Government Standards of Conduct in Contracting

There are a number of safeguards within the Federal Acquisition Regulations (FAR) that prescribe policies and procedures for avoiding improper business practices and personal conflicts of interest and for dealing with their apparent or actual occurrence. Most of these are found in FAR Subpart 3.1. The overarching principle reads as follows:

Government business shall be conducted in a manner above reproach and with complete impartiality and with preferential treatment for none. Transactions relating to the expenditure of public funds require the highest degree of public trust and an impeccable standard of conduct. The general rule is to avoid strictly any conflict of interest or even the appearance of a conflict of interest in Government-contractor relationships. While many Federal laws and regulations place restrictions on the actions of Government personnel, their official conduct must, in addition, be such that they would have no reluctance to make a full public disclosure of the actions (FAR 31.101-1, emphasis added).

In a recent Comptroller General bid protest, a company alleged that its winning competitor had an unfair competitive advantage that the Government failed to "meaningfully consider". This competitor had hired the former director of the office awarding the contract. The former director had left office during the procurement and began employment with the competitor after the submission of initial proposals but prior to the date of final proposal revision (FPR). The former director, it was contended, had access to non-public, competitively useful information. The agency however, took no affirmative steps to avoid or mitigate the apparent conflict, contrary to FAR requirements.

The Comptroller General (CG) noted that according to the record, the contracting officer had not contemporaneously investigated the competitor's potential unfair competitive advantage prior to contract award. In response to the bid protest however, the Agency performed a thorough investigation and concluded that there was no reason to believe that the former director could have shared proprietary information with his new company and therefore the award was not tainted by any conflicts.

The problem with this post-award investigation however is that it did not meet the regulatory obligations to avoid even the appearance of conflict. The CG stated:

In this regard, where a firm may have gained an unfair competitive advantage through its hiring of a former government official, the firm can be disqualified from a competition based upon the appearance of impropriety which is created by this situation, even if no actual impropriety can be shown, so long as the determination of an unfair competitive advantage is based on facts and no on mere innuendo or suspicion.

The CG further stated that it typically reviews contracting officer's conflict of interest investigations and, where an agency has given meaningful consideration to whether a significant conflict of interest exists, it will not substitute its judgment for agency's, absent clear evidence that the agency's conclusion is reasonable. However, in this case, the contracting officer had failed to meaningfully consider whether the competitor's employment of the former director had access to competitively useful, non-public information that gave it an unfair competitive advantage.

In this case, the CG sustained the bid protest. To read the full case, click here.

Unpaid Delinquent Tax Liabilities and Felony Convictions

If you are planning to enter into contracts with the Department of Defense or even bidding on such, you need to be aware of DoD's policy that prohibits funds to be used to enter into contracts with firms that are either delinquent in paying their Federal tax liabilities or have been convicted of a felony criminal violation under any Federal law within the past 24 months.

Specifically, this prohibition applies to corporations that:

• Has any unpaid Federal tax liability that has been assessed, for which all judicial and administrative remedies have been exhausted or have lapsed, and that is not being paid in a timely manner pursuant to an agreement with the authority responsible for collecting the tax liability, where the awarding agency is aware of the unpaid tax liability, unless the agency has considered suspension or debarment of the corporation and made a determination that this further action is not necessary to protect the interests of the Government; or
• Was convicted of a felony criminal violation under any Federal law within the preceding 24 months, where the awarding agency is aware of the conviction unless the agency has considered suspension or debarment of the corporation and made a determination that this further action is not necessary to protect the interest of the Government.

DoD contracting officers are now including a provision in all solicitations that require prospective contractors to "represent" that it has not unpaid Federal tax liabilities of the type described above and that it has not been convicted of a felony criminal violation under a Federal law within the preceding 24 months.

You can read more about these prohibitions by clicking here.

Manufacturing and Production Engineering Costs (M&PE)

One of the least known FAR cost principles is FAR 31.205-25 covering Manufacturing and Production Engineering Costs (M&PE). In has remained unchanged since 1983 when it was expanded to expand upon the activities covered by the definition. The definition of allowable MP&E costs includes:

1. Developing and deploying new or improved materials, systems, processes, methods, equipment, tools and techniques that are or are expected to be used in producing products or services
2. Developing and deploying pilot production lines;
3. Improving current production functions, such as plan layout, production scheduling and control, methods and job analysis, equipment capabilities and capacities, inspection techniques, and tooling analysis (including tooling design and application improvements);
4. Material and manufacturing producibility analysis for production suitability and to optimize manufacturing processes, methods, and techniques.

The FAR definition of M&PE also includes a listing of the activities that are not included in the definition.

1. Basic and applied research effort related to new technology, materials, systems, processes, methods, equipment, tools and techniques. Such technical effort is governed by the IR&D (Independent Research and Development) FAR cost principle (see FAR 31.205-18)
2. Development effort for manufacturing or production materials, systems, processes, methods, equipment, tools and techniques that are intended for sale. Such effort is also governed by the IR&D FAR cost principle.

Sound confusing? Think of it this way. IR&D entails developing a potential new product. M&PE on the other hand entails developing a process or tool that is not intended for resale.

Prior to 1992, there were caps imposed on what the Government was willing to reimburse contractors for IR&D expenses. In some cases these caps were negotiated as advance agreements. In other cases, there were formula that escalated prior year expenditures. When the caps were lifted, the significance of this M&PE cost principle was diminished. The reason for that was because if a contractor came close to expending its IR&D budget, thereby not getting reimbursed for the expenditures, it would simply reclassify the activities into M&PE which was not subject to caps. There were several cases involving contractor attempts to reclassify IR&D costs into M&PE. In most cases, the contractor lost.

Now, since neither IR&D nor M&PE costs are capped, it makes seemingly little difference on how the costs are classified with one exception. Contractors can capitalize M&PE expenses and amortize those costs over a period of years. IR&D costs on the other hand, are considered period costs and must be expensed in the year incurred. This could make a difference for some contractors under certain circumstances.

Forged Documents Lead to Conviction

Back in 1993, the President of a Pennsylvania machine company was convicted of paying bribes to secure Government contracts and paying hush money to the company controller in an attempt to cover it up. It was a felony conviction and he was fined $20 thousand and sentenced to four months of house arrest, 400 hours of community service, and three years probation.

A few years later, this person with a felony conviction on his record was at it again. He bought a defunct division from his old company and soon began winning millions of dollars in Government contracts to produce critical hardware components used in military helicopters and other aircraft. These contracts allowed the company to receive progress payments based on cost incurred.

In 2011, the Defense Contract Audit Agency (DCAA) performed an audit of a progress payment submitted by the company. During the audit, the owner directed two employees to present a copy of a altered cancelled check to a subcontractor in the amount of $69,000. The the true amount of the check was $25,000. The auditor accepted the falsified documentation as authentic, obviously failing to observe actual documentation or otherwise corroborating the information, wrote up a clean report, and the contractor went on to receive additional progress payments.

One of the employees who was asked to provide falsified documentation to the auditor subsequently blew the whistle and the Justice Department opened a criminal investigation. Ultimately, the investigation revealed that the contractor had diverted $1.2 million of progress payments to other uses. Subcontractors were not getting paid so they stopped work. This caused delivery delays under the contracts and quality concerns. Some of the items paid for by the Government were never delivered.

On December 17, 2014, a federal judge entered a $3.6 million civil judgment against the company and its owner. The owner agreed to the orders and did not dispute his liability.

There are a couple of obvious points that arise from this incident. First, the Government's system for dealing only with reputable contractors is broken. A man with a felony conviction was able to get right back into Government contracting and win millions in Government contracts. Second, the DCAA auditors were easily duped.  They relied on forged documentation to support their audit objectives. This embarrassment ultimately led to changes in the way that DCAA looks at supporting data. Auditors are now more likely to insist on viewing "original", rather than copies of documentation - invoices, purchase orders, cancelled checks, etc. - when performing their audits.

Another Case of Labor Mischarging

A couple of months ago, the Justice Department announced that a defense contractor had paid $13.7 million to settle a false claims allegations that it had billed the Government for a higher level of skill mix than had actually worked on the contract. In other words, the contractor billed the Government for an engineer but provided the services of a technician. You can read more about that case by clicking here. These kinds of cases are not that infrequent. In our posting that we just linked, we referred to two other recent similar cases. These kinds of cases are not difficult for an auditor to find either. Companies with T&M (Time and Material) contracts will be audited and a basic audit step is to verify the bonafides of the employees performing the work.

While the case just mentioned involves a Government contractor that is not particularly well known, such claims are not limited to just the small guy. Last week, the Justice Department announced that Lockheed Martin (the first or second largest DoD contractor depending upon how one measures) paid $27.5 million to settle the same kind of charges brought under the False Claims Act. Justice reported that the alleged mischarging occurred on two Army contracts where Lockheed provided rapid access to products and services in Iraq and Afghanistan. Lockheed violated the terms of the contracts by using under-qualified employees who were billed to the Government at the rates of more qualified employees.

The natural and probably consequences of these schemes is an increase in profits for the contractor at percentages above what was contemplated during negotiations and considered fair and reasonable.

Lockheed Martin stated that it had settled to avoid the distraction and risks of litigation. The company also reported that it had self-disclosed the issue when it came to their attention and that settlement was not an admission of liability. The self-disclosure rules for contractors is an interesting concept that we will take up at a later date.

You can read the Department of Justice's press release here.

Eliminating Excessive Pass-Through Costs

According to Section 802 of the 2013 NDAA (National Defense Authorization Act), the Department of Defense as well as the State Department and the Agency for International Development (AID) were required to issue guidance and regulations to ensure that contracting officers complete additional analyses prior to awarding contracts over $700 thousand ($150 thousand for State and AID) where the prime contractor proposes to subcontract 70 percent or more of the total cost of work to be performed (these are called pass-through contracts). The concern, of course, is that with significant subcontracting activity, the Government might not be getting much value out of the prime contractor’s involvement in the contract.

The NDAA requires a “Notification, Review, and Determination” procedure for pass-through contracts. Under these procedures, if an offeror intends to award subcontracts for more than 70 percent of the total cost of work to be performed, it must inform the Government and identify the amount of the indirect costs and profit/fee applicable to the subcontracted work as well as a description of the value-added the offeror will provide to the Government.

The contracting officer then, must (i) consider the availability of alternative contract vehicles and the feasibility of contracting directly with a subcontractor or subcontractors that will perform the bulk of the work, (ii) make a written determination that the contracting approach selected is in the best interest of the Government and (iii) document the basis for such determination.

In June of this year, the GAO (General Accountability Office) initiated a review to determine how well the Agencies had implemented this new rule. The GAO found that nothing had really changed in the interim. In fact, DoD had done nothing because the Department was waiting for revisions to its FAR Supplement. As a result, the GAO concluded that the Government continues to be at risk for paying excessive contract prices.

As a result of its review, the GAO recommended that DOD, State, and AID issue guidance to assist contracting officers by identifying approaches for or examples of how to assess alternative contracting approaches to include the feasibility of contracting directly with proposed subcontractors, and documenting a determination that the approach selected is in the best interests of the Government. Additionally, the GAO recommended that the Agencies revise the processes and guidance governing management reviews of procurements to ensure that such reviews assess whether contracting officers are complying with the provisions of the 2013 NDAA.

You can read the entire GAO report here.

Searching for Government Bid Opportunities

Every Government contractor and anyone looking to pursue Government work is familiar with the Federal Business Opportunities (FBO or FedBizOps) website where the Government publicizes its needs and solicits offers to fill those requirements. Perhaps the most frustrating thing about the website for the casual user (that would be most small companies) is the difficulty in searching and finding opportunities to bid on. It does take a lot of patience and experience to gain proficiency with the FBO search engine. Right now, as we write this, there are 24,000 plus opportunities listed on the site. Finding ones in the right NAICS code, in the right location, of the right size, can be a challenge. There are companies out there that specialize in matching companies to bid opportunities.  Often times this can be cost-effective for small firms that do not have the resources to dedicate to pursuing the FBO website. For very small companies, the local PTAC (Procurement Technical Assistance Center) provide that service for free or a nominal fee.

A recent GAO bid protest decision illustrates some of the complexities and pitfalls associated with using poor search criteria when looking for bid opportunities. In this case (Creative Mobility Group) protested the award of a contract to another company on the grounds that it was unable to find the solicitation on FBO and therefore unable to submit a quote. The reason for not finding the solicitation is because the Agency had not identified the specific state or states for the "place of performance". According to Creative Mobility Group, the Agency should have, at a minimum, selected four states as the place of performance since the work was to have been performed in each of those four states. The Agency maintained that the solicitation was easily retrievable using applicable terms in other search categories which the protestor could have reasonably availed itself of such searches and found the solicitation.

The GAO denied the protest, noting that a prospective contractor must demonstrate that it availed itself of every reasonable opportunity to obtain the solicitation documents. In this case, Creative Mobility failed to do so. As an initial finding, GAO noted that Creative Mobility was the incumbent contractor for the work and failed to inquire about a follow-on until three weeks prior to the end of the contract, by which time the opportunity to bid on the follow-on had ended. Secondly, the Agency demonstrated that the solicitation was easily obtainable from FBO using a variety of search terms such as NAICS code, the VA network to be served, "home medical equipment", or HME all would have returned the solicitation materials.

GAO ruled that the Agency's decision to not include the place of performance did not mislead the protestor because there were alternative search categories that would have allowed it to retrieve the solicitation.

You can read the entire GAO decision here.

Closure to the Largest Bribery and Kickback Scheme in the History of Federal Contracting

Monday of this week, the Department of Justice announced that Eyak Technology LLC and Eyak Services LLC (related companies) agreed to pay $2.5 million and relinquish any rights to additional payments from the United States Government, to resolve allegations that the companies submitted false claims to the Corps of Engineers. These companies are subsidiaries of Eyak Corporation, an Alaska Native Corporation (ANC). When the fraud was first exposed, the Corps of Engineers stopped payment on all of Eyak's invoices. Eyak has agreed not to pursue those payment requests.

You may remember this case that first came to light in 2011. Eyak had a $1 billion contract with the Corps of Engineers to provide and install high-tech equipment. Between 2007 and 2011, Eyak's director of contracts accepted kickbacks from several subcontractors. The  kickbacks were included in billings from the subcontractors and subsequently passed along to the Government. In many cases, work was never performed. The Justice Department emphasized also that Eyak lacked the internal controls to detect the improper charges and that's where the Corporation got in trouble. Yes, there were rogue employees but the lack of adequate internal controls allowed the fraud to occur and fester for so many years.

The main contractor employee in the scheme is now serving a seven year prison sentence and was forced to pay $9 million in restitution. A Corps of Engineers participant is serving a 19 year sentence. So far, more than 20 people and businesses have been convicted of charges related to their involvement in the contract fraud scheme.

This case should be a reminder to all Government contractors of the importance of implementing effective internal controls, ethics, and compliance programs. This case also illustrates what can happen when the Government purchases commercially - there is no Government oversight of the contractor.

You can read the Department of Justice press release here.

Who's Watching the Purse? Turns Out No One Is

NASA spent $15.6 billion in fiscal year 2013, more than half of that on cost-type contracts. Cost-type contracts pose a financial risk to NASA (and the Government, and the taxpayer) because they do not promise delivery of goods and services at set prices. To mitigate the risk associated with the use of cost-type contract, FAR requires contractors to submit annual incurred cost submissions. These submissions are then audited (or should be audited) to assess whether costs are properly applied to contracts, sufficiently supported, and allowable.

NASA (and all Government agencies) generally has six years to recover any unallowable costs from the date an adequate incurred cost proposal is submitted. Heretofore, the Defense Contract Audit Agency (DCAA) has been performing the incurred cost audits under a reimbursable agreement. According to NASA estimates, there are 1,153 incurred cost proposals waiting to be audited, 39 percent of which predate 2009.

Yesterday, the NASA Office of Inspector General (NASA-IG) issued a report on an audit intended to assess whether NASA had adequate procedures to ensure that costs passed on to the Agency are supportable, allowable, reasonable, and allocable. The report disclosed that NASA is at increased risk of paying unallowable, unreasonable, and unallocable incurred costs and of losing the opportunity to recoup improper costs because NASA contracting officer rely too heavily on DCAA's incurred cost audit process. Under DCAA's new risk-based methodology, DCAA has significantly decreased the number of contractor proposals it audits in an effort to reduce its six-year backlog of incurred cost proposals awaiting review.

The NASA-IG determined that NASA had not strengthened its internal controls to account for the significant reduction in DCAA oversight of NASA cost-type contracts. The IG also concluded that NASA's reliance on DCAA is inhibiting the Agency's efforts to timely close out contracts.

To remedy these deficiencies, the IG recommended that NASA revise its FAR Supplement to allow independent public accounting firms to provide supplemental audit coverage for NASA contracts where DCAA cannot be responsive to NASA's need for an audit. This change would be consistent with what other Agencies have done recently - i.e. rely on independent CPA firms to perform incurred cost audits. NASA agreed with the recommendation and provided a plan to revise the NASA FAR Supplement so as to allow outside firms to supplement DCAA audits.

It seems that not every Agency is enamored with DCAA's new risk-based approach to auditing - an approach that pretty much ignores any proposal under $5 million. That high of a threshold is too much in the eyes of some for protecting the Government's interests. This new plan of NASA's heralds yet more diminution of DCAA's workload and influence in the contract audit environment.

GAO Review of Access to Contractor Internal Audits

Long time readers of this blog will recall back in the 2012 and 2013 National Defense Authorization Acts (NDAAs), there was a lot of attention to whether the Government should or should not have access to contractor internal audit reports. There were provisions in early iterations of the 2012 NDAA bills that would have given the Government access to internal audit reports. Those were deleted in the final bill. In 2013, the issue came up again. Ultimately, there was no provision requiring contractors to furnish internal audit reports but there was a requirement for the Government (namely DCAA or Defense Contract Audit Agency) to document requests made to contractors for copies of those audit reports and report on contractors' responses to those requests every six months. Specifically, the 2013 NDAA required auditors to document that

1. access to company internal audit reports is necessary to an ongoing DCAA audit
2. a request to the contractor, and
3. the contractors' responses.

In the five month period ending December 1, 2013, DCAA made 163 requests for internal audits. In April of this year, the GAO (General Accountability Office) initiated a review to determine DCAA's level of compliance with these documentation requirements. The GAO randomly selected eight of the 163 requests to determine the level of DCAA compliance with the statute. They issued their report last month.

One aspect of GAO's review, perhaps the most important point, was verifying that DCAA's requests for access to internal audit reports contained a clear connection between DCAA's work and the audit and that it included narrative justifying how obtaining the audit would benefit DCAA's work. The drafters of the legislation were justifiably concerned that DCAA would simply go on a fishing expedition and request every audit, regardless of its relevance to the internal control systems that DCAA considered necessary to protect the Government's interests. So, the NDAA included specific requirements that DCAA establish a nexus between contractors' internal audits and their own audits.

Both DCAA and company internal auditors have responsibility for assessing the quality of company internal controls. Broadly speaking, internal controls refer to management processes designed to provide reasonable assurance about a company's ability to provide reliable financial reporting, promote effective and efficient operations, and comply with applicable laws, regulations, and contract provisions. While contractor internal audit departments have a very broad scope, the internal control audits performed by DCAA are limited to those systems that impact costs charged to Government contracts, e.g. estimating systems, accounting systems, and billing systems.

The GAO found that none of the eight sampled requests for access to contractor internal audits were adequately documented. None contained a full statement of the requested report's connection to DCAA's work and two did not cite any connection. The justifications were too broadly stated such as "we determined that we should view the audit report to support our assessment of the efficacy of internal controls". This kind of broad justification, according to the GAO, did not identify which aspects of internal controls were to be particularly addressed - it did not provide a detailed explanation of how the internal report was connected to the ongoing work of evaluating internal controls or risk assessment.

Contractors that are recipients of requests for internal audits could help DCAA by insisting that the Agency properly draw a connection between the requested documents and the objectives of the internal control audit being performed. That wouldn't necessarily commit a contractor to providing the internal report but it would be useful to know whether a particular report could contribute to the DCAA audit objectives, thereby reducing the level of testing required.

Employee Fraud - Directing Subcontractors to Use Designated Lower-Tier Subcontractors

Whenever we read of a fraud case, our interest goes immediately to questioning what went wrong - what internal control system did not exist or was not adequate to prevent it from occurring. According to the Fraud Triangle model, there are three factors that, when taken together, lead to fraudulent behavior. These three factors are (i) perceived unshareable financial need, (ii) perceived opportunity, and (iii) rationalization. Take away any of these three conditions and you will reduce the likelihood of occupational fraud occurring in your organization. Internal control systems fall within the "opportunity" condition - good internal control systems should decrease the opportunity for someone to commit fraud against your organization.

Yesterday, the Department of Justice publicized the results of a jury trial where an employee of a large, multi-national construction and engineering firm was convicted of fraud. In this case, the employee was able to direct the recipients of subcontracts he had awarded, to hire certain other companies as lower-tier subcontractors. Directing a subcontractor to award lower-tiered subcontracts to specific firms would be inappropriate in any purchasing system. But to compound the problem, these lower-tiered subcontractors happened to be companies he himself controlled. In one case, he owned a shell company with no employees had the employees of the prime contractor - his co-workers - perform the work. In the other case, he owned 51 percent of the shell company but it also had no employees to perform the construction work.

In these cases, the subcontractors who agreed to the conditions were partly to blame. They probably knew what was going on but perhaps they figured that it was just the cost of doing business. If they didn't play, they wouldn't get the work. Kickbacks are difficult to detect but there are some red flags that contractors should be aware of.

• Lack of competitive bidding procedures
• Poor supervision of the purchasing function
• Prices of goods or services appear to be higher than market value
• Employees promote or lobby for a vendor who others in the industry shun
• Employees appear to be unusually chummy with a particular vendor
• Management applies inordinate pressure on purchasing employees to use a particular vendor
• The vendor is in a highly competitive industry where kickbacks and bribery are connonplace

Contractors need to be cognizant of conditions within their organization that would allow opportunities for fraud to occur. Once identified then, contractors need to develop and implement control systems that will prevent and detect fraud from occurring.

New Interim FAR Rule on Minimum Wage Requirements

Did you know that raising employee wages will reduce contract costs? According to the Government, in an interim rule issued today (December 15, 2014), that is exactly what will happen on February 13, 2015 when the new minimum wage rules begin applying to FAR-based contracts. Although that logic may seem counter-intuitive, the Government reasons that raising the minimum wages for employees working on Government contracts to $10.10 per hour will increase efficiency and costs savings because the new minimum wage will

• increase morale
• increase productivity
• increase quality of their work
• lower turnover and accompanying costs
• reduce supervisory costs

There are a few exemptions to the new minimum wage rule. These include

• learners, apprentices, or messengers
• students
• individuals employed in a bona fide executive, administrative, or professional capacity
• workers who perform work duties necessary to the performance of the contract but who are not directly engaged in performing the specific work called for by the contract, and who spend less than 20 percent of the hours worked in a particular workweek performing in connection with such contracts.

These new rules apply to subcontractors at all levels, first, second, third tier, etc. Prime contractors are responsible for the compliance by any subcontractor or lower-tier subcontractor, "whether or not the contract clause was included in the subcontract". If prime contracts do not enforce compliance, they could become liable for the additional compensation at the upper-tier subcontractor but not lower-tier subcontracts since there is no "privity of contract" with subcontractors. Specifically, the new interim rule provides that the Government may withhold payment from the contractor to (i) reimburse unpaid wages and (ii) or a failure to make payroll records available to the contracting officer and the Department of Labor.

This is a complicated rule, running 10 Federal Register pages. Contractors and prospective contractors need to spend some time understanding and implementing its provisions.

 

Forward Pricing Rate Proposal Adequacy Checklist - Final

A year ago May, DoD published a proposed rule requiring contractors who submit forward pricing rate proposals, to include a completed checklist along with that proposal in order to ensure that the proposals were submitted in an acceptable form. This proposed rule followed an initiative from DCAA (Defense Contract Audit Agency) about six months earlier when it published its own forward pricing rate agreement checklist. The two were very similar but not exactly the same.

Yesterday (December 11, 2014), DoD published its final rule on this matter along with a revised checklist. That checklist, in Word format, can be downloaded here. There are substantive differences between the proposed and final checklists, most notably the removal of references to FAR Table 15-2 to remove "... any misunderstandings of the intent and content of the table submission items". Table 15-2 pertains to forward pricing proposals, not to forward pricing rate proposals.

Negotiation of forward pricing rate agreements (FPRA's) may be requested by the contracting officer or the contractor or initiated by the administrative contracting office (ACO). In determining whether or not to establish such an agreement, the ACO should consider whether the benefits to be derived from the agreement are commensurate with the effort of establishing and monitoring it. Normally, FPRA's are reserved for contractors having a significant volume of Government contract proposals (see FAR 42.1701).

Under this new rule, whenever a DoD contractor submits a forward pricing rate proposal, the contracting officer will also require it to complete and submit the new Forward Pricing Rate Proposal Adequacy checklist with its forward pricing rate proposal. Note, the forward pricing rate proposal is a FAR provision and applies to all Government contractors. The "checklist" is a DoD FAR Supplement provision and applies only to DoD contractors.

The purpose of the checklist according to DoD is to ensure submission of thorough, accurate, and complete proposals, provide consistency, and communicate common expectations to prevent rework and improve the efficiency of the negotiation process. Establishment of common expectations for contractors and the Government will promote adequate initial submissions of proposals, which should shorten the acquisition cycle making for more efficient negotiations for both contractors and the Government. The checklist is not geared to stimulate a contractor to create documentation other than the basic information that both the Government and contractor need to support and negotiate fair and reasonable rates. The checklist identifies those elements that would typically be included in a well-supported and complete forward pricing rate proposal.

Acquisition Reform? What Insiders Really Think

Last October, the Government Business Council, a research arm of Government Executive (see below for information on Government Executive) conducted a poll of 378 Defense Department employees to gauge their confidence in a number of acquisition related matters. The majority of those polled do not believe that the Pentagon's acquisition reforms (e.g. Better Buying Power) are working.

Here are some of the results:

• Only 30 percent of those surveyed are confident or very confident that the defense acquisition process provides the military the tools it needs to achieve its strategic objectives.
• Only 44 percent are confident or very confident that defense contractors will be able to ensure the military's technological edge through innovation.
•  Hardly anyone, only 8 percent (and 9 percent of polled workers who are in the acquisition/procurement field) are confident or very confident that the Pentagon's Better Buying Power initiative will resolve major defense acquisition problems. 

Concerning questions as to whether the acquisition workforce possess the skills and competencies needed to do their jobs, the results varied by function. For program management, 56 percent of the respondents feel that they have the necessary skills and competencies. For engineering and technical skills, that percentage rose to 64 percent. For contract management however, that confidence drops to 55 percent. One aspect of these poll numbers is that in each of these skill categories, there was 5 to 10 percent of the respondents who didn't know whether they possessed adequate skills and competencies. That should be worrisome.

These results do not really surprise us - procurement personnel have been through reform after reform after reform, and nothing seems to substantially change. In fact, more regulation pile up every week.

You can read more about the Government Executive survey by clicking here.

Govexec.com is a government business news daily and calls itself the premier website for federal managers and executives. Government Executive magazine is a monthly business magazine serving senior executives and managers in the federal government's departments and agencies.

Who Writes the FAR?

Often, when we report on a new FAR proposal or final regulation, we use the term "FAR Councils" when describing the source of the change. For example, we might state, "Last week, the FAR Councils published a proposed revision to ....". Well, the FAR councils are made up of real individuals working at various Federal agencies. There are two councils.

Revisions to the Federal Acquisition Regulations (FAR) are prepared and issued through the coordinated action of two councils; the Defense Acquisition Regulations Council (DAR Council) and the Civilian Agency Acquisition Council (CAA Council).

Members of these councils represent their agencies on a full time basis. They are preemptively selected for their superior qualifications in terms of acquisition experience and demonstrated professional expertise.

The chairperson of the CAA Council (Civilian Council) is a representative of the General Services Administration (GSA). Other members include representatives from Agriculture, Commerce, Energy, Health and Human Services, Homeland Security, Interior, Labor, State, Transportation, Treasury, EPA, Social Security, SBA and Veterans Affairs. Currently there are 19 members including the Chair.

The Director of the DAR Council is appointed by the Secretary of Defense. Members include representatives of the military departments, the Defense Logistics Agency (DLA), the Defense Contract Management Agency (DCMA) and NASA. Currently there are 14 members on the DAR Council including the Director.

The responsibility for processing revisions to the FAR is apportioned by the two councils so that each council has cognizance over specified parts or sub-parts. Each council shall be responsible for agreeing on all revisions with the other council. If agreement cannot be reached, the issues are elevated up the chain until agreement is reached.

The councils are supported by the FAR Secretariat. The GSA is responsible for establishing and operating the FAR Secretariat, to print, publish, and distribute the FAR through the Code of Federal Regulations system. Additionally, the FAR Secretariat provides the two councils with centralized services for

1. keeping a synopsis of current FAR cases and their status
2. maintaining official files
3. assisting parties interested in reviewing the files on completed cases, and
4. performing miscellaneous administrative tasks pertaining to the maintenance of the FAR.

One can imagine that there is a lot of coordination involved in bringing a regulation to publication. Between the two councils, there are 31 members representing a variety of organizations and interests that must eventually agree on concept and wording. Some changes take a long time to resolve. The oldest open FAR case is from 2010 which is attempting to implement a 2009 Executive Order (EO). Some of the changes are directed by Statute as when Congress sets caps on compensation levels. Some changes originate at the grass-roots level where acquisition professionals see a need and propose a change.

Watch your Contract Periods of Performance

During a recent incurred cost audit, DCAA (Defense Contract Audit Agency) took exception to about $300 thousand in costs charged to Government Contract Task Orders. These charges were booked to the Task Orders after the period of performance had ended. The auditor cited FAR 31.201-2(a)(4) as a basis for taking exception to the costs. That particular FAR provision states that a cost is allowable only when the cost complies with, among other things, the terms of the contract. The terms of the contract specified a specific period of performance so the auditor reasoned that any costs incurred outside the period of performance did not comply with contract terms.

In assessing the transactions, the auditor stated that they had "reviewed vendor invoices, purchase orders, payment records traced to (the contractor's) bank statements and conducted inquiries with (the contractor) regarding claimed expenses and documentation reviewed." Something did not ring true with that statement. If the auditor had really examined purchase orders, they would have noted that in all cases, the purchase orders were issued prior to the period of performance end. Although the vendor invoices were dated after period of performance, the binding obligation on the contractor was the date of the purchase order. Yet, no mention was made of these facts in the audit report.

The contracting officer, when shown the same information as was provided the auditor, immediately discarded the auditor's recommendations. So, other than wasting a lot of Government and contractor time, there was no cost impact to the contractor as a result of the audit finding.

The point we want to make here however is not that the Government was wrong, but to alert everyone to the potential that auditors will be comparing the dates of transactions to contact periods of performances. If you are aware of any such potential, we recommend that you contact your contracting officer, explain the situation, and obtain his/her approval before the auditors arrive.

Office of Federal Procurement Announces Another Procurement Reform

The Office of Federal Procurement Policy (OFPP) has a new administrator, Anne Rung, and this new Administrator has her focus set on procurement reform. Last week she issued a memorandum to the Chief Acquisition Officers and Senior Procurement Executives throughout the Executive Agencies announcing the new reforms.

The focus of these reforms is to simplify the "Federal contracting space" in order to drive greater innovation and creativity and improve performance. Industry has long complained about the complexity of the contracting process claiming that it leads to higher costs, slower procurements, and less innovation. That statement rings true. Some of the problems include 100 page request for proposals with overly prescriptive, Government-unique requirements, significant contract duplication across Government, and very little sharing of pricing and other contract information between agencies and industry.

1 Buying as "one" through category management. There is a critical need for a new paradigm for purchasing that moves from managing purchases and price individually across thousands of procurement units to managing entire categories of common spend and total cost through category management. Each category will be led by a senior Government executive who is a true expert in the category and who will develop a Government-wide strategy to drive improved performance.

2. Develop talent and tools across agencies and growing talent within agencies to drive innovation - instill a culture that rewards innovation (whatever that means). Nothing new here. Training has been a hallmark of every procurement reform program.

3. Building stronger vendor relationships. Early, frequent, and constructive engagement with industry leads to better outcomes, according to Ms Rung. Under this reform, OFPP has laid out four objectives.

• Creating better interfaces for government-industry interactions - modernizing the IT infrastructure.
• Removing regulatory barriers to innovation - get rid of useless FAR requirements (and useless requirements contained in individual agency FAR supplements).
• Vendor feedback - new guidelines coming that will allow frank, open assessment feedback by offerors and existing contractors for agencies to consider as part of their ongoing efforts to strengthen the acquisition processes and practices.
• Appointing enterprise-wide vendor managers - one Government manager per contractor instead of multiple contracting officers per contractor.

Best get started, Ms. Rung. You only have a couple of years and then you'll be gone when a new administration shows up. Your successor, no doubt, will have a reform agenda as well, but probably of a different flavor.

House Committee on Science, Space and Technology Hearing on Use of Management Fees

Yesterday (December 3, 2014) the House Committee on Science, Space and Technology held a hearing on two audits conducted by the Defense Contract  Audit  Agency (DCAA) on the National Ecological Observatory Network (NEON). NEON is non-profit organization funded by the National Science Foundation (NSF). Although the reports covered a variety of issues, the primary focus of the questioning related to NEON's use of management fees.

Management fees are amounts negotiated in cooperative agreements that grantees/contractors use to pay for unallowable or non-reimbursable costs. The NSF Inspector General stated that management fees are recognized at non-profits who are almost wholly dependent on Government funding who may need to incur costs that could not be reimbursed by the Government but were otherwise "ordinary and necessary" to maintain the entity's financial viability. Such expenses might include working capital and interest payments. One way to view management fees for non-profit organizations is to consider them analogous to profit earned by commercial organizations.

One of the audits reported that NEON had used management fees to pay for unallowable activities including

• $25 thousand for a Christmas party
• $11 thousand for coffee service
• $3 thousand for alcohol
• $3 thousand for t-shirts
• $83 thousand for business development
• $112 thousand for lobbying

In his opening comments, Chairman Lamar Smith almost accused the IG and DCAA of an attempted cover-up of these issues. The findings were not reported in the final audit report but were raised by a whistleblower.  Chairman Smith stated:

These suspicious taxpayer funded activities were not detailed in the (DCAA) audit submitted to the Inspector General. But to his credit, the principle auditor ... invoked the Whistleblower Protection Act to make sure the Inspector General, Congress, and ultimately the public is aware of the hundreds of thousands of taxpayer dollars being spent on improper activities.

According to both the Inspector General's and the DCAA Director's written comments and testimony, the reason for not taking exception to these costs was the lack of an authoritative basis for doing so. According to OMB Circular A-122, these costs would be unallowable if charged to the agreement/contract as costs. According to the NSF Inspector General and the Director of DCAA however, these costs were not claimed as allowable expenses under the agreement but were charged against the management fee. Both witnesses contend that there is no guidance, regulations, or any other authoritative document that restricts how a firm spends its management fee.

Evidently there is another hearing scheduled for early next year where NSF representatives will appear and explain why they allowed NEON to charge the taxpayers for these nefarious expenses.

To learn more about this hearing and listen to the archived webcast, click here.

New Recommendations for Reforming the Acquisition Process

The NDIA (National Defense Industrial Association) issued a report last month entitled "Pathway to Transformation". It lays out twelve recommendations pertaining to acquisition reform in three broad categories; authority and responsibility, matching requirements to resources, and evidence based decision making. The entire report can be downloaded or read here.

A lot of the recommendations seem old because they have been bandied about for years; more commercial pricing, delegate more authority, get rid of regulations, and improve management of the acquisition workforce. But, being former Government auditors ourselves, the one that caught our eye first concerned DCAA (Defense Contract Audit Agency).

Here's NDIA's recommendations for DCAA.

Problem Description: Inefficient audit practices are delaying the acquisition process and adding unnecessary overhead costs to the government and to industry support of the acquisition process.

Root Cause Analysis: In a compliance-driven process, audits are seen as key to successful system performance, but current audit requirements exceed DCAA's capabilities and resources. Recent statements by DCAA leaders indicate that 40 percent of DCAA personnel have five or fewer years or less experience in government auditing, which, when combined with vigorous assertions of audit independence, can lead to wasteful expensive audit practices. Decentralized DCAA management allows variation in practice and culture among its auditors which can also be unhelpful.

Solution Proposal: Improving the relationship of government auditors with government vendors is one of the greatest challenges in acquisition policy, since auditors must simultaneously look for inaccuracies in vendor reporting or documentation to protect the taxpayer while also avoiding unnecessary waste caused by inefficient audit practices.

Two general principles applied at the level of the individual auditor help to accomplish these goals:

     1.a risk-based approach to auditing that focuses on materiality, and

     2. an advisory approach to auditing that focuses on helping vendors come into full                compliance rather than an adversarial approach that seeks to identify every possible          error in vendor reporting and documentation and penalize them for it.

The law does not specify these practices, nor should it, since individual auditors ultimately need the flexibility to behave toward the vendor in the manner most befitting the given circumstances, which no law could be flexible enough to capture in its entirety. Instead, the problem is ripe for oversight and management, and therefore NDIA recommends an approach that combines the two.

10 USC 2313a which establishes an annual reporting requirement for DCAA, should be amended to include a report of DCAA's efforts to align its audit policies and practices across its various regions. At the organization level, increased commonality will encourage organizational learning as the regions connect with each other to identify and adopt best practices and to learn from mistakes.

Because most audit issues are unique to the company in question, the congressional defense committees should encourage DCAA to create outreach opportunities through meetings with companies, industry trade associations, and other contractor groups, to identify vendor complaints, review the facts, and resolve them effectively for both the vendor and auditors involved. Just as companies should not be treated as adversaries by auditors, neither should auditors be treated as adversaries by companies, and both should approach the audit process with a desire to learn and improve outcomes.

Everyone complains about the auditors and in a few cases, such complaints are justified. But these recommendations display a lot of ignorance on NDIA's part as to the nature and purpose of auditing. First of all, auditing, should never be allowed to degenerate into cozy relationships. One only has to recall the Enron scandal that was revealed in 2001 to see what can happen when clients and auditors blur the standards of independence. The auditors are there to protect the Government's interest, not to join the company's softball league. And, NDIA's comments about materiality are way off base. Materiality, significance, and risk assessments are factored into every audit performed. No audit entity is going to spend time reviewing immaterial items. Audit procedures are designed to provide "absolute" assurance, but "reasonable" assurance.

Its popular to criticize the auditors and perhaps NDIA threw in these recommendations as a bone to its 91,000 members. It is unlikely that such recommendations will contribute to acquisition reform unless one redefines reform as eliminating the auditors.

Prohibitions on Purchases of Products Produced by Forced or Indentured Child Labor

The ILAB (Bureau of International Labor Affairs), a division within the Department of Labor maintains a listing of products produced by forced or indentured child labor (click here to review that listing).

This listing goes back to the Clinton Administration and Executive Order 13126 which prohibited the Government from acquiring products mined, produced, or manufactured wholly or in part by forced or indentured child labor. The implementing regulations are found in FAR Part 22.15.

Before a contracting officer may make an award for an end product of a type identified on the "list", the contractor (or prospective contractor) must certify that

1. It will not supply any end product on the "list" that was mined, produced, or manufactured in a country identified on the "list" for that product or
2. It has made a good faith effort to determine whether forced or indentured child labor was used to mine, produce, or manufacture any end product to be furnished under the contract that is on the "list" and was mined, produced, or manufactured in a country identified on the "list" for that product and on the basis of those efforts, the offeror is unaware of any such use of child labor.

There is no guidance or instructions on what it means to make a "good faith effort" to determine whether forced or indentured child labor was used to mine, produce or manufacture products. Obviously, an offeror has to do something and document that activity and present it to the contracting officer to see whether it is adequate. In most cases, there would be no expectation on the Government's part that the offeror go out and physically observe the production activity and interview workers, managers, and owners.

Currently, there are 35 items on ILAB's list, most of which would not be in high demand by the U.S. Government. We just cannot imagine the Government buying a lot of bricks from Burma, carpets from Nepal, cattle from South Sudan, coal from Pakistan, diamonds from Sierra Leone and granite from Nigeria. Perhaps electronics from China, which is also on the list, might be a possibility. One very very curious item on the list is pornography from Russia. Now why in the world would the U.S. Government want or need to buy pornography from anywhere? Some procurement regulations are just weird. (UPDATE: Someone just mentioned that pornography might be procured for PSYOPS purposes).

Dept of Justice Intervenes in a Whistleblower Suit Alleging False HUBZone Certification

Historically Underutilized Business Zones (HUBZones) are areas that have historically had trouble attracting business. Companies who have their primary place of business inside a HUBZone, often receive preferential treatment when competing for Government contracts. Some Government contracts are exclusively set aside, or reserved, for HUBZone companies.

To find out whether your primary business location is situated in a HUBZone, refer to the SBA's HUBZone map.

The primary purpose in SBA's HUBZone program is to help create jobs in areas that historically, have had trouble attracting business. Companies that maintain their principal office in a zone (and meet certain other requirements) can apply to the SBA for certification as a HUBZone small business company.

As one might expect, this program is sometimes abused by companies that seek the preferential treatment but do not maintain their businesses in a HUBZone area. Such is the complaint filed yesterday involving a contractor making false statements to the SBA to obtain HUBZone certification.

The complaint alleges that the company first applied to the HUBZone program in 2010 by claiming that its principal office was located in a designated HUBZone. The complaint further alleges that the office was a "virtual office" where no employees worked - the real office was in a non-HUBZone location. The company also falsified a lease agreement for its purported HUBZone office.

After obtaining the HUBZone certification, the company then used the certification to obtain contracts from the Corps of Engineers, the Coast Guard, and the Interior Department worth millions of dollars. One contract alone was worth $11 million.

The scheme might have continued indefinitely if it were not for a whistleblower. The whistleblower, in fact, was an employee of a competitor whose duties included monitoring competitors' bidding activity. While doing so, she learned that the company had listed an Orlando, Florida address for HUBZone certification when she knew that it was actually located in Chuluota, Florida, a non-HUBZone area.

If you want to read the entire Department of Justice press release, click here.

Additional Inflation-Related Acquisition Thresholds to be Increased

Last week, we reported on the proposed increase in the TINA (Truth-in-Negotiation Act) threshold from $700 thousand to $750 thousand - an inflation related adjustment. That same proposal included many other inflation related thresholds requiring changes to 91 different sections of FAR (Federal Acquisition Regulations). Most of these changes relate to internal Government procedures but a few will be of interest to Government contractors.

Micro-Purchase Threshold. Micro-purchases are acquisitions of supplies and services where the Government uses simplified acquisition procedures, the aggregate amount of which does not exceed the micro-purchase threshold. That threshold will increase from $3,000 to $3,500 under the new rules. The simplified acquisition procedures for micro-purchases are covered in FAR 13.2 and generally means the Government will use commercial purchase cards. The use of these procedures do not require provisions or clauses.

Subcontracting Plans. Any contractor receiving a contract for more than the simplified acquisition threshold (currently $150 thousand) must agree that small business, veteran-owned small business, service disabled veteran-owned small business, HUBZone small business, small disadvantaged businesses, and women-owned small business concerns will have the maximum practicable opportunity to participate in contract performance consistent with efficient performance. When the contract exceeds $650,000, the contractor is required to submit a formal "subcontracting plan". Under the proposed rule, the threshold for the formal subcontracting plan will increase from $650 thousand to $700 thousand.

Reporting Executive Compensation and First-Tier Subcontract Awards. FAR 4.14 (and FAR 52.204-10) requires contractors to report subcontract award data and the total compensation of the five most highly compensated executives of the contractor and subcontractor. This applies to all contracts exceeding $25,000. Failure to comply is a reportable condition in the performance rating system. Under the proposed rule, the threshold for reporting will increase from $25,000 to $30,000. The subcontract award information is publicly available at usaspending.gov. Compensation data is not publicly available.

Sleeter Group Announces 2015 "Awesome Applications"

Each fall, the Sleeter Group, arguably the most popular provider of technical reference materials, software expertise, and QuickBooks training materials for small businesses, has recognized accounting products in the SMB (small to medium business) market place. For many years, this list was called "Awesome Add-Ons" as in adding to the functionality of QuickBooks. Beginning in 2012, the group opened the competition to non-QuickBooks related products and changed the name from "Awesome Add-Ons" to "Awesome Applications". There remains, however, a strong QuickBooks flavor to the listing.

As consultants with many clients using QuickBooks, we are always interested in and looking for improvements to the basic QuickBooks platform, as well as improved or added functionality provided by third-party add-ons. With hundreds (if not thousands) of add-ons available however, it is difficult to assess which ones are worthwhile. Reviews by independent organizations such as the Sleeter Group help in assessing a product's strengths, weaknesses, and value.

This year's "winners" that could be of interest to Government contractors include the following:

TSheets is a repeat winner from last year. TSheets is an employee time-tracking system that can be used on mobile devices and desktop computers. We've been recommending this product lately for its ease of use, integration with QuickBooks, and its cost effectiveness (it runs about $20 per month plus $5 per month per employee with per-user prices decreasing as number of users increase). The publishers claim "DCAA Compliant" for this product - it requires supervisory review and approval, maintains an audit trail, and prompts for timely entries. For companies looking to automate their timekeeping systems, this product is worth a look.

Acctivate is a cloud-based inventory management system that made the top ten list. There may be a few Government contractors out there who require inventory management add-ons but most of these seem geared to the wholesale/retail.

If you're not satisfied with QuickBooks, you might look at a couple of other accounting systems that made the top ten; Zoho and Xero. We don't know too much about these products but they are gaining in popularity. Both are cloud-based platforms which hold a lot of appeal.

Many companies struggle with budgeting and forecasting. LivePlan is a cloud-based application that allows small businesses to easily create business plans, create and tract budgets and forecasts, and track financial trends. It can be set up, for example comply with Limitation of Costs/Limitation of Funds provisions in many Government contracts.

To review the complete listing of "Awesome Applications", click here.

To see prior year's winners, follow these links:

2014 winners

2013 winners

2012 winners

2011 winners

2010 winners

Routine Audits Can Turn Into Investigations

What good are policies and procedures if no one follows them? What good does it do to develop good policies and procedures if no one enforces them? Why have polices and procedures in the first place if no one monitors compliance or checks to see if they're working, as intended?

In news article published today, a State Auditor's Office performing a routine audit identified two employees whose overtime totals stood out from all other employees. As part of the audit, the auditors compared overtime hours claimed with information compiled from their building access cards. There were substantial differences so the auditors referred the matter to State investigators. The investigation found that two employees "gobbled up" $130 thousand over a three year period in "bogus overtime" payments.

Needless to say, these two employees are in trouble. One was fired and the other resigned but they may be facing other legal consequences. Their supervisor was demoted for lax oversight and the article is blaming the matter on failure to follow policy.

Our take on this matter is different. We believe that a failure of the internal controls allowed these individuals to skirt established policies. The policies and procedures may have been good but if compliance is not tested from time to time, those policies and procedures will be rendered ineffective. When a scheme goes undetected for three years, there would have had to have been a significant lack of internal controls including oversight, employee training, monitoring, and feedback.

One of the most fundamental methods of internal control is the segregation of duties. When it comes to overtime, one individual should not be capable of initiating, authorizing, executing, and subsequently reviewing overtime requests for appropriateness. An individual should not request overtime. Overtime should be requested by a supervisor based on need. The supervisor should obtain approval from someone higher up the chain. Someone from finance should authorize funds. The employee and the supervisor should sign the timecard/timesheet certifying that the hours were worked and charged to the appropriate job. Payroll should verify that overtime hours were approved and reviewed by appropriate supervisors and management. Internal audit or special teams should periodically review these practices for compliance.

Internal controls are not that difficult to implement.

FAR Council Proposing to Raise Certified Cost or Pricing Data Threshold to $750,000

The FAR Council today published a proposed rule that will raise the threshold for for certified cost or pricing data from $700 thousand to $750 thousand. Under FAR 15.403-4, contractors and prospective contractors are required to certify that the cost or pricing data submitted in support of a proposal is current, complete, and accurate. The actual certification states:

This is to certify that, to the best of my knowledge and belief, the cost or pricing data (as defined in Section 2.101 of the Federal Acquisition Regulation (FAR) and required under FAR subsection 15.403-4 submitted, either actually or by specific identification in writing, to the Contracting Officer or to the Contracting Officer's representative in support of ________ are accurate, complete, and current as of ____________. This certification includes the cost or pricing data supporting any advance agreements and forward pricing rate agreements between the offeror and the Government that are part of the proposal.

The intent for increasing the TINA threshold (Truth-in-Negotiations Act), according to the FAR Council, is not to reduce Government oversight but to maintain the status quo, by adjusting thresholds to keep pace with inflation. If the threshold was not adjusted for inflation, the number of contracts subject to TINA would continue to grow, because more and more contracts will be above the stated threshold.

The new threshold will probably become effective on October 1, 2015.

Bill to Prohibit "Boycotting Persons"

A bill was recently introduced in the House that, if passed, will require contractors and prospective contractors to certify that they are not "boycotting persons".  Anyone who has gone through the certification and representations section of SAM (System for Award Management) is well aware of the checklist certs and reps that are already required. This bill would add one more certification to the list.

Although the Bill itself does not mention Israel, Congressman Doug Lamborn's (CO) news release does. He calls it the Bill to prevent US Government Contracts from Going to Participants in the BDS Movement. The BDS Movement (Boycotts, Divestitures, and Sanctions) is a worldwide movement to increase economic and political pressure on Israel to end its occupation and colonization of Palestinian land, to provide full equality for Arab-Palestinian citizens of Israel, and to respect the right of return of Palestinian refugees. The news release reads;

Today I introduced H.R 5727 to thwart efforts by Palestinian organizations to pressure different corporations, companies and educational institutions to boycott, divest,and sanction Israel. Sadly, just yesterday we heard that some in the European Union are drafting new regulations with a similar aim. These attacks and the falsehoods being spread about Israel are harmful to any honest effort to bring peace to the region. (read the full news release here).

The term "boycotting person" means a person who takes or knowingly agrees to take any of the actions described in the next paragraph, with the intent to comply with, further, or support any boycott against a country with which the United States has a free trade agreement and which is not itself the object of any form of boycott pursuant to United States law or regulation.

The "actions" referred to in the previous paragraph include refusing, or requiring any other person to refuse, to do business with or in the boycotted country, with any national or resident of the boycotted country, or a business concern organized under the laws of the boycotted country.

The penalties for false certification are harsh. If it is determined that a person (i.e. a contractor) has submitted a false certification, the contract will be terminated and the person will be debarred and ineligible for any Federal contracts for at least two years.

Now, this bill could prove problematic for some contractors, individuals, and educational institutions who are already engaged in various forms of boycotting.

What are ERP (Enterprise Resource Planning) Systems?

ERP or Enterprise Resource Planning systems is one of those terms that we tend to throw out there and expect everyone to know what we're talking about. When you here the acronym, think of a huge software application that performs many different business functions. The term itself is somewhat vague and to find out what the capabilities of any particular ERP system, you have to ask a lot of questions. No two ERP systems are the same.

Enterprise Resource Planning (ERP) had its beginnings back in the late 1970s or early 1980s. Back then, it was simply called Materials Requirement Planning (MRP) and had the capability to plan efficiently while considering bills of materiel quantities, scrap and yield factors, various lead times, various lot sizes, minimum and maximum quantities, safety stocks and safety lead times.

Later on in the 1980s, MRP II cam along and added master scheduling, forecasting, customer service, order entry, capacity requirements planning, procurement, production control, inventory management, standard costing and accounting. The goal of MRP and MRP II was to allow companies to react and re-plan as it received feedback on performance against plan.

In the 1990s MRP II evolved into ERP, Enterprise Resource Planning. ERP included functionality for quality management just-in-time manufacturing, financial planning and budgeting, executive support systems, EDI (electronic data interchanage), sales support systems, manufacturing executive systems, logistics, plant and equipment maintenance, and advanced planning systems.

Over the years, more and more functionality has been included into ERP systems. Now we have collaborative planning, forecasting and replenishment features, supplier relationship management, CRM (customer relationship management). Additionally, there is the internet and mobile devise functionality being added all of the time.

Investments in ERP systems require significant resources, both time and money. We recently learned that one Government contractor had already spent $7 million and wasn't finished. A typical ERP project involves re-engineering business processes and selecting and implementing commercially available software packages from vendors such as SAP, Oracle, and Deltek. Costs include:

• Preparation of request for proposal
• Current state assessment: The process of documenting the entity's current business process. This activity is sometimes called mapping, developing an "as-is" baseline, flow-charting, or determining current business process structure.
• Process re-engineering: The effort to re-engineer the entity's business process to increase efficiency and effectiveness. This activity is sometimes called analysis, determining "best-in-class", profit/performance improvement development, or developing "should-be" processes.
• Restructuring the work force: The effort to determine what employee makeup is necessary to operate the re-engineered business process.

Generally Accepted Accounting Standards (see ASC 720-45) require that the cost of business process re-engineering activities, whether performed internally or by third parties, is to be expensed as incurred. The cost of software development on the other hand, whether acquired or developed in-house, must be capitalized (see ASC 350-40). Therefore it is important to properly segregate the software component from the re-engineering activities of ERP development.

Rental Costs - Part 2

Yesterday we began this two part series on rental costs by emphasizing the need for contractors to document their justification for determining rental costs are reasonable. Generally, rental costs are going to be allowable but the FAR cost principle governing rental costs make a great deal about "reasonableness" and provides a number of attributes that contractors need to document in order to demonstrate cost reasonableness. It is not uncommon for contract auditors to request that information during audits. If you missed Part 1, click here.

"Sales and leasebacks" are specifically called out in this FAR cost principle (FAR 31.205-36). Companies sometimes sell their assets and lease them back. One common reason for this practice is to get some cash (working capital) for operations but there are also income tax considerations that can work in their favor.

Rental costs under a sale and leaseback arrangement are almost always higher than ownership costs had the contractor retained title to the asset. Obviously, there is going to be some imputed interest in the rental rate. Therefore, FAR caps rental costs under sales and leaseback arrangements at the amount the contractor would be allowed (ownership costs) had the contractor retained title to the asset. The ownership costs are computed on the net book value of the asset(s), adjusted for gain or loss on the disposition of the asset(s) on the date the contractor became a lessee. Contract auditors will specific tailor their audit procedures to test for sales and leasebacks and other less than arms-length transaction.

The other thing to be concerned about with leases relates to terminated contracts. The FAR cost principle pertaining to rental costs (31.205-36) refers to a different cost principle for terminations (FAR 31.205-42). When a contract is terminated, contract performance is truncated and leases entered into for the purpose of the contract, have not yet run their course. Rental costs under unexpired leases are generally allowable under these circumstances but allowability is not automatic. The contractor must demonstrate that the lease was reasonably necessary for the performance of the terminated contract. The contractor must also demonstrate that the amount of rental claimed does not exceed the reasonable use value of the property leased for the period of the contract. Finally, the contractor must make reasonable efforts to terminate, assign, settle, or otherwise reduce the cost of such leases.

Leases between related parties. We previously covered the special rules governing leases between divisions, subsidiaries, and organizations under common control. To read that coverage, click here.

Rental Costs - Part 1

There are two kinds of leases capital leases and operating leases. Earlier this year, we presented a five-part series on capital leases (see Part 1, Part 2, Part 3, Part 4, and Part 5). The cost principle governing capital leases is found in FAR 31.205-11(h). A different cost principle, FAR 31.205-36 covers operating leases.

FAR 31.205-36 applies to the cost of renting or leasing real or personal property acquired under operating leases. Generally, such rental costs are allowable, but the rates, terms, and conditions must have been reasonable at the time the lease was signed. The determination of "reasonableness" is always subjective but it is not common for contract auditors to question rental costs unless it is less than an arms-length transaction.

For a discussion on rent paid to related parties, click here.

Before entering into any rental agreement, contractors should consider and document the following FAR induced factors. The Government may ask for it.

• Rental costs of comparable property, if any
• Market conditions in the area
• The type, life expectancy, condition, and value of the property leased
• Alternatives available, and
• Other provisions of the agreement.

How much premium does five miles justify?

A number of years ago, the Government challenged a major contractor's rental payments for office space. The particular office space was adjacent to a major university and the employees working there were assigned to the contractor's research and development department. Five miles down the Interstate, the contractor leased other facilities for half the cost of those situated next to the university. The contract auditors determined that the contractor had not considered alternatives. The auditors noted that there was plenty of vacant office space in the half-price vicinity and recommended that the contractor consolidate its operations into the less expensive area. The cost savings to the Government would have been more than a million dollars per year.

The contractor argued that the particular R&D section benefited greatly by being close to a research university - its employees could more easily collaborate with University researchers than they could if they were five miles away. Basically, the contractor built a case based on perceived or intangible benefits. The contracting officer (Defense Contract Management Agency) was persuaded by the contractor's arguments and did not sustain the auditor's position.

Tomorrow we will look at other aspects of this cost principle (see Part 2)

Purchasing Systems and Their High Propensity for Fraud

According to the 2014 Association for Financial Professionals Payments Fraud and Control Survey, a staggering 60 percent of businesses were exposed to actual or attempted payments fraud in 2013. The typical fraud-related loss experienced by businesses was $23 thousand. Ten percent of businesses recovered the full amount of money defrauded from them. Thirty percent of those impacted by fraud recovered nothing.

Not surprisingly, small businesses are more susceptible to fraud than larger firms. Many small businesses do not have internal control systems, they're disorganized, they do not perform business fundamentals like reconciling checkbooks regularly, and they put a lot of trust in their employees.

There are many ways to defraud. If the fraud is the accounts receivable clerk kiting checks, the resolution is between the clerk, the company, and perhaps local law enforcement. But woe to the company where the impact of fraud is passed along to the Government through a contract or grant. That company will feel the immense weight of the Government investigative and judicial juggernaut as they pursue prosecution and/or settlement.

Consider the Department of Justice press release from yesterday. Sevenson was a company founded in 1917 by one man. The company was passed on in the 1940s to the man's sons and from the sons to the grandsons in the 1970s. Here was a nearly 100 year old environmental remediation company that became quite successful by any standard - except for one detail. They had some employees who exploited weak internal controls.

These employees accepted kickbacks, rigged bids, and passed inflated charges to the Government. The DOJ press release stated that the employees accepted more than $1.6 million in kickbacks from six companies in exchange for the award of subcontracts for work at a EPA clean-up site. Then, those employees conspired with the subcontractors to pass the majority of those kickbacks to the EPA through inflated charges.

Obviously, this kind of fraud is perpetrated through a contractor's purchasing system and that is one reason why the adequate purchasing system are so important to the Government (e.g. DCMA performs periodic Contractor Purchasing Reviews (CPSR) at larger contractors). Internal controls can be devised to prevent fraud. Contractors should implement sound policies, procedures, and practices before its too late.

Contractors Must Identify the "Place" of Contract Performance

Contracts awarded under sealed bidding (FAR Part 14) and by negotiation (FAR Part 15) both require prospective contractors to identify the place of contract performance and owner of the plant or facility at which the work will be performed. It is also necessary to identify the place of contract performance when determining and applying SCA rates (Service Contracting Act). Most prospective contractors disclose this information when making their certifications and representations as part of the SAM (System for Award Management) process.

Why is such information necessary? What will the Government do with it?

Information relative to the place of performance and owner of plant or facility, if other than the prospective contractor, is a basic requirement when contracting for supplies or services (including construction). A prospective contractor must affirmatively demonstrate its responsibility. Hence, the Government must be apprised of this information prior to the award.

The contracting officer must know the place of performance and the owner of the plant or facility to

1. determine bidder responsibility
2. determine price reasonableness
3. conduct plant or source inspections, and
4. determine whether the prospective contractor is a manufacturer or a regular dealer.

Back in 2011, we wrote a six part series describing how the Government conducts "responsibility" determinations on prospective contractors. That series can be viewed here.

The information is used to determine the prospective contractor's eligibility for awards and to assure proper preparation of the contract. Prospective contractors are only required to submit place of performance information on an exceptional basis; that is, whenever the place of performance for a specific solution is different from the address of the prospective contractor as indicated in the proposal.

Cancelling Funds

The National Defense Authorization Act of 1991 established a canceled phase for funding. Funds are canceled five years after the date last available for obligation and may no longer be paid out, even if already obligated. Therefore, if all contract obligations using those funds are not paid by that date, the Government must find an alternative source of funds. Usually these alternative sources are from current appropriations.

Obligating funds throughout the life of the contract is a balancing act. Contracting officers do not want to obligate too much funding and potentially lose it. On the other hand, they do not want to obligate too little funding and then later have to find the money from another source.

Contract audits play a big role in cancelling funds. Its very difficult to estimate funding needs when incurred cost audits are backlogged. Will the contractor owe the Government money because final rates were lower than billing rates. If so, those overages could be lost as a source of funding other projects. Will the Government owe the contractor money because the billing rates were lower than the final rates? You would think that from the Government's perspective, underbilling would be a good thing. However, if the obligations for that contract have expired, then the Government has to find the money from other sources.

When the Government has to find money from other sources, payments are often delayed because the Government must figure out from what bucket its going to draw from to pay the extra money. We know of one case right now that is into its fourth month without payment. The contractor's (audited) final rates were significantly higher than its billing rates. The Government acknowledges its liability but has not yet found the funds to pay (by the way, Prompt Payment Interest began accruing after 30 days).

It is to everyone's advantage to resolve final indirect rates quickly and efficiently so that neither party is impacted by cancelling funds.

Another DoD-IG Review of DCAA Audits

Last September, the DoD Inspector General issued another one of its oversight reports on the quality and adequacy of DCAA (Defense Contract Audit Agency) audits. The IG reviewed 16 audits that were completed between 2011 and 2013. They found significant inadequacies in 13 of the 16 audits including deficiencies in i) audit planning, ii) evidential matter, iii) working paper documentation, and iv) supervision. They made 96 recommendations of which DCAA agreed with 72. Not happy with the concurrence rate, the IG wants DCAA to reconsider their response to the remaining 24 recommendations.

Someone should try to get through to the DoD-IG's office that DCAA's audits, by any reasonable measure, are pretty darn good. Experienced DCAA auditors have an innate ability to quickly ferret out audit risks and to develop audit procedures commensurate with those risks. Audits are designed to provide "reasonable" assurance that a proposal price is based on adequate cost or pricing data or that incurred costs are allowable, allocable, and reasonable. The IG's expectation seems to be that DCAA should provide "absolute" assurance.

Someone should also tell the IG that no one really cares about their audits of DCAA any longer. Congress has long since lost interest and the press certainly doesn't cover their ad nauseam reports on DCAA any longer. Seriously, is it really a National interest that an auditor somewhere did not comply with GAGAS (Generally Accepted Government Auditing Standards) because he failed to initial off on a working paper. Is National security at stake? Will the defense budget become overrun as a result? The public doesn't understand GAGAS nor will they ever take the time to do so - especially when there's IRS abuses, illegal immigration, and the rising cost of health care premiums to worry about. Come on IG, get a life. You've had your 15 minutes of fame back in 2009. Time to move on.

Compliance audits have got to be the most mundane of any audit type. Picture the (highly paid) IG auditor who sits in a room and pours over a DCAA audit work package - looking for even the most minute infraction. Where's the job satisfaction in that? Are they adding value to the procurement process? In many cases, the IG auditors spend more time reviewing individual DCAA working paper packages than the auditor spent on the entire audit. How does that pencil out? Could private enterprise survive under such circumstances?

We think its time for the Department of Defense to redirect the Inspector General's office toward more productive activities.

Final Indirect Rate Determination - Contracting Officer or Auditor?

Final indirect cost rates can be established on the basis of contracting officer determination or auditor determination. FAR (Federal Acquisition Regulations) contain guidance on who gets that responsibility (see FAR 42.705). Basically, the contracting officer is the one responsible for settling indirect expense rates. Under certain circumstances, the contracting officer may delegate that responsibility to the contract auditor.

Settlement of indirect expense rates for the big dollar contractors is always reserved for contracting officer determination. Business units of multi-divisional corporations under the cognizance of a corporate administrative contracting officer (CACO) must be settled by the contracting officer. Likewise, indirect expense rates at business units not under the cognizance of a CACO but having a resident administrative contracting officer must be settled by the contracting officer (a resident administrative contracting officer is one who spends more than 75 percent of his/her time on a single contractor). Rates at educational institutions, state and local governments, and nonprofit organizations are also reserved for contracting officer determination. Everything else can be delegated to the contract auditor for final determination if the contracting officer decides to delegate the responsibility. In other words, its totally up to the contracting officer to delegate or retain the responsibility for final determination.

There are several factors that the contracting officer will consider when deciding whether to delegate or retain settlement responsibility. The contract auditor must agree to accept the delegation however. If the contract auditor does not agree, the contracting officer is stuck with the responsibility.

Before responsibility is delegated, the contracting officer and the auditor must agree that the indirect costs can be settled with little difficulty and any one of four circumstances are present. These include:

1.  The business unit has primarily fixed-price contracts, with only minor involvement in cost-reimbursement contracts (contractors with predominately fixed price work are considered lower risk than those with predominately cost reimbursable contracts).
2. The administrative cost of contracting officer determination would exceed the expected benefits (does this presume that a contracting officer's time is more valuable than an auditor's time?)
3. The business unit does not have a history of disputes and there are few cost problems (this would cover most contractors).
4. The contracting officer and auditor agree that special circumstances require auditor determination.

If the contractor and the contract auditor cannot agree on rates for a submission that has been delegated to the contract auditor for determination, the contracting officer takes over the responsibility for final determination. This happens somewhat frequently for a variety of reasons. Most often its because a contract auditor cannot "negotiate" a settlement - issues are black and white and questioned costs are based on applicable cost principles. Recognizing that there are grey areas and costs where "reasonableness" comes into play, the contracting officer, by authority of his/her warrant, can negotiate a mutually agreeable settlement.