New Nondiscrimination and Affirmative Action Requirements for Contractors

The Department of Labor's Office of Federal Contract Compliance Program (OFCCP) has proposed new regulations that will require "covered" Federal Government contractors and subcontractors and federally assisted construction contractors and subcontractors to ensure nondiscrimination in employment on the basis of sex and to take affirmative action to ensure that applicants are employed, and treat employees are treated during employment, without regard to their sex.

Now at this point, you might be thinking ho-hum, this requirement has been around forever. Not really. The main purpose of these new regulations is to implement the President's Executive Order (EO) 13672 from last July. That EO, for the first time, added sexual orientation and gender identity as prohibited bases of discrimination.

The EO prohibits contractors from discriminating in employment on the basis of race, color, religion, sex, sexual orientation, gender identity, or national origin. It also requires contractors to ensure equal employment opportunity for employees and applicants for employment without regard to those attributes. It goes further in requiring contractors to take affirmative action to ensure that applicants are employed, and that employees are treated during employment, without regard to the race, color, religion, sex, sexual orientation, gender identity, or national origin.

So, who is to be covered under these new regulations? Practically everyone. The requirements apply to any business or organization that holds a $10,000 contract or contracts totaling more than $10,000 in a 12-month period. The penalties for violating the EO and the forthcoming rules are substantial. A contractor in violation may be subject to suit for make-whole and injunctive relief and to having its contracts canceled, terminated, or suspended or to debarment after the opportunity for a hearing.

These new rules are intended to advance the employment status of female employees of Federal contractors in several ways. First, the rules address both quid pro quo and hostile-environment sexual harassment. Second, they clarify that adverse treatment of an employee because of gender-stereotyped assumptions about family care-taking responsibilities is discrimination. They clarify that childcare leave must be available to fathers on the same terms as they are to mothers. And finally, the rules will also confirm the requirement that contractors provide equal retirement benefits to make and female employees, even if doing so costs more for one sex than the other.

Quite possibly the most significant and costly aspect to this new rule concerns compliance. In this regard, contractors have affirmative duties to maintain data, conduct internal reviews, and monitor pay practices for potential discrimination, as well as comply with the ban on discrimination in the payment of wages, salaries, and other forms of compensation. Read that again. "Contractors have affirmative duties to maintain data, conduct internal reviews, and monitor pay practices ..."

If you care to read the new 100 plus page draft of the new rules, you may do so by clicking here.

Identifying Expressly Unallowable Costs

Yesterday we wrote about recent DCAA guidance telling its auditors how to spot "expressly unallowable costs" and turn those costs into a money-making deal for the U.S. Government. Earlier this month, DCAA (Defense Contract Audit Agency) "enhanced" that guidance in order to assist auditors in making determinations whether specific cost principles identify expressly unallowable costs. A copy of the "enhanced" guidance can be downloaded here.

According to DCAA's enhanced audit guidance, the overarching criteria for determining whether a cost is expressly unallowable is this:

In order for a cost to be expressly unallowable, the Government must show that it was unreasonable under all the circumstances for a person in the contractor's position to conclude that the costs were allowable. Thus, a cost principle makes costs expressly unallowable if (i) it states in direct terms that the costs are unallowable, or leaves little room for differences of opinion as to whether the particular cost meets the allowability criteria and (ii) it identifies the specific cost or type of costs in a way that leaves little room for interpretation.

There are many costs included in the FAR section on cost principles (FAR 15, Part 31) that leaves little room for interpretation as to whether the cost is expressly unallowable. Take FAR 31.205-51, Costs of alcoholic beverages, for example. The regulation states that the costs of alcoholic beverages are unallowable. Therefore, the cost of alcoholic beverages are expressly unallowable and contractors who fail to exclude such costs from their billings or incurred cost submissions, face the prospect of having the costs questioned and then being subjected to penalties. There are a lot of cost principles are not that clear or straight-forward and that's where one can expect that DCAA will take aggressive positions on whether such costs are expressly unallowable - especially given this new emphasis on identifying expressly unallowable costs.

In many situations, cost principles do not state in direct terms whether costs are unallowable. But, according to DCAA, the "... mere fact that the cost principle does not include the word unallowable or phrase not allowable does not mean that costs questioned based on that cost principle are not expressly unallowable." DCAA imparts a lot of weight on an old ASBCA case (Emerson Electric Co., ASBCA No. 30090, 87-1 BCA 19478) where the Board ruled that although the regulation did not state that foreign selling costs were unallowable, the only logical interpretation of the language was that they were expressly unallowable. DCAA loves the phrase "the only logical interpretation" because they use it over and over again throughout the guidance.

There is one aspect of the guidance that offers sound advice to auditors. It reads:

... the audit team will have to make a determination regarding whether the cost principle, used as the basis for questioning the costs, identifies expressly unallowable costs. In order for the cost to be expressly unallowable, it is not enough that our logical interpretation of the language is that the questioned costs are expressly unallowable. The Government must establish that it was "unreasonable under all the circumstances for a person in the contractor's position to conclude that the costs were allowable." Therefore, in situations where a cost principle does not specifically state that the applicable cost is unallowable or not allowable, the audit team will have to employ critical thinking when determining whether the cost principle identifies expressly unallowable costs. The audit team will need to analyze whether the cost principles identifies a cost or type of cost clearly enough that there cannot be a reasonable difference of opinion as to whether a questioned cost meets the criteria specified.

One aspect of penalties is that DCAA is advisory to the contracting officer. DCAA cannot levy penalties. Contracting officers have the authority to waive penalties and often do waive penalties, especially when they are immaterial or the administrative cost of recovering them would exceed whatever amounts could be recovered. Additionally, auditors and contracting officers often do not agree on whether costs are questionable and even if they do agree that a cost is unallowable, often disagree on whether the cost is expressly unallowable.

Cost Principles that Identify Expressly Unallowable Costs

The Defense Contract Audit Agency (DCAA) just published a listing cost principles found in the Federal Acquisition Regulations (FAR) and the DoD FAR Supplement (DFARS) that identify expressly unallowable costs. Expressly unallowable costs of course are subject to penalties if, for example, a Government contractor fails to exclude them from its annual incurred cost proposal. DCAA's new 32 page listing is sure to be controversial because not everyone believes as DCAA believes when it comes to whether certain costs are expressly unallowable or merely unallowable. Keep in mind that this listing represents DCAA's "view" of costs that are expressly unallowable and while in many cases such views are not controversial (e.g. the cost of alcoholic beverages), there are some items where reasonable parties may disagree as to whether they are "expressly" unallowable.

Penalties are nothing to take lightly. The amounts can add up and become rather punitive. For information on penalties on unallowable costs, please refer to our five part series on the subject beginning here.

The new DCAA audit guidance, which can be accessed here is referred to as a tool to help determine whether statements from the cost principles that are used as a basis to question costs are expressly unallowable. Auditors are cautioned however not to blindly follow the listing but to exercise auditor judgment when evaluating the costs. But, in the same paragraph and in an almost contradictory manner, the guidance emphatically states that "If an audit team questions costs, based on a statement from a cost principle that is on the list, it should treat the questioned costs as expressly unallowable and subject to penalties." What happened to the exercise of judgment?

The guidance then cautions that the 32 page listing is not comprehensive. It states that "The fact that a statement in a cost principle is not included on the list does not mean that costs questioned, based on that statement, are not expressly unallowable. There could be situations where costs questioned could be expressly unallowable based on the facts and circumstances of that particular situation". Here, DCAA is encouraging its auditors to find examples to add to the listing.

There are many examples throughout the listing where DCAA has taken liberty with the precise wording of the cost principle. Take "advertising" for example. The cost principle (FAR 31.205-1) does not use the term "unallowable" or "not allowable". However, DCAA determined that the costs were expressly unallowable based on a 25 year old ASBCA (Armed Services Board of Contract Appeals) decision from 1987. Perhaps so, but there are many FAR experts out there that might disagree with that position.

Get ready for some fun and games.

The American Jobs Matter Act of 2015

Congresswoman Elizabeth Esty (D. Connecticut) introduced a bill in the house last week that, if passed, would require contracting officers to "consider" information regarding domestic employment before awarding a Federal defense contract.

According to her press release, the American Jobs Matter Act will leverage taxpayer money spent on federal contracts to support American manufacturers and boost job creation. The bill will reqire the Department of Defense to take into account the creation and retention of American jobs when issuing contracts. Esty stated that between 2007 and 2013, DoD spent over $700 billion on manufactured goods with over $150 billion spent on goods produced overseas. During the same period, the United States lost an estimated 1.7 million manufacturing jobs. Presumably, this intent of this Act is to bring back some of those lost manufacturing jobs or at least slow down future outsourcing to other countries.

Well, what does "consider" mean in the context of this legislation?

In prescribing the evaluation factors to be included in each solicitation for competitive proposals for covered contracts, an agency shall include the effects on employment within the United States of the contract as an evaluation factor that must be considered in the evaluation of proposals.

This applies generally to contracts in excess of $1 million.

The head of an agency, in issuing a solicitation for competitive proposals, shall state in the solicitation that the agency will consider as an evaluation factor a Jobs Impact Statement to include

1. the number of jobs expected to be created or retained in the US if the contract is awarded
2. The number of jobs created or retained in the US by the subcontractors expected to be used by the offeror in the performance of the contract.
3. A guarantee from the offeror that jobs created or retained in the US will not be mvoed outside the US after award of the contract unless doing so is required to provide the goods or services stipulated in the contract or is in the best interest of the Gvoernment.
4. The contracting officer may request that contractor support with additional information its jobs impact statement
5. Require the agency each year to assess the accuracy of the Jobs Impact Statement
6. Shortages between proposed jobs and actual jobs will affect a contractor's past performance in the award of future contracts.

We have no idea as to whether this bill will pass. But, it seems benign enough not to warrant a lot of opposition. Contracting officers won't like it. The Act will require more work by contracting officers, not only to consider the Jobs Impact Statement when awarding contracts but also to track and monitor performance against plans.

You can read the entire Act by clicking here.

Past Performance vs Relevant Experience

There is a difference between "past performance" and "relevant experience".

A bidder on a task order for IT support services to the Department of Energy protested the award of that task order to another company based on a number of challenges including DOE's evaluation under the past performance and relevant experience criteria. The protestor contended that it was "incongruous for its quotation to be rated good under the relevant experience criterion yet outstanding under the past performance criterion given that (DOE) reviewed the same past performance projects under both criteria".

The solicitation advised vendors that award would be made on a "best-value" basis considering price and the following non-price criteria, listed in descending order of importance: business management, technical approach, past performance, and relevant experience. For purposes of award, the solicitation stated that the non-price criteria, when combined, were significantly more important than price.

The Comptroller General (CG) did not sustain the appeal. According to the CG, an agency's assessment under the past performance criterion considers the "quality of performance and successful performance relative to the scope, size, complexity and duration to the work described in the solicitation. In contract, an agency's assessment under the relevant experience criterion evaluated the relevance and extent that the contracts submitted for review are similar in size, scope and complexity to the work described in the performance work statement.

Thus, past performance related to how well a contractor performed, while relevant experience pertained to the type of work a contractor performed - two distinct criteria.

Given the fundamentally different nature of the evaluations, a rating in one factor would not automatically result in the same rating under the other.

The CG examined the record to ensure that the evaluation was reasonable and consistent with the solicitation's evaluation criteria and procurement statutes and regulations. The evaluation of experience and past performance by its very nature, is subjective, and a vendor's disagreement with an agency's evaluation judgments does not demonstrate that those judgments are unreasonable. The CG's review did not disclose any inconsistencies between DOE's evaluations and the solicitation's evaluation criteria.

You can read the entire decision here.

New Survey on the Health of the Acquisition Workforce

The Professional Services Council (PSC) and Grant Thornton LLP just released the results of their 2014 Acquisition Policy Survey. The report is titled "A Closing Window: Are We Missing the Opportunity for Change?" and the theme centers around the Government's failure to ensure that its buyers of good and services are receiving "fresh training" and "modern skill sets" needed to innovate and acquire the complex technology called for in today's agency missions. One might think so given all the documented acquisition inefficiencies such as the spectacular and costly "HealthCare.org" debacle we reported on just a couple of days ago.

Here are some comments from the report's Executive Summary.

The ability of the federal acquisition workforce to deliver quality outcomes ... is only partially determined by their individual commitment and talent. Outcomes are also driven by the environment and culture inwhich the workforce operates. Professional development opportunities, required policies and practices, and other external factors also play key roles... Respondents have consistently identified a lack of training resources and opportunities, misalignment of critical skills to operational needs, process-driven decision making, resistance to communication and collaboration, and excessive oversight, as primary areas of concern.

These concerns were similar to concerns raised in prior surveys so the designers of this year's survey set out to determine whether things have improved in the intervening two years. They wanted to find out whether the budget situation improved, whether the Government's investments in acquisition workforce development - which have been significant - helped to restore and create needed capabilities, whether the relationship with industry become more open and collaborative, and whether the application of oversight has been employed in appropriate and streamlined ways to minimize risk.

Their conclusion - "Regrettably, the answer to these questions is "not really."

One of the most significant takeaways was the low value place on pursuing innovation through the acquisition process. In sharp contrast to the stated goals of administration and agency leaders, and many on the  operational side of government, survey respondents ranked innovation as next to last in a list of key objectives for acquisition.

The survey identifies a number of challenges that the Government faces.

1. There is a growing risk that the acquisition workforce and ecosystem will be increasingly distanced from the kinds of innovations that can greatly enhance mission performance.
2. There remains a clear need for the various communities across government to align their objectives and interests
3. The survey clearly documents gaps in the acquisition workforce's business acument and related skills, strongly suggesting a continuing need to re-think and re-design the education and training of the acquisition workforce.
4. The acquisition workforce is increasingly buffeted between policy prescriptions and on0the-ground expectations.
5. Congress needs to act to restore regular budget order so the proper planning needed to address theses challenges can be put in place.

You can read the entire report by clicking here.

Proposed Rule Allows Contractor Employees to Blow the Whistle on Government Wrong-doing

Contractor employees have had, for some time, whistleblower protections when it comes to blowing the whistle on their Government contractor employer. Those protections do not extend to blowing the whistle on a Government agency or employee - until now.

The U.S. Office of Special Counsel (OSC) is proposing to revise its regulations to expand who may file a whistleblower disclosure with OSC. The revision will allow employees of Federal contractors, subcontractors, and grantees to disclose wrongdoing within the Federal government if they work at or on behalf of a U.S. government component for which OSC has jurisdiction to accept disclosures.

Congress implemented the Whistleblower Protection Act (WPA) in order to encourage Federal employees to report government fraud, waste, and abuse and to provide protections for Federal employees who blow the whistle on government wrongdoing. Federal employees (and former Federal employees) may disclose to OSC information that they reasonably believe shows a violation of any law, rule, or regulation, gross mismanagement, a gross waste of funds, an abuse of authority, or a substantial and specific danger to public health or safety.

Since the passage of the WPA, the federal workforce has changed significantly because of the Government's increased reliance on contractors. In the modern workforce, employees of contractors, subcontractors, and grantees (collectively “contractors”) often work alongside Federal employees, having similar if not identical duties. Thus contractors are similarly situated to observe or experience the same type of wrongdoing as are Federal employees. According contractors a safe channel to report wrongdoing within the government advances Congress’s purpose in enacting the WPA. Moreover, Congress recently extended protection against retaliation to government contractors who
make whistleblower disclosures, thereby signaling its encouragement of such disclosures. OSC deems such protection against retaliation a precondition to asking insiders to risk their careers to report wrongdoing.

Under the proposed rule, OSC may receive disclosures from current and former contractors who allege retaliation for making a protected disclosure under 41 U.S.C.4712, if they work or worked on behalf of a U.S. government agency in which Federal employees are themselves eligible to file disclosures.

Once a disclosure is received from an eligible contractor, OSC will evaluate the information and make a determination as to whether there is a “substantial likelihood” that it discloses wrongdoing  A contractor working at a Federal facility, alongside Federal employees and under the line supervision of a Federal employee, is virtually in an identical posture to a Federal employee. As such, his/her disclosure will likely carry a comparable degree of reliability as that of a Federal employee. On the other hand, if a contractor’s situation differs greatly from that of a Federal employee, it is less likely that OSC will be able to find that the contractor has credible information about government wrongdoing needed to make a substantial likelihood finding. For example, an off-site contractor, or one not working under Federal line supervision, is much less likely to directly encounter government wrongdoing and, therefore, may not have sufficiently reliable information. For that reason, to meet the “substantial likelihood” threshold, he or she may be required to produce compelling documentary information establishing government wrongdoing.

If OSC determines that a disclosure meets the “substantial likelihood” threshold, the Special Counsel will refer the matter to the relevant agency head, who will be required to conduct an investigation into the disclosure. The identity of a contractor who makes a disclosure to OSC will not be revealed without his or her consent, unless the Special Counsel determines that there is an imminent danger to public health or safety, or an imminent violation of criminal law.

Contracting Deficiencies at DHHS (Department of Health and Human Services)

Everyone is aware of of the troubled launch of HealthCare.gov. The Office of Inspector General (OIG) for the Department of Health and Human Services (DHHS) set out to find out the causes and has just released a report noting that the root causes were primarily contract related (no surprise there).

The Federal Marketplace at HealthCare.gov was designed to enable millions of Americans to select health insurance in a "one-stop shop" environment. A project of that magnitude required the development, integration, and operation of multiple information technology (IT) systems and Government databases. The CMS (Centers for Medicare and Medicaid Services) was the organization within DHHS responsible for the project. CMS acquisition planning and procurement activities were among the first steps critical to ensuring the success of this project. CMS awarded 60 contracts to 33 different companies to perform the work. The fractured launch of the Federal Marketplace raised a number of concerns, including questions about the adequacy of CMS's planning and procurement efforts for the project.

In its report, the OIG noted that CMS did not always meet contracting requirements. For example,

• CMS did not develop an overarching acquisition strategy for the Federal Marketplace
• CMS did not perform all required oversight activities
• CMS missed opportunities to leverage all available acquisition planning tools and contracting approaches to identify and mitigate risks
• CMS did not exercise the option to plan for a lead systems integrator to coordinate all contractors' efforts prior to the launch of the Federal Marketplace.
• CMS did not perform thorough reviews of contractor past performance when awarding two key contracts.
• CMS made contracting decisions that may have limited the number of acceptable proposals for much of the key work.
• CMS selected contract types that placed the risk of cost increases for this work solely on the Government (i.e. CMS awarded cost-reimbursable contracts).

And, of course, CMS made a number of dutiful recommendations corresponding to these identified deficiencies but such recommendations are pretty much meaningless - its like closing the barn door after the cows have left the barn. CMS may never have another program of the size and magnitude of the Federal Marketplace  - and if they do, perhaps it would be wise to ask for help from an agency that has experience in major systems acquisition planning and contracting.

It always amazes us that after some major flare-up like the roll out of HealthCare.gov, the agency's Inspector General arrives for an audit, spends a lot of time, and issues reports stating the obvious - you didn't follow policies and procedures. Agency responses are always the same - oops, you're right and it will never happen again because we're going to do this, that, and the other thing. The OIG then says something like "good response, your proposed corrective action will work", then go home and collect their paychecks.

You can read the entire OIG report here.

Taxes, When There is a Question on Allowability

Back in 2010, we posted a discussion on the allowability of taxes under FAR 31.205-41 (click here to read that post). The standard lists a number of taxes that are allowable under Government contracts and some that are not. One type of tax that is not allowable under Government contracts are taxes from which exemptions are available directly, or available based on an exemption afforded the Government, except when the contracting officer determines that the administrative burden incident to obtaining the exemption outweighs the corresponding benefits accruing to the Government.

After we posted our initial write-up, the ASBCA (Armed Services Board of Contract Appeals) issued a decision that helps clarify the "exemptions afforded the Government" provision of the FAR cost principle. (see ASBCA No. 5796, Westech International, Inc.).

The State of Arizona imposes a transaction privilege tax (TPT) on certain tangible personal property purchases. For several years leading up to the time of the appeal, Westech and the Government had been working to determine whether there was an exemption for TPT taxes for Government contracts.
The Government was not willing to reimburse the Contractor until such time as the applicability of the tax was resolved.

The Government attorney advising the contracting officer advised that Arizona's TPT tax was a legitimate expense and no exemption appeared to be applicable. However, the attorney also advised that the contractor should continue to seek ways to avoid the tax if possible. In 2009, the contracting officer, in turn, authorized the contractor to pay the tax but also, to continue to seek ways to avoid the tax if possible.

Evidently, authorizing the contractor to pay the tax and reimbursing the contractor for the taxes under a cost reimbursable contract are two different things. The contracting officer refused to reimburse the contractor for the paid taxes "until further direction is received". The contractor paid the taxes, the Government refused to reimburse, so the contractor appealed to the ASBCA.

The Board ruled in favor of the contractor. It ruled that FAR establishes a procedure for determining whether taxes are due in case of doubt. If the Government really believed such an exemption was available (despite its agency attorney's advice to the contrary, it could have instructed the contractor to litigate that issue in Arizona. The contracting officer did not do so. The Government evidently seeks to have the Board independently determine whether the Arizona exemption was available, but that is a matter for the Arizona taxing authorities and courts.

Further, the Government was on the hook for the penalties and interest on back taxes because the contractor did not pay the taxes on time at the contracting officer's direction. That made such costs specifically allowable under FAR 31.205-41(a)(3) which states:

Interest or penalties incurred by the contractor for non-payment of any tax at the direction of the contracting officer or by reason of the failure of the contracting officer to ensure timely direction after a prompt request is allowable.

Whenever there is a question regarding the applicability of taxes levied by a State, county, municipality or other taxing authority, contractors should engage their contracting officers right away for help in determining the propriety of those taxes charged to Government contracts.

Contractor Appeals DCAA Audit Results

Back in the 2007 to 2009 timeframe, Sperient Corporation was awarded several SBIR (Small Business Innovative Research Program) contracts by the Air Force and Marine Corps to perform research on fuzing sensors for munitions. These SBIR Phase II contracts were cost reimbursable contracts. In due course, DCAA (Defense Contract Audit Agency) conducted audits of the costs incurred by Sperient under the contracts and took exception to some of the costs. The contracting officers agreed with the audit results and Sperient has now appealed those final decisions to the United States Court of Federal Claims.

There are several issues in dispute.

Equipment rental costs. Sperient leased equipment from a company called Resperience. DCAA noted that the two companies were owned by the same person and therefore under common control. Being under common control, allowable costs are limited to the actual costs of ownership. Sperient countered with documentation showing the leases were reasonable when compared with market prices. The complaint raised a secondary defense stating that the owner of Sperient was only a minor shareholder of Resperience and therefore the two entities were not under common control.

Radar Range Rental Costs. Rental payments for the radar range were made pursuant to a lease agreement between Sperient and another private party. The property included a residence where, for a time, Sperient's CFO resided. It is unclear why DCAA questioned the amounts. One contracting officer final decision states the costs were not supported with invoices. This might be accurate as the complaint states that Sperient went out and got an appraisal for what the fair market value would have been. However, the complaint also mentions that DCAA questioned the costs because it didn't represent an arms-length transaction.

Consultant Housing. Sperient hired a consultant for these projects. The consultant costs are not in question. However, Sperient also paid the rent for office space in the consultant's home because, according to the complaint, the consultant had medical conditions that required him to work from home. DCAA questioned (and the contracting officers agreed) that such costs, in order to be allowable, must be included as part of the consulting agreement. Sperient argues that such costs are "reasonable accommodations" required by the Americans with Disabilities Act of 1990.

Credit card processing fees. DCAA questioned these costs on the basis that they were not necessary and therefore not allocable to the contracts. Sperient argues that the Government required them to obtain the ability to accept credit cards as payments.

Cell phones. DCAA questioned the cost of cell phones used by consultants and the owner of the radar range mentioned above. Sperient argues that the costs are reasonable and there is no restriction in FAR or elsewhere that prohibits a contractor from providing cell phones to consultants and lessees.

Sperient is seeking $520 thousand in its claim. There is one aspect to this case that might be problematic. The Marine Corp contract representing $410 of the $520 claimed amount, was terminated for default.

Now its up to the courts to decide the outcome. You can read the entire complaint here.

Amortization and Depreciation in a Post-Merger Accounting Period

For the past few days, we've been discussing restrictions on depreciation and amortization costs when a business combination occurs, i.e. when one company buys another and Government contracts are involved. Today we'll conclude this series by focusing on what the contract auditor might ask for and look at when auditing incurred costs.

The first thing that the auditor will look for is whether the company (the entity) has engaged in any business combination activities, either as the acquiring party or the acquired party. If there is no such activity, there is obviously no risk to the Government so the auditor will simply move along to other areas. The ICQ (Internal Control Questionnaire), which most contractors are familiar with because they've been asked over and over to help fill it out, is used to document whether business combination activities have occurred.

If there has been business combination activities, the auditor request a certain level of data and information necessary to ensure that the Government is not overcharged. The expectation is that contractors will have all the documentation necessary for the auditor to make that assessment. And, the auditor is on solid grounds for asking for the information. For example, for contracts subject to TINA (Truth-in-Negotiations Act) FAR 52.215-19 requires contractors to notify the Government of any changes in contractor ownership which would impact asset valuations. The clause also expressly requires maintenance of the records and calculation of the expense amounts which are required in order to comply with FAR 31.205-52 (Asset Valuation Resulting from Business Combinations). As noted yesterday, this cost principle limits the amount of allowable amortization, depreciation, and cost of money to the total amount that would have been allowable had the combination never taken place.

Once the auditor has acquired the necessary records and documentations, audit guidance requires auditors to make three determinations.

First, the auditor must verify that contracts do not receive increased costs flowing from asset revaluation resulting from business combinations.

Secondly, the auditor must verify whether the acquired tangible capital assets generated depreciation or cost of money charges on Federal Government contracts or subcontracts negotiated on the basis of cost during the most recent cost accounting period. For tangible capital assets that generated such depreciation expense or cost of money charges, no write-up and no write-down of asset values is permitted and no gain or loss is recognized on asset disposition. For tangible capital assets that did not generate such depreciation or cost of money charges, asset values are written-up or written-down in accordance with CAS 404)

Finally, the auditor must verify that for contracts awarded after 1998, whether or not subject to CAS, the allowable depreciation and cost of money would be based on capitalized asset values measured and in accordance with CAS 404.50(d). This is one of those areas where CAS (Cost Accounting Standards) have been incorporated into FAR Cost Principles.

Refer to the DCAA Contract Audit Manual (CAM) Sections 7-1705 for further details on this audit guidance.

The most common problem encountered by contractors in this area involves the adequacy of records. Sometimes, after a few years, the visibility into asset valuations and historical depreciation amounts is lost. It doesn't help when the auditors have years of backlogged incurred cost audits waiting to be performed. If there are record retention issues that arise during an audit, contractors are advised to bring their contracting officers on-board right away to help resolve any issues that may arise.

Assets and Business Combinations

For the past two days, we've been discussing the allowability of costs under Government contracts when there has been a business combination accounted for under the "purchase" method (virtually all business combinations are accounted for under the purchase method since 2001). In Part 1, we discussed the prohibition against amortizing Goodwill and charging it off on Government contracts. In Part 2, we discussed the idea that if acquired assets have been depreciated against Government contracts, the acquiring company cannot write-up the assets and depreciate them all over again. That would be akin to the Government paying for the same asset twice.

It would probably have been useful to define tangible and intangible assets at the outset of this series. These are terms of art that we accountants take for granted. Tangible assets have physical substance while intangible assets do not. Definitions for both tangible and intangible assets are found in FAR 31.001.

• Tangible capital asset means an asset that has physical substance, more than minimal value, and is expected to be held by an enterprise for continued use or possession beyond the current accounting period for the services it yields.
• Intangible capital asset means an asset that has no physical substance, has more than minimal value, and is expected to be held by an enterprise for continued use or possession beyond the current accounting period for the benefits it yield.

Tangible assets include property, plant, and equipment. Intangible assets include intellectual property such as patents and copyrights, and goodwill, among others.

There are other related FAR cost principles. FAR 31.205-10, Cost of Money, and FAR 31.205-11, Depreciation, preclude the use for cost allowability purposes of asset write-ups resulting from the the purchase method of accounting for a business combination. FAR 31.205-16, Gains and Losses on Disposition of Depreciable Property or Other Capital Assets provides that no gain or loss shall be recognized as a result of the transfer of assets in a business combination.

The entire purpose behind all of these restrictions is to ensure that the Government does not pay more that it would have had a business combination never occurred. At the time most of these restrictions were placed into the FAR (1990) there were significant and sizable mergers among Government contractors. In its promulgation comments to these rules, the FAR Councils concluded that the Government should not recognize depreciation, amortization, or the cost of money expense flowing from asset write-ups that result from the purchase method of accounting for business combinations. The Councils further stated that they did not believe that, in the special circumstances of Government procurement in which companies recorded cost structures are often directly reflected in the price, the Government should be at risk of paying higher prices simply because of ownership changes at its suppliers.

Tomorrow we will look at some of the guidance that auditors are instructed to consider when encountering business combinations.

Asset Valuations Resulting from Business Combinations

Yesterday, we wrote about the FAR (Federal Acquisition Regulation) prohibition against expensing goodwill against Government contracts (see FAR 31.205-49). Today we address a related matter - how to value assets resulting from business combinations. Or rather, how to value assets for Government cost accounting purposes, which may or may not be the same as for financial reporting purposes. As you recall, under the purchasing method of accounting for business combinations, assets of the acquired company are recorded at their fair value by the acquiring company. Usually, but not always, this results in a write-up of assets. Assets may have been fully depreciated but there is still economic life to those assets. Land, which is not depreciated, is carried on the books at its acquisition cost when typically, the value increases with time.

FAR 31.205-52 addresses asset valuation from business combinations. FAR distinguishes between tangible and intangible assets and states:

• (a) For tangible capital assets, when the purchase method of accounting for a business combination is used, whether or not the contract or subcontract is subject to CAS, the allowable depreciation and cost of money shall be based on the capitalized asset values measured and assigned in accordance with CAS 404, if allocable, reasonable, and not otherwise unallowable.
• (b) For intangible capital assets, when the purchase method of accounting for a business combination is used, allowable amortization and cost of money shall be limited to the total of the amounts that would have been allowed had the combination not taken place.

To figure out what the foregoing really means, one must refer to CAS 404.50(d). CAS 404 states, concerning capitalized values of tangible capital assets acquired in a business combination:

• (1) All the tangible capital assets of the acquired company that during the most recent cost accounting period prior to a business combination generated either depreciation expense or cost of money charges that were allocated to Federal government contracts or subcontracts negotiated on the basis of cost, shall be capitalized by the buyer at the net book value(s) of the asset(s) as reported by the seller at the time of the transaction.
• (2) All the tangible capital asset(s) of the acquired company that during the most recent cost accounting period prior to a business combination did not generate either depreciation expense or cost of money charges that were allocated to Federal government contracts or subcontracts negotiated on the basis of cost, shall be assigned a portion of the cost of the acquired company not to exceed their fair value(s) at the date of acquisition. When the fair value of identifiable acquired assets less liabilities assumed exceeds the purchase price of the acquired company ... the value otherwise assignable to tangible capital assets shall be reduced by a proportionate part of the excess.

So, to simplify things, Government contractors cannot write-up the value of tangible capital assets that have already been charged to the Government through depreciation - the Government doesn't want to buy the assets twice.

Intangible capital assets other than goodwill (e.g. intellectual property such as patents and trademarks) bear no such distinction. Amortization is limited to the amount that would have been allowed had the combination not taken place. It doesn't matter whether the Government was previously charged for the amortization. There can be no write-up of values.

Goodwill Write-off, Allowable or Not?

Mergers, acquisitions, and business combinations are terms describing the combining of two or more entities. They occur frequently in the business world including among Government contractors. Once an agreement has been reached on the "selling price", the acquiring party has to figure out how to account for the purchase. Government contractors need to realize that some of the purchase price may not be recoverable under its Government contracts.

There are two methods of accounting for business combinations; the purchase method and the pooling of interests method. Under the purchase method, the acquiring company accounts for the business combination as if it were acquiring the assets of the acquired company. The acquiring company records the transaction as the fair value of the assets acquired less the liabilities assumed. This results of this transaction can result in either a step up or write down of the assets recorded values. The difference between the acquiring company's cost and the sum of the fair values of tangible and identifiable intangible assets, less liabilities is recorded as goodwill (usually an asset).

The pooling of interests method on the other hand accounts for a business combination as the uniting of ownership interests of two companies. The recorded assets and liabilities of the constituent companies are carried forward to the combined corporation at their recorded amounts without any revaluation. Generally Accepted Accounting Principles (GAAP) however severely limit the circumstances whereby the pooling method may be used. Therefore, the pooling method of accounting is not commonly used when companies merge.

Goodwill is an unidentifiable intangible asset. It originates under the purchase method of accounting for a business combination when the price paid by the acquiring company exceeds the sum of the identifiable individual assets acquired less liabilities assumed, based upon their fair values. The excess is commonly referred to as goodwill. Goodwill may arise from the acquisition of a company as a whole or a portion thereof. The GAAP rules for writing off or writing down goodwill have changed over the years. Under current GAAP (SFAS No. 142) goodwill is written down or written off upon impairment (impairment is an accounting term used to describe a situation where the recorded value is no longer reasonable).

Now comes the difficult realization for contractors that need to write down or write off the goodwill recorded on their books. According to FAR 31.205-49, any costs for amortization, expensing, write-off, or write-down of goodwill, however represented, are unallowable.

Knowing this, many acquiring companies will attempt to minimize the goodwill recognized in their accounting records. The easiest way to do this is to step up the value of the assets acquired in the transaction. Contract auditors are aware of this however and will probably ask to see an appraisal or other support for the values placed on the acquired assets.

Non-profits to be Included in Low-Risk Incurred Cost Sampling Pool

Back in 2013, DCAA (Defense Contract Audit Agency) established new procedures for sampling low-risk incurred cost proposals. You can read a summary of those new procedures here or read DCAA's entire 13 page policy here. Basically, incurred cost proposals from contractors with no history of significant questioned costs, are not audited. The term "significant" is defined in the policy and fluctuates depending upon how many dollars have been incurred on flexibly priced Government contracts.

DCAA recently announced that incurred cost proposals submitted by non-profit organizations are now subject to these same low-risk incurred cost procedures. Most notably, this affects a lot of contractors administered by ONR (Office of Naval Research) and to a lesser extent, NASA (National Aeronautics and Space Agency).

This should be welcome news for many non-profit organizations whose incurred cost submissions were being audited at a much higher percentage than those of their for-profit counterparts. We know of one non-profit with only one contract valued at about $350 thousand per year, that has been audited year after year after year without any audit findings.

This new policy does not extend to universities. Audits of universities are performed as Single Audits (also known as A-133 audits). Government dollars spent at universities usually exceed the $250 million threshold to which DCAA's low-risk incurred cost audit procedures apply anyway, making such exclusion moot.

Blame the Government - That'll Work, No?

Last fall, the ASBCA (Armed Services Board of Contract Appeals) issued a decision on a appeal filed by a contractor whose contract had been terminated for default. The initial solicitation required bidders to provide proof that electricians working on the construction project had a current and active U.S. State Certified Electrician License. This requirement was also listed as an evaluation factor in the selection process.

Vertex Construction and Engineering (VCE), the winning bidder, submitted a proposal listing an electrician out of New Mexico with a current license. Almost immediately, the project ran into technical problems and the Government demanded that the electrician show up at the job site. Turns out however, this guy from New Mexico had only been a journeyman electrician, not a master electrician as required. Moreover, his license had expired in 2006, seven years before VCE submitted its proposal. The Government terminated the contract for default. VCE appealed to the ASBCA.

The Government moved for summary judgment on the grounds of fraud asserting that VCE's misrepresentation rendered the contract void "ab inito" (from the beginning). VCE appealed the termination. VCE argued that it did not knowingly misrepresent the electrician and that it did not have access to US licensing facilities. But here's the interesting argument. VCE's primary defense is that the Government had an obligation to verify the certificate and had it done so, appellant's misrepresentation would have been discovered, and the Government could have disqualified VCE from the bidding process.

The ASBCA didn't buy that argument. It stated in its decision that the argument that bids can present misinformation, and the burden is on the Government to ferret it out, is not persuasive. The requirement for the Government to verify the certificate submitted by VCE was for the  benefit of the Government, not for VCE. The law is clear that when contractors try to shift responsibility for their deficiencies not discovered when the Government has conducted a pre-award survey, a contractor's obligation to verify information submitted in its bid remains. It is the contractor's responsibility, not the Government's, to determine its own capability to perform a contract and, thus, even if a Government pre-award survey is conducted negligently, that circumstance can be of no consequence or benefit to the contractor.

In this case, VCE presented no evidence contradicting the Government's facts, only unsupported arguments as to why its misrepresentations should be excused. In addition to blaming the Government for not discovering VCE's fraud by verifying the master electrician's certification, VCE tried to justify its failures by pointing to is small size, its status as a local company, and its lack of computer capability. However, even if those assertions were relevant, VCE provided no evidence upon which such statements were based.

You can read the entire ASBCA case here.

PowerPoint Slides Do Not Trigger Statute of Limitations

The Boeing Company filed a motion with the ASBCA (Armed Services Board of Contract Appeals) to dismiss a government claim for $650 thousand plus interest. The issue, which isn't really relevant to this discussion, involved required cost accounting practice changes resulting from consolidating a couple of divisions.

Boeing contended that the Government's claim "accrued no later than February 2, 2007 whereas the Government contended that it accrued no earlier than February 16, 2007. One wouldn't necessarily think that two weeks would make any difference. However, this two-week difference is critical because of the contracting officer's final decision at issue was dated February 8, 2013, and the Contract Disputes Act contains a six-year statute of limitations on claims.

In July 2006, Boeing disclosed its intention to consolidate two of its sites in California in early 2007. From November 2006 to February 2007, the contracting officer repeatedly implored Boeing to comply with the cost accounting disclosure requirements contained in FAR. Boeing submitted a revised CAS Disclosure Statement and revised it twice. It met with the Government and made presentations on PowerPoint slides. However, throughout this process, Boeing never submitted was is referred to in FAR as a general dollar magnitude (GDM) of the change until February 8, 2007.

Although the GDM was not submitted until February 8, 2007, Boeing maintained that it had advised the Government of the cost impact before that date through PowerPoint presentations. Boeing placed a lot of emphasis on information convened in its PowerPoint slides used in its presentations in November 2006 and again in January 2007. Boeing requested the ASBCA to conclude that it conveyed enough information through those slides to trigger accrual of the claim. The ASBCA stated that Boeing's request was a "tall order" given that i) the Board was not at the meetings where the slides were discussed, ii) the Board did not hear live testimony (subject to cross-examination) from witnesses who were at the meetings; iii) the shorthand style of communication in the slides means that they are inherently subject to multiple interpretations and iv) the Board lacks a full appreciation of the highly complex business relationship between the parties - a relationship characterized by highly sophisticated contracts, people, and most of all, accounting practices - making it difficult to determine the accrual date of the government's claim using PowerPoint slides as a guide.

The Board concluded that Boeing did not convey sufficient information to the government in a timely manner to trigger the statute of limitations. As a result, the Board denied Boeing's motion. Now, the issue will need to be decided on its merits rather than thrown out on a technicality.

You can read the entire ASBCA decision here.

Limitation on Indirect Costs Allocated to Basic Research

The Defense Appropriations Acts for 2008, 2009, and 2010 contained provisions that limited payments of indirect costs to just 35 percent of total cost of a contract, grant, or cooperative agreement for "basic research". Basic research in this case means funds in programs withing DoD's Budget Activity 1 of the Research, Development, Test and Evaluation appropriations. If you are uncertain whether any of your DoD awards include basic research funds, you should clarify such before the contract auditors arrive. They were recently instructed to verify whether contractors are complying with these provisions during their audits of incurred costs. Interestingly, the DoD Appropriations Acts of 2011, 2012, and 2013 did not carry forward these limitations.

The limitation of payments apply only to prime contractors. The restriction does not flow to to subcontractors or other subordinate instruments.

For the restriction on payment of indirect cost as a percentage of total cost, "total cost" has the meaning given in the Federal cost principles that apply to the particular awardee. For "for-profit" contractors, this would be the cost principles in FAR Part 31. "Indirect costs" are those defined in FAR 31.203, Indirect Costs. Non-profits will want to refer to 2 CFR part 220, 225, or 230, as appropriate.

During an audit, contractors may be requested to demonstrate their internal procedures for compliance with this limitation.

Sometimes, federal awards are incrementally funded. This may entail the use of funds subject to the restriction and funds that are not subject to the restriction. This will require additional accounting complexities to ensure that the system can account for restricted and non-restricted funds.

If your indirect costs do not exceed 35 percent of total direct costs, this restriction becomes moot and contractors can document such and move on. For most recipients of basic research funds, indirect costs will exceed the 35 percent threshold and care will need to be exercised to ensure that the Government is not overbilled.

DCAA Once Again Chastised for Poor Auditing - Part 2

Yesterday we discussed the results of a DoD Inspector General's (DoD-IG) report that found significant deficiencies in a DCAA (Defense Contract Audit Agency) audit - the audit was not conducted in accordance with Generally Accepted Government Auditing Standards (GAGAS). If you missed Part 1, read it here. There was a second finding in the DoD-IG's report related to the method used by DCAA to disallow costs, the "DCAA Form 1". According to the DoD-IG, DCAA made "significant errors on DCAA Form 1, Notice of Contract Costs suspended and/or Disapproved". This form is attached to audit reports of incurred costs when there are audit exceptions disclosed by the audit.

As we mentioned yesterday, DCAA inappropriately questioned 20 percent of subcontract costs (approximately $6.6 million) because, in the auditor's opinion, the costs were not adequately supported. DCAA included the $6.6 million on the Form 1. DCAA also included an additional $3.9 million of subcontract costs where the assist audits had not yet been completed. These amounts were termed "qualified costs". The problem here is that there is duplication in the two amounts. The $6.6 million, representing 20 percent of total subcontract costs, included subcontracts that were also "qualified". This could have led to the contracting officer making an unintended or premature final determination on improper amounts.

The DoD-IG also noted that, according to DCAA's own guidance, a DCAA Form 1 should include only DoD contracts and non-DoD contracts where the auditor has been granted audit authority. In this instance, the DCAA Form 1 included costs for 13 contracts where DCAA had not been granted audit authority by other Government agencies. As a result, DCAA overstated disallowed costs on its Form 1 by an additional $288 thousand.

It would be interesting to know who called the DoD hotline on this audit. Seemingly, it would have been the contractor or an auditor who disagreed with the way in which the audit results were reported. If you have any insight into this matter, let us know. If it was a contractor representative, this might herald in a new mechanism to resolving differences with auditors - especially when it is evident that the audit position is not defensible. Certainly, if a contractor cannot get a contracting officer's interest in a matter, they can always pick up the phone and call the "Hotline".

DCAA Once Again Chastised for Poor Auditing - Part 1

Late last year, the Defense Department's Inspector Generals Office (DoD-IG) issued a report on its investigation of a Hotline Complaint regarding the examination of DCAA (Defense Contract Audit Agency) audit of subcontract costs at an unspecified contractor.

In this case, the auditor used a 20 percent decrement factor to question subcontract costs that, in her opinion, were not adequately supported by the contractor. The DoD-IG found that DCAA had not followed Generally Accepted Government Auditing Standards (GAGAS) in performing the audit because the auditor had not obtained sufficient evidence to conclude the costs were unallowable. In addition, the 20 percent decrement factor was arbitrary and unsupported and inconsistent with DCAA policy. The DoD-IG recommended that DCAA withdraw its audit report and consider re-evaluating subcontract costs at this particular contractor. The Director of DCAA concurred with the IG's findings.

The complainant alleged that a DCAA office did not comply with GAGAS or DCAA policy when it questioned $6.6 million of a DoD contractor's claimed fiscal year 2008 subcontract costs. Specifically the complainant alleged that the office failed to comply with GAGAS when the auditor concluded that the contractor did not adequately support its claimed subcontract costs, and inappropriately applied a 20 percent decrement as a basis for questioning subcontract costs.

There was a total of $33 million in subcontract costs incurred during 2008. DCAA sampled 70 subcontractor invoices representing $13.5 million of the claimed amount. DCAA claimed that the contractor did not provide adequate documentation to support the allowability of any of the 70 invoices but rather than question costs based on the statistical sample (which would have been 100 percent of the costs based on DCAA's rationale for not accepting sampled costs), the auditor chose to question 20 percent based on its consideration of "contractor performance and product delivery" (whatever that is supposed to mean).

The IG found DCAA's methodologies fundamentally flawed. The IG reported that DCAA failed to comply with GAGAS by not obtaining adequate evidence to support its conclusion that $33 million in subcontract costs were unsupported. In fact, the IG noted that the audit working papers contained additional evidential matter submitted by the contractor that DCAA didn't even review or at least there was no evidence that DCAA considered it in its opinion.

The IG also noted that DCAA's use of the 20 percent decrement was inappropriate. DCAA guidance clearly states that the 20 percent decrement is advisory in nature (advisory to the contracting officer) when a contractor fails to timely submit required annual incurred cost submissions. In this case, the contractor did not fail to submit timely incurred cost submissions so the factor should not have been applied. The IG also drew the distinction between using the factor to question costs (inappropriate) versus recommending it to the contracting officer as a  tool to spur recalcitrant contractors into submitting their required incurred cost submissions (appropriate).

Click here to read Part 2 of this story.

You can read the entire DoD-IG report by clicking here.

Prompt Payment Interest Rate - Jan to Jun 2015

The Prompt Payment Interest Rate is slightly increased for the first six months of 2015. It has risen from 2.000 percent to 2.125 percent. This is the interest rate that the Government must pay contractors when it is delinquent, for whatever reason in paying for the delivery of goods or services, including progress payments and cost vouchers (i.e. public vouchers or WAWF submissions). It is often referred to as the Prompt Payment Interest Rate. It also applies to interest paid under the Contract Disputes Act.

This interest rate applies whether a contractor requests interest. In most cases, in the event payment on a voucher is delayed, the Government will add the interest. Generally, it begins accruing 30 days after receipt of an "adequate" voucher. Thus, if say the auditor rejects a WAWF submission because of an inadequacy, the clock doesn't begin until it has been revised and accepted.

Here's a table showing the interest rate history since 2012.

Some of you may remember the early 1980s with the astronomically high interest rates. The Prompt Payment interest rate peaked in 1982 at 15.5 percent. We were auditors back then and were continuously being cautioned not to do anything that would delay payments to contractors.

Click here for a complete table of historical rates.