Why Can't Contractors Perform Their Own Incurred Cost Audits?

There has been a lot of discussion lately about the state of incurred cost audits and more specifically, DCAA's (Defense Contract Audit Agency) ability to complete them in a timely manner. DCAA for its part, is subject to the unpredictability of Federal budgets, hiring freezes, and attracting qualified workers. In recent Congressional testimony, the DCAA Director worried that recent gains in reducing the backlog of incurred cost audits could evaporate because of hiring freeze imposed on them by the current administration. Recently we've been discussing proposed legislation that would require the Department of Defense to outsource at least 25 percent of incurred cost audits.

But is there another way of getting these audits completed in a timely manner? Perhaps there is. What if contractors were contractually required to perform their own incurred cost audits? Now that sounds like an idea fraught with problems, like letting the fox guard the hen house, right? But wait. The Department of Energy is requiring just that on a cost-type contract worth $900 million per year.

Since 1965, Battelle Memorial Institute (Battelle) has operated the Pacific Northwest National Laboratory under contract with the Department of Energy. This lab performs research and innovations in the areas of environmental protection and clean up, energy resources, and national security.

Battelle is required by it contract to "audit" costs expended under the contract to ensure that only allowable costs are claimed - costs that are reasonable, allocable, and allowable in accordance with the terms of the contract, applicable cost principles, laws, and regulations. To accomplish this, Battelle is required to have an internal audit function. The contract requires the following.

The contractor agrees to design and maintain an internal audit plan and an internal audit organization. The contractor must submit to the contracting officer for approval an internal audit implementation design to include the overall strategy for internal audits. The audit implementation design must describe ... the overall internal audit strategy of this contract, considering particularly the method of auditing costs incurred in the performance of the contract.

Is it working? It seems to be working just fine. The Department of Energy's Office of Inspector General (OIG) recently completed an audit to determine whether Battelle's internal auditors were doing an adequate job of assessing the propriety of incurred costs claimed under the contract. The OIG concluded the following:

Based on our assessment, nothing came to our attention to indicate that the allowable cost related audit work performed by Battelle's Internal Audit ... could not be relied upon. We did not identify any material internal control weaknesses with cost allowability audits, which generally met the Institute of Internal Auditors International Standards for the Professional Practice of Internal Auditing (IIA Standards). During its FYs 2013 and 2014 audits of cost allowability, Internal Audit identified $375,983 in questioned costs, all of which had been resolved.

The IIA Standards referred to above are very similar to GAGAS standards.

So there you have it. Battelle's internal auditors reviewed incurred costs. DOE's IG reviewed what the internal auditors had done and found that the Department could rely on their work as a basis for accepting incurred costs. Its too bad that DCAA and DoD's OIG cannot engage in the same level of cooperative audit strategy.

We do not know how the cost of Battelle's internal audit of incurred cost compares to outsourcing or or reimbursing another Agency's contract auditors (e.g. DCAA) to audit incurred costs. Battelle's internal audit department is certainly not free to the Government - its costs are included in the $900 million per year that is reimbursed by the DOE.