Common Accounting System Deficiencies

 Most Government contractors and prospective contractors realize that an "adequate" accounting system is a necessary prerequisite to winning a negotiated contract. And, there is no mystery to what constitutes an "adequate" system. The attribute are listed on SF Form 1408 - Pre-Award Survey of Prospective Contractor Accounting System. We've covered these attributes on this blog several times. See, for example Preaward Surveys - SF From 1408 and Two Kinds of Accounting System Audits. Contractors (and prospective contractors) should not underestimate the importance of an adequate accounting system. Companies have lost out on opportunities by not having adequate systems. See, for example Accounting System Adequacy and Bidder Disqualified for Failing to Provide Evidence of an Adequate Accounting System.

DCAA (Defense Contract Audit Agency) is the Federal Agency most responsible for auditing accounting systems although other agencies perform such reviews and in the past few years, commercial firms have also gotten into the business. Implementing an adequate accounting system is not difficult but it does require discipline. Companies at risk include those without accountants - where the accounting function is performed by perhaps a founding member who is also responsible for other functions including direct work on a contract. Another group that seems to struggle are those that are moving from a commercial to a Governmental environment.

DCAA published the top five reasons why accounting systems fail the adequacy review. Prospective contractors should consider whether their accounting systems might have similar deficiencies:

1. Contractors not making interim (at least monthly) determination of costs charged through routine posting to books of account. This deficiency is quite common among small contractors without regular accounting help. The idea that someone will get around to it someday will not satisfy the auditor. If you find yourself in this situation and cannot afford an accountant, look to outsource the function - it doesn't have to be expensive.

2. Failure to properly segregate direct and indirect costs. This speaks to the design of the accounting system. Somehow, the accounting system must be capable of capturing direct and indirect costs as the costs are booked. Some companies set up their charts of account for that purpose. But there are other methods of accomplishing the same thing, depending upon which accounting software is used.

3. Improper timekeeping. This could mean a lot of things from no functional timekeeping system to one that has insufficient controls. For a rundown on what constitutes an adequate timekeeping system, see Timekeeping Systems - Regulatory Requirements.

4. Failure to exclude unallowable costs. FAR 31.201.6, Accounting for Unallowable Costs, requires contractors to identify and exclude unallowable costs (e.g. interest, advertising, bad debts, alcohol, etc) from any proposals, claims, billings, or progress payments submitted to the Government. Obviously to know what to exclude requires a basic understanding of the FAR Part 31 cost principles and then once identified, a system to ensure that those costs don't become part of any submission to the Government.

5. Procedures to ensure that subcontractor and vendor costs are only included in billings if payment to subcontractor or vend will be made in accordance with the terms and conditions of the subcontract or invoice and ordinarily within 30 days of the contractor's payment request to the Government. The key here is that contractors should not make payment to vendors and subcontractors contingent upon reimbursement from the Government. There is always some expectation that contractors will need a certain amount of working capital to pursue Government work in the same manner that it would require for commercial work.

Bidder Disqualified for Failing to Provide Evidence of an Adequate Accounting System

In March 2016, the National Institute of Health (NIH) issued a solicitation for "IT solutions and services. Leader Communications was one of the bidders but was excluded from further consideration for failing to submit verification of an adequate cost accounting system from DCAA (Defense Contract Audit Agency).

The Request for Proposal (RFP) contained detailed instructions regarding the submission of proposals including the following: offerors "must have verification from [DCAA]... of an accounting system that has been audited and determined adequate for determining costs applicable to this contract in accordance with FAR 16.301-3(a)(1)." The solicitation also required that an offeror provide in its proposal a contact name and contact information (i.e. phone number, address, email address) of its representative at its cognizant DCAA and submit, if available, a copy of the Pre-Award Survey of Prospective Contracting Accounting System (SF 1408), provisional billing rates, and /or forward pricing agreements.

Proposals were to be evaluated in two phases. In phase 1, the government would evaluate the proposals based on four go/no-go requirements, one of which was the verification of an adequate accounting system.

NIH received 552 proposals including one from Leader Communications. Leaders proposal contained a document stating that its accounting system was approved by DCAA in 2008 and provided the audit report number and contact information  for the cognizant DCAA office and representative.

NIH determined that Leader's proposal failed to comply with the requirements of the solicitation because Leader's own representations about its accounting system did not meet the requirements to provide verification of an adequate accounting system. As a result, Leaders proposal was found to be unacceptable and ineligible for further consideration.

Leader appealed to the Comptroller General, essentially arguing that the solicitation required only that offerors had received verification from DCAA that their accounting systems had been audited and determined adequate, bud did not require the submission of any documentation from DCAA itself. Elimination from competition was unreasonable because Leader met the solicitation's requirement by providing its own unambiguous statement that its accounting system had been audited and approved by DCAA, along with the DCAA audit report number and additional information. In Leader's view, this information was sufficient for NIH to independently confirm with DCAA the verification and audit of its accounting system.

NIH defended itself by stating that a DCAA audit report would have been an acceptable source of verification. The solicitation expressly required offerors to furnish verification from DCAA with its proposal - the solicitation did not permit offerors to essentially self-verify the adequacy of their accounting systems. By requiring offerors to provide verification from DCAA, NIH would obtain independent verification that offerors' accounting systems had been audited and determined adequate.

The GAO sided with NIH on this appeal. The GAO found that NIH's interpretation of the solicitation, when read as a whole, is reasonable, whereas Leader's interpretation is not reasonable. In this case, the solicitation stated that an offeror must have verification from DCAA of an accounting system that has been audited and determined adequate in order to be eligible for award. The solicitation also advised that NIH would evaluate evidence that the offeror has an adequate accounting system. Finally, the solicitation cautioned that failure to furnish verification of an adequate system would result in a rating of unacceptable.

DCAA is probably feeling very empowered by this decision. You can read the entire decision here.

Incidentally, the solicitation also provided an alternative to DCAA verification. NIH would also accept verification from third-party certified public accountants (CPA) as long as it was on the CPA's letterhead. Bidders that did not have DCAA audit coverage could qualify by hiring outside CPAs to perform pre-award accounting system surveys. PNWC performs pre-award surveys for companies that find themselves without independent verification of the adequacy of their accounting system. If you find yourself in that position, give us a call.