The Panel concluded that DoD has not been obtaining timely assurance that internal controls for defense contractor accounting systems are properly designed and functioning. In their opinion (and we agree), ensuring effective internal controls is one of the most efficient ways to protect the Government's interest, reduce risk, and improve performance.
To do business with the Government, contractors (and prospective contractors) must demonstrate capability to meet the requirements outlined in the Standard Form 1408, Pre-Award Survey of a Prospective Contractor Accounting System. This pre-award system review should not be confused with the reviews required by the DFARS Business System rule that tests the design and capability of the system, as well as whether controls are in place and functioning properly although essentially the same attributes are being considered in both types of reviews. While the SF 1408 has a checklist format, the business system rules focuses on processes and related internal controls.
The Panel is recommending that the 18 system criteria found in DFARS be scrapped and replaced with an internal control audit framework to assess the adequacy of contractors' accounting systems. The envisioned internal control audits will focus on assessing the key controls that ensure government objectives are being met. Auditors' conclusions on the effectiveness of the key controls are essential information for contracting officers and contractors to evaluate whether the Government's interests are adequately protected.
Specifically, auditors will evaluate whether key internal controls are in place and operating to provide reasonable assurance of the following seven accounting system criteria:
- Direct costs and indirect costs are classified in accordance with contract terms, FAR, CAS and other regulations, as applicable.
- Direct costs are identified and accumulated by contract in accordance with contract terms, FAR, CAS, and other regulations, as applicable.
- Methods are established to accumulate and allocate indirect costs to contracts in accordance with contract terms, FAR, CAS, and other regulations, as applicable.
- General ledger control accounts accurately reflect all transactions recorded in subsidiary ledgers and/or other information systems that either integrate or interface wit the general ledger including, but not limited to, timekeeping, labor cost distribution, fixed assets, accounts payable, project costs, and inventory.
- Adjustments to the general ledger, subsidiary ledgers, or other information systems bearing on the determination of contract costs (e.g. adjusting journal entries, reclassification journal entries, cost transfers, etc.) are done for reasons that do not violate contract terms, FAR, CAS, and other regulations, as applicable.
- Identification and treatment of unallowable costs are accomplished in accordance with contract terms, FAR, CAS, and other regulations, as applicable.
- Billings are prepared in accordance with contract terms, FAR, CAS and other regulations, as applicable.
Using a "framework" methodology is well-established in the private sector but it may take some time, training, and experience for Government auditors to become proficient in applying such a framework. For one, it requires auditors to exercise a lot more professional judgement than the methods traditionally applied to evaluating the adequacy of contractor accounting system.