticisms of contractor audits could easily prompt False Claims Act allegations based on alleged misstatements in the private audits or other alleged inadequacies in the audit process. We agree with SheppardMullin that no one should be deluded into believing that DCAA will accept those self-assessments or those prepared by the contractors' CPAs.

Law360 quotes a representative of PSC (Professional Services Council) stating that this new rule is more than what contractors wanted. Contractors want the option of getting their own independent CPA audit or waiting for the Government to get around to doing one. PSC is currently withholding comment on the proposed rule. Law360 also warns that the new rule "...tries to recapture some of the access to information, work papers, internal audits that would be traditionally off limits to the government if they were to do this review themselves.

WileyRein expressed concern about the efficacy of the proposed rule. "Since these contractor and CPA reports are subject to DCAA review, it remains to be seen how long DCAA takes to review the reports and whether DCAA will accept CPA audits or review them so critically that the anticipated efficiencies are lost."

The National Law Review expresses the same concern: "It is not clear however, whether this new proposed framework would realize meaningful time efficiencies. Government auditors who review third-party CPA audits may not be inclined to rubber stamp those findings".

JDSupra Business Advisor lists a number of concerns including i) the qualifications of CPA firms to perform the business system examinations, ii) extent to which independence of the CPA firms will be determined, iii) effectiveness of CPA firm examination in the eyes of a follow-on DCAA assessment and iv) liability borne by both the CPA firm and the contractor if a system found to have no deficiencies by the CPA is later determined to have deficiencies based on subjective criteria.

This proposal is such a radical departure from the way that DoD has conducted its business ever since there were contract auditors that no one really knows how it will turn out. The biggest unknown right now is how DCAA intends to review the work of contractor internal assessments and external CPA reviews. It would be useful if DCAA were to publish those procedures and timelines now, rather than wait until the rule goes final.

Legal Costs Related to Whistleblowers

The FAR Councils recently revised the cost principle at FAR 31.205-47, Legal Costs, to address the allowability of legal costs related to employee whistleblowers.

Employee whistleblowers seems like a new growth industry - especially when the whistleblowing is attached to a Qui Tam action under the False Claims Act. Many times, the employee has nothing to lose - they find an attorney to take the case on commission and if the Government steps in (enjoins) the suit, most of the legal costs from then on are borne by the Government. If the relator/Government wins, the relator gets a cut of the action - 10 or 20 percent, or so.

Regardless of whether the Government enjoins, contractors are going to incur legal costs to defend themselves. Are these costs to defend themselves allowable, or not? It depends.

The revised rule implements a statutory requirement. Costs incurred in connection with any proceeding brought by a contractor or subcontractor employee submitting a whistleblower complaint of reprisal are now treated exactly the same as the pre-existing cost principle's treatment of costs incurred in connection with any proceeding brought by a Federal, State, local, or foreign government for violation of, or a failure to comply with, law or regulation by the contractor, or costs incurred in connection with any proceeding brought by a third party in the name of the United States under the False Claims Act.

Such legal costs are unallowable if the result is, in a civil or administrative proceeding, either (i) a finding of contractor liability where the proceeding involves an allegation of fraud or similar misconduct; or (ii) imposition of a monetary penalty, or (iii) an order issued by the agency head to the contractor or subcontractor to take corrective action, where the proceeding does not involve an allegation of fraud or similar misconduct.

Therefore - caution to contractors - be careful how you word any settlements with whistleblowers. Recovery of legal costs may be dependent upon how settlements are worded.

SBA Meets its Fiscal Year 2013 Small Business Contracting Target

The U.S. Small Business Administration (SBA) announced last Friday that in fiscal year 2013, the Federal Government met its small business contracting goals. This was the first time in the past eight year that it had met, or exceeded its small business contracting goal. The goal is set at 23 percent of Federal contracts and has been since at least 2007. In fiscal year 2013, the contracting with small businesses totaled 23.4 percent. In 2012, that percentage was 22.25 and the year before is was 21.65. So it seems evident that progress is being made.

Prime contractors, on the other hand, did not meet their small business subcontracting goals. Their goals are understandably higher than the Government's. You won't find small businesses building fighter jets and aircraft carriers. However, contractors building fighter jets and aircraft carriers should have plenty of opportunities to subcontract some of that work to small businesses. For prime contractors, the small business subcontracting goal is 36 percent. In fiscal year 2013, prime contractors achieved a 34 percent factor. This was up slightly from 33.6 percent from fiscal year 2012 but down from 35 percent in fiscal year 2011.

In terms of dollars, the 23 percent represented about $83 billion going to small businesses. That's a significant amount of money by any measure. If you add the subcontracting piece, the number jumps to around $160 billion.

We do have to wonder however whether the ever-shifting thresholds for small business size standards has anything to do with the Government meeting its goals. As thresholds rise (sales and numbers of employees) for various NAICS codes, more and more firms will qualify as small businesses. Contracts (and subcontracts) awarded to those firms, might now fall in the "small business" bucket whereas before, awards to those firms were not considered as awards to small businesses.

New Executive Order - Fair Pay and Safe Workplaces

Yesterday, July 31st, the President signed an executive order (EO) that will require companies interested in doing business with the Government to disclose recent violations of a panoply of labor related laws. Additionally, the EO prevents contractors from forcing employees to agree to arbitration in lieu of going to court. Although not stated, these disclosures will probably be incorporated into SAM (System for Award Management) where many representations and certifications already reside.

The disclosure requirement applies to contracts in excess of $500 thousand while the forced arbitration prohibition applies to solicitations in excess of $1 million.

Under the EO requirements, prospective contractors must make an affirmative representation that there have not been any administrative merits determinations, arbitral award or decisions, or civil judgment rendered against it within the preceding 3 years for violations of:

• The Fair Labor Standards Act
• OSHA Act of 1970
• National Labor Relations Act
• Davis-Bacon and Service Contract Acts
• EEO
• Family and Medical Leave Act
• Civil Rights
• Americans with Disabilities Act
• Age discrimination
• Executive Order requiring Government contractors to pay minimum wage.
• And more.

If there are any violations, the contracting officer, as part of the responsibility determination, will provide the offeror an opportunity to disclose the steps taken to correct the violations or improve compliance with the labor laws listed earlier including any agreements entered into with an enforcement agency. The agency's Labor Compliance Advisor will review the disclosure and advise the contracting officer as to its sufficiency and adequacy.

Many labor contracts contain provisions that employees in the case of labor disagreements, employees agree to arbitration in lieu of taking the matter to court. Under this new EO, contractors are precluded from requiring arbitration. Now, arbitration to settle disputes can only be made with the voluntary consent of the employee.

The entire Executive Order can be read by following this link. Be warned - its lengthy.