Tuesday, May 31, 2011

Government Oversight of Contractor Ethics

We've written quite a bit about the FAR requirement for contractors to maintain codes of business ethics and conduct. At a minimum, Government contractors must have their codes in writing, make them available to every employee and exercise due diligence to prevent and detect criminal conduct and promote an organizational culture that encourages ethical conduct and a commitment to compliance with the law. There are more requirements applicable to non-small businesses.

While the requirement was published a number of months ago, there was no assignment of a Government oversight role. We speculated once that DCAA would review for compliance in conjunction with audits of contractor accounting systems because there is a large component of the standard audit program dealing with contract ethics. These reviews however are few and far between because they are only performed at contractors with $100 million or more in annual costs under cost-reimbursable contracts.

The lack of Government oversight has now been fixed. The FAR Councils have added to the list of contract administration functions in FAR 42.302, a requirement to ensure that contractors have implemented the mandatory contractor business ethics program requirements of FAR 52-203-13. This change, published and effective today, was made in response to recommendations from a recent GAO report on strategies to improve the effectiveness of the Government's oversight of contractor business ethics and conduct programs.

Contractors should expect some form of communication from contract administration (e.g. DCMA) regarding this added function and possibly some implementing procedures they will follow to ensure contractor compliance.

Friday, May 27, 2011

Access to Records - When Disputes are not Resolved

Companies desiring to enter the Government contracting arena must be prepared to open their books and records to the Government. Whether its estimating, purchasing, billing, tracking (e.g. EVMS), or quality, there is always the potential for someone from the Government to peer over contractors' shoulders to see if they're doing things correctly. The relevant statutes, regulations, and contractual provisions however do not give the Government access rights to anything and everything. There must be a nexus between the purpose of the audit or purpose of the review and the records being requested. If contractors have any concern over the relevance of any requested record, auditors must be prepared to discuss the basis for the request.

Once in awhile, the contracting parties reach an impasse. The Government determines that a particular record is absolutely critical to its review to the extent that it cannot proceed or express an audit opinion without it. The contractor is just as adamant that the data is not required and refuses to turn provide it to the Government. When elevating the issue up the various levels within the respective organizations fails to resolve the issue, the Government can and will take a number of actions.

If the audit pertains to forward pricing, claims, terminations, or requests for equitable adjustment, auditors will question any costs that are not adequately supported. If the amount in question is significant, the auditor will express an opinion to the effect that the contractors proposal (or assertion) is not acceptable as a basis for negotiating costs. This will most likely halt any negotiations.

If the audit pertains to incurred costs, billings, progress payments, or billing rates, the auditor will suspend or disapprove costs that are not supported. This action could have a detrimental impact on a contractor's cash flow situation.

Most audit agencies have subpoena authority. DCAA's own guidance lists subpoena power as one possibility for compelling contractors to provide requested data. However, DCAA has not issued a subpoena in more than 20 years so that seems an unlikely option. Its much more expedient for the Government to disallow or question costs.

The Government has the upper hand in these matters. Contractors can choose to forgo contracts and claims or face the prospect of not having all of their allowable and allocable costs reimbursed. However, if these are not desirable outcomes, the Government will ultimately get its way.

Thursday, May 26, 2011

Access to Records - To Provide or Not to Provide

For the past couple of days, we've been discussing the Government's right to access Government contractors' books and records. While avoiding a detailed exposition of all of the statutory and regulatory, not to mention contractual provisions that allow the Government access to books and records required to conduct audits, we laid out the idea that contractors wanting to pursue Government contracts must be prepared to open their books to the Government's auditors, contract administrators, and technical representatives.

The statutes and regulations and relevant auditing standards are finely crafted to ensure that only such records as are necessary to meet the audit objectives should be requested and need to be furnished. However, auditor judgment plays a big part in determining what records are necessary. In a recent case, an auditor requested to review a contractors basis for estimating the cost on a subcontract. Since the audit was of a price proposal, that was a reasonable request. The auditor wanted to ensure that the contractor followed its own estimating policies and procedures to get the best price. However, once the file was turned over to the auditor, the auditor then proceeded to request copies of every email that passed between the contractor and each of the offerors submitting bids for this particular subcontract. We advised the prospective contractor not to provide emails because (i) it was not a reasonable request, (ii) it had nothing to do with establishing the reasonableness of the proposed subcontract price, (iii) it was onerous on the contractor, and (iv) there was no way to ensure that "every" email could be located.

The difficult part in responding to requests for data is determining where to draw the line. Most contractors try to avoid conflicts by providing everything that is requested of it, relevant or not. However, as we've stated in this blog on several occasions, never assume that an auditor coming into your facility is only interested in the audit being performed. The goods ones will be making observations and developing audit leads for future reviews. There are no innocuous questions - every question is designed to solicit data and information. They'll be scanning for idle facilities and idle capacity, observing how full the parking lots are, and looking at organization structures (a four person company should not have a highly compensated VP of Finance who happens to be the founder's son, who happens to drive a BMW, and who is never around). We could recount many cases where information provided in one context, is used later in another.

Tomorrow we will conclude this series by telling you what you can expect if you deny the Government access to certain books and records.

Wednesday, May 25, 2011

Access to Records - Denial by Contractors

We began a discussion of access to records by Government auditors yesterday. Today we will continue that discussion.

Auditors are required by Generally Accepted Government Auditing Standards (GAGAS) to develop sufficient, competent, evidential matter to support their conclusions and recommendations. Requests for such data, records, and information must be relevant to the audit being performed. There is no basis in any regulations, statute, or contract provision that authorizes auditors access to records beyond what is necessary to perform the audit.

If it is not intuitively obvious to contractors why certain requested data is relevant to the audit being performed, contractors should inquire as to the purpose or the intended use of the data. Auditors are required to be prepared to answer such questions. If the auditor cannot do so to the contractors' satisfaction, denying access may be appropriate. Of course, from an auditor's perspective, denials tend to be met with suspicions that the contractor may be hiding something. Therefore, while denial might be appropriate, it may not be advisable.

Once denial is alleged by the Government, the issue is raised to higher and higher levels within the contractors' and governmental organizations. At some point, the issue is resolved or the Government seeks a subpoena. In practice however, these issues are generally resolved at low levels. Common sense usually prevails is such matters. However, the Government has published guidelines on conditions that qualify as access to records problems. These include:
  1. Contractor refusal to provide access to any requested record including support for unclaimed costs excluded under CAS 405 or records maintained in an electronic or optical format.
  2. Unreasonable delays by contractor representatives in permitting the audit commencement or in providing access to needed data or personnel.
  3. Restrictions on reproduction of necessary supporting evidential matter.
  4. Partial or complete denial of access to internal audit data or other management reports on contractor operations.
  5. Denial of access to the contractor's data base.
  6. Chronic failure of contractor personnel to comply with agreed-to dates for furnishing data.
  7. Assertion of attorney-client privilege or attorney work product rule. The auditor is not in a position to accept a claim of attorney-client privilege or the work product rule. Therefore, auditors are instructed to obtain a legal opinion from counsel when a claim of privilege is made.

Tuesday, May 24, 2011

Access to Records

There are many statutes, implementing regulations and contract terms that provide access to contractor records for purpose of audit by GAO, the Inspector General (IG) organizations, and contracting officer (CO) representatives usually meaning the cognizant contract audit organization. The Government has clearly defined rights to come in and audit the books and records of Government contractors. The right of access however does not extend beyond what is reasonably required for the audit being performed. We hear from time to time including a case last week where auditors request books and records that do not, on the surface, pertain to the matter at hand. So we think that it would be opportune to review the policies. We do so from the guidance published for the DoD contract auditors.

Inherent in audit responsibility is the right of auditors to determine the specific records or other evidential matter needed to accomplish the audit. Auditors must adhere to generally accepted Government auditing standards in determining what comprises competent, relevant, and sufficient evidential matter. Therefore, auditors must use good judgment and rationale in deciding what contractor records or other evidential matter should be sought. In determining the sufficiency of evidence needed, auditors must consider the audit objective, the risk, and materiality of an error or misstatement in the area being audited and the effect on the audit opinion (see CAM 1-504.1.d.)

Most of the time, auditors will make informal requests (either orally or as a written list) for records. The audit need for the requested information is rather obvious and the records are routinely provided. For example, an auditor, reviewing incurred costs claimed for reimbursement might request to review the support for a material purchase. Keeping things informal greatly facilitates the audit and that is to the benefit of both the auditor and the contractor.

Sometimes, however, auditors will make requests for data and records that, in the contractors judgment, have no bearing on the matter under audit. In those cases, contractors should question the relevancy of the request. According to DoD guidance, auditors must be prepared to discuss the basis for the request and to explain the underlying audit need (see CAM 1-504.36.a). A retort along the lines "because I want it" as we recently witnessed, is not satisfactory or compliant with DoD guidance.

Unusual or extensive requests must be made in writing by someone higher than the auditor (see CAM 1-504.36.e). "Unusual or extensive" is not defined so that could potentially become an issue in itself. Auditors are not permitted to remove original records from the contractor premises. They can make (or request) copies of pertinent records for working paper documentation. However, auditors should not request contractors to reproduce records so that he/she can work at home (or another worksite).

Monday, May 23, 2011

Business Systems Rules - Summary of Changes

Last week we reported that DoD had issued an interim rule in its FAR Supplement designed to improve the effectiveness of DoD oversight of contractor business systems (i.e. withhold contract funds until contractors fix their systems). We've watch these rules evolve through two iterations of proposed rules very closely and so did a lot of people judging by the extraordinary number of responses submitted to DoD. Comments certainly matter because there were many changes between the first and second proposed rules and the second and this interim rule. There is also a comment period for the interim rule that runs through July 18, 2011.

You can read our previous coverage on business systems by using the search box to your right. Just search on the term "business systems". 

Within the results you will find the criteria of what constitutes an adequate system for each of the six business systems covered by this interim rule; accounting, estimating, purchasing, EVMS, MMAS, and property management.

Following is a summary of the rule changes from the previous draft. 

1. The term ``significant deficiency'' is defined as a shortcoming in the system that materially affects the ability of officials of the Department of Defense to rely upon information produced by the system that is needed for management purposes.

2. While the proposed rule allowed for the implementation of payment withholdings with or without disapproval of system deficiencies that adversely affect the contractor's business systems, this interim rule sets forth requirements that a contracting officer's final determination shall include a disapproval of the contractor's business system and the implementation of payment withholdings if a significant deficiency still exists after the contracting officer's evaluation of the contractor's response to the initial significant deficiency determination.

3. Where the proposed rule allowed for system approval after the contracting officer determines that the contractor has substantially corrected the system deficiencies removing the potential risk of harm to the Government, this interim rule requires that there are no remaining significant deficiencies before a system is approved.

4. The contracting officer will be required to reduce a payment withholding by at least 50 percent if the contracting officer has not made a determination whether the contractor has corrected all significant deficiencies as directed by the contracting officer's final determination, or has not made a determination whether there is a reasonable expectation that the corrective actions have been implemented.

5. The 16-month timeframe for completion of a contractor's initial Earned Value Management System validation has been revised to allow for a timeframe that is approved by the contracting officer to allow for flexibility in the initial validation process.

6. The term ``covered contract'' has been defined as a contract that is subject to the Cost Accounting Standards under 41 U.S.C. chapter 15, as implemented in regulations found at 48 CFR

       (a) The clause prescription for the clause at 252.242-7005, Contractor Business Systems, requires that the resulting contract will be a ``covered contract,'' which exempts small business contracts. Consequently, all language pertaining to payment withholdings for small business has been struck from the rule.

       (b) While the proposed rule set forth a $50 million contract threshold for the incorporation of the clause at 252.242-7005, Contractor Business Systems, this interim rule prescribes the incorporation of the clause for covered contracts in accordance with the established definition.

7. The proposed rule applied payment withholdings against all contracts that contained the clause at 252.242-7005, Contractor Business Systems. This interim rule allows the contracting officer the discretion to withhold payments from one or more contracts containing the clause.

8. This rule revises procedures for the implementation of payment withholdings by replacing the requirement for contracting officers to issue unilateral modifications with the requirement to issue written notifications. Therefore, references to unilateral modifications for payment withholding as well as the sample language for the unilateral modifications have been deleted from this rule.

9. The clause prescription at 242.7002 for the clause at 252.242-7005, Contractor Business Systems, is revised to exempt contracts with educational institutions or Federally Funded Research and Development Centers (FFRDCs) operated by educational institutions.

10. The references to construction contracts that include the clause at FAR 52.232-27, Prompt Payment for Construction Contracts, under 242.7502(a), 242.7503, and 252.242-7005 have been removed as unnecessary.

11. The initial written determination language under 242.7502(d)(2)(ii)(A) has been revised to provide a description of each significant deficiency in sufficient detail to allow the contractor to understand the deficiency.

12. The term ``business system'' is replaced with the term ``contractor business system.''

13. The total percentage of payments that may be withheld on a contract shall not exceed 10 percent. Additionally, while multiple payment withholdings may be implemented due to significant deficiencies in multiple contractor business systems, for clarity, the interim rule limits the total percentage of payments withheld to five percent for one or more significant deficiencies in any single contractor business system.

14. The accounting system criteria under 252.242-7006(a)(1) has been revised to delete the unnecessary phrase ``that is adequate for producing accounting data that is reliable and costs that are recorded, accumulated, and billed on Government contracts in accordance with contract terms.''

15. The purchasing system criteria under paragraph (c) of the clause at 252.244-7001, Contractor Purchasing System Administration, has been revised to add paragraph (24) requiring contractors to establish and maintain procedures to notify the Contracting Officer in writing if--

     (a) The Contractor changes the amount of subcontract effort after award such that it exceeds 70 percent of the total cost of work to be performed under the contract, task order, or delivery order. The notification shall identify the revised cost of the subcontract effort and shall include verification that the Contractor will provide added value; or

     (b) Any subcontractor changes the amount of lower-tier subcontractor effort after award such that it exceeds 70 percent of the total cost of the work to be performed under its subcontract. The notification shall identify the revised cost of the subcontract effort and shall include verification that the subcontractor will provide added value as related to the work to be performed by the lower-tier subcontractor(s).

Friday, May 20, 2011

Financial Capability Risk Indicators

Government auditors, contracting officers, price/cost analysts, and most people involved in procurement are trained to be on the lookout for signs that contractors are in financial distress. Aside from the normal financial capability reviews that they perform (upon request), procurement folks are told to be cognizant of the events and conditions that can significantly affect a contractor's ability to perform on Government contracts. These indicators include, but are not limited to the following:

  • Defaults on loan/line of credit agreements
  • Defaults on usual trade credit from supplies
  • Restructuring of debt where the contractor is charged a higher interest rate above the prime rate than the prior rate charged by lending institutions. (The increase in the rate charged above the prime could be attributable to perceived contractor financial distress.
  • Denial of usual trade credit from suppliers
  • Noncompliance with loan/line of credit covenants
  • Contracts in significant loss position
  • Legal proceedings/pending claims
  • Loss of principal customer/supplier
  • Uninsured or under insured catastrophic events
  • Labor strikes
  • Unpaid state, local and federal tax liabilities
  • Contingent liabilities
  • Deteriorating bond ratings
  • Significant dollar amount of accounts receivable
  • Significant post award or suspected irregularity conduct audit findings and other significant questioned costs that are unresolved
  • Contract termination for default
  • Deferral of payments to suppliers
  • Failure to fund pension plans
  • Loans from employees or issuing stock to employees in lieu of salary
  • Environmental clean-up impact
  • Significant unpaid contractor debts
  • Unusual progress payments or other billing concerns
  • Poor physical conditions of the work facilities
  • Unpaid insurance liabilities

These are only indicators and, if noted, might generate an inquiry. Or, more likely, the risk indicator would be documented and added to a permanent file somewhere to followup at another time or when the number of indicators becomes sufficiently large where the Government must look deeper into a contractors financial viability.

Thursday, May 19, 2011

Contractor Business Systems - Interim Rule

DoD amended its FAR Supplement yesterday by adding an interim rule to "improve the effectiveness of DoD oversight of contractor business systems". This "improve the effectiveness" language is a euphemism for withholding contract payments if a particular business system does not meet their idea of what an adequate system should look like.

We've been following this rule making process, and have written extensively about it, since the initial proposal was published in January 2010. A second proposal was published last December. This time, its an interim rule with a request for comments meaning that it is effective right now but that the final rule could look a little different based on comments received.

Business systems covered by this new rule include
  1. Accounting systems
  2. Estimating systems
  3. Purchasing systems
  4. Earned value management systems (EVMS)
  5. Material management and accounting systems (MMAS)
  6. Property management (with emphasis on Government property)

Payments could be withheld on most types of contracts including
  • Interim payments under
    • cost reimbursement contracts
    • incentive type contracts
    • time and materials contracts
    • labor hour contracts
  • Progress payments
  • Performance-based payments
One of the most significant changes in the interim rule over the previous proposals relates to its applicability. Whereas the interim rules were somewhat vague regarding thresholds for applicability, the interim rule applies only to CAS covered contractors. That feature alone significantly limits the applicability of this interim rule. CAS coverage requires at least a $50 million contract but there are also many exemptions available such as to small businesses, commercial items, contracts performed overseas, etc.

We will be discussing aspects of the business system rules further as we have time to review and comprehend the 23 Federal Register pages that comprise the new rule.

Wednesday, May 18, 2011

CAS 420 - Accounting for IR&D and B&P Costs

CAS 420 - Accounting for Independent Research and Development Costs and Bid and Proposal Costs (IR&D/B&P).

The purpose of CAS 420 is to provide criteria for the accumulation of IR&D and B&P costs and for the allocation of such costs to cost objectives based on the beneficial or causal relationship between such costs and cost objectives.

Except for a couple of minor provisions involving the allocation of IR&D and B&P costs incurred at a home office or a segment on behalf of another segment of the same company, CAS 420 is applicable to all contractors – even those that are exempt from CAS or fall under the “Modified Coverage” provisions (see FAR 31.205-18).

The standard provides definitions for IR&D/B&P. Some disputes between contractors and the Government could be avoided if the parties understood the definitions.

  • Independent research and development (IR&D) means the cost of effort which is neither sponsored by a grant, nor required in the performance of a contract, and which falls within any of the following three areas;
    • Basic and applied research
    • Development, and
    • Systems and other concept formulation studies
  • Bid and proposal (B&P) costs means the cost incurred in preparing, submitting or supporting any bid or proposal which effort is neither sponsored by a grant, nor required in the performance of a contract.
CAS 420 (and FAR 31.205-18) requires that IR&D/B&P costs be accumulated by project, similar to the way in which contract costs are accumulated. Project costs consists of all allocable costs except business unit G&A. This would include labor, fringe benefits, overhead, as well as materials, subcontracts, and ODCs (other direct costs).

IR&D/B&P cost pools of a home office must be allocated to segments on the basis of the beneficial or causal relationship between the IR&D/B&P costs and the segments reporting to that home office. The IR&D/B&P cost pools of a business unit must be allocated to the final cost objectives of that business unit on the basis of the beneficial or causal relationship between the IR&D/B&P costs and the final cost objectives.

B&P costs incurred in a cost accounting period must not be charged to any other cost accounting period. The same rule applies to IR&D costs except for cases permitted pursuant to provisions of existing laws, regulations, and other controlling factors.

Tuesday, May 17, 2011

Interest Expense

The ASBCA (Armed Services Board of Contract Appeals) recently passed down a decision involving financing costs. FAR 31.205-20 states the interest on borrowings (however represented), bond discounts, costs of financing and refinancing capital (net worth plus long-term liabilities), legal and professional fees paid in connection with preparing prospectuses, and costs of preparing and issuing stock rights are unallowable. This cost principle has been broadly applied by the Government to question or disallow all costs associated with financing including, not only interest, but also fees and other related expenses. The ASBCA recently added a bit of a twist to this long-standing position in the Appeal of SRI International, ASBCA No. 56353, February 18, 2011

By way of background, the contractor (SRI) sought to recover costs incurred to maintain a standby Letter of Credit (LOC) issued by a bank to guarantee its ability to repay long-term debt. The Government argued that the costs were unallowable under FAR 31.205-20 (Interest and Financing Costs) as long term financing. SRI argued that the costs are allowable because they are similar to bonding costs allowable under FAR 31.205-4, and alternatively, as administrative costs of short-term borrowings for working capital allowable under FAR 31.205-27(a)(3).

The ASBCA sided with SRI. The Board concluded that the LOC costs are allowable for three reasons:
  1. FAR 31.205-20 is inapplicable to disallow the LOC costs because SRI treated the full amount of its long-term bond debt as part of its "current liabilities", not as "long-term" liabilities and the Government failed to show this treatment is inappropriate.
  2. Paying an annual fee (the LOC costs) for a one-year bank LOC for the purpose of collateralizing or guaranteeing its ability to repay the full amount of its long-term debt in the short-term (one year) qualifies as administrative costs for short-term borrowing for working capital allowable under FAR 31.205-27(a)(3).
  3. The LOC costs in dispute are not fixed and upfront costs and are therefore different in kind from the typical costs of financing.
No word yet on whether the Government will appeal this decision.

Monday, May 16, 2011

CAS 418 - Allocation of Direct and Indirect Costs

CAS 418 - Allocation of Direct and Indirect Costs. CAS 418 pertains to direct and indirect costs. It is intended to improve classification of costs as direct and indirect and the allocation of indirect costs. The standard does three things. First, it requires contractors to be consistent in the way it classifies costs as direct or indirect (and to maintain a written statement of accounting policies and practices for classifying direct and indirect costs). Second, it establishes criteria for accumulating indirect costs in indirect cost pools and requires that pools be homogeneous. And thirdly, it provides guidance on allocating indirect cost pools to cost objectives in reasonable proportion to the beneficial or causal relationships of the pooled costs to cost objectives.

To a certain extent, CAS 418 parallels the FAR coverage on indirect costs found in FAR 31.203. However, CAS goes beyond the requirements of the FAR and provides more definitive guidance for selecting allocation bases. For example, the requirement for a written statement of accounting policies for classifying costs as direct or indirect is found in CAS but not FAR.

As mentioned, CAS requires that indirect expense allocation pools be homogeneous. The term "homogeneous" is not defined in this standard. One has to refer to the CAS Board's Statement of Objectives, Policies, and Concepts to find the definition.
Homogeneity means that the costs of functions allocated by a single base have the same or similar relationship to the cost objectives for which the functions are performed, and the grouping of such costs in homogeneous pools for allocation to benefited cost objectives results in a better identification of cost with cost objectives.

The concept of homogeneity has often been a contentious issue between the Government and its contractors. There have been several Board cases (Armed Services Board of Contract Appeals) involving CAS 418. In the latest case, the contractor prevailed because, although the Government demonstrated a "better" allocation method, it had not addressed "materiality".  In other words, just because you can find a better method, it doesn't matter unless it also results in a material difference on contracts. Materiality is a judgment call but there is some materiality criteria found in CAS 903.305. In determining whether amounts of cost are material or immaterial, the following criteria shall be considered (also, no one criterion is necessarily determinative):
  1. The absolute dollar amount involved. The larger the dollar amount, the more likely that it will be material.
  2. The amount of contract cost compared with the amount under consideration. The larger the proportion of the amount under consideration to contract cost, the more likely it is to be material
  3. The relationship between a cost item and a cost objective. Direct cost items, especially if the amounts are themselves part of a base for allocation of indirect costs, will normally have more impact than the same amount of indirect costs.
  4. The impact on Government funding. Changes in accounting treatment will have more impact if they influence the distribution of costs between Government and non-Government cost objectives than if all cost objectives have Government financial support.
  5. The cumulative impact of individually immaterial items.
  6. The cost of administrative processing of any necessary price adjustments.
For purposes of selecting an allocation base, CAS 418 distinguishes between two types of indirect cost pools; those which include a material amount of the costs of management and supervision of activities involving direct labor or direct material, and those which do not.

  • Material amount of management and supervision: If an indirect cost pool contains a material amount of the costs of management or supervision of activities involving direct labor or direct material, the standard requires selecting an allocation base representative of the activity being supervised. Allocation bases are limited to direct labor hours or dollars, machine hours, units of production, or material costs, whichever is more likely to vary in proportion to the costs included in the cost pool being allocated.
  • Immaterial amount of management and supervision: If an indirect cost pool does not contain material amounts of the costs of management or supervision of activities involving direct labor or direct material, the standard specifies criteria for selecting a base representing an appropriate measure of resource consumption. The standard establishes a hierarchy of acceptable representations of beneficial or causal relationships between the activities in the pool and benefiting cost objectives. The best representation is a measure of the resource consumption of the activities of the indirect cost pool. If consumption measures are unavailable, or impractical to ascertain, the next best representation is a measure of the output of the activities of the indirect cost pool. If neither resources consumed nor output of the activities can be measured practically, the standard requires the use of a surrogate that varies in proportion to the services received to be used as a measure of resources consumed.

Beneficial/Causal: The allocation base used should result in an allocation to cost objectives in reasonable proportion to the beneficial or causal relationship of the pooled costs to cost objectives. Where the allocation base used is direct labor hours or dollars, all work accomplished, including hours worked in excess of 8 hours per day/40 hours per week by exempt employees or assigned costs, should be included as appropriate in the base for allocation of overhead costs.

Special Allocations. CAS 418.50(f) provides for a special allocation of indirect costs if a particular final cost objective (e.g., contract) would receive a disproportionate allocation of indirect costs from an indirect cost pool. However, the allocation from the indirect cost pool to a particular final cost objective must be commensurate with the benefits received. The amount of special allocation must be removed from the indirect cost pool and the particular final cost objective’s base costs must be removed for the base used to allocate the indirect cost pool.

Friday, May 13, 2011

Political Contribution Disclosure Draft Executive Order

Back on April 24th, we reported on a draft Executive Order (EO) that, if enacted, would require that all entities submitting offers for federal contracts to disclose political contributions and expenditures that they and certain individuals within the organization have made within two years prior to the submission of their offer. Since that draft EO came to light, the blogosphere has been overflowing with both criticism and support, more of the former and less of the latter.
Yesterday, the House Committee on Oversight and Government Reform held a hearing on the proposed EO as part of its “…responsibility to safeguard the federal contracting and procurement processes from the exploitation and the undue influence of partisan political concerns.” The title given to this hearing was “Politicizing Procurement: Would President Obama’s Proposal Curb Free Speech and Hurt Small Business?” You can get a good idea of what the Committee thinks about the proposal from just the title. According to the Committee,

There is now bipartisan alarm on Capitol Hill that the proposed Executive Order runs afoul of the government's responsibility to keep federal procurement and contracting fair and unbiased. Indeed, Congress must protect U.S. taxpayers from the kinds of corrupt spoils system that could develop if federal contract awards were seemingly tied to partisan political affiliations.
The acquisition and procurement laws are specifically designed to ensure impartiality in the selection of contractors. Competing offers are judged on the merits of their proposals and in the best interests of U.S. taxpayers. If the President's proposed Executive Order is authorized, political donation information would be readily available to political appointees who are immediately involved in the contracting process. That risk is unacceptable.
The Committee heard from seven witnesses, one from the Executive Department (OMB) and six representing private industry. The OMB representative said that it would be inappropriate for him to comment on a proposed order so he spent his time talking about all the things that the administration is doing to improve the procurement process and make it more transparent. Five of the six industry/academia witnesses (PSC, NDIA, AIA, etc) were decidedly and emphatically against the proposal. One called it an “ill-advised power grab”. The sixth one, representing the U.S. Women’s Chamber of Commerce, was for the proposal except she wanted the reporting threshold raised to a level that would not impact small businesses.

There are many others who have weighed in on the issue. The U.S. Chamber of Commerce has come out strongly against the proposal while POGO (Project on Government Oversight) is strongly for it. Both have good arguments to support their position. There will be, no doubt, much more to come on this subject. If you wish to read the prepared testimonies of the witnesses, gohere.

Thursday, May 12, 2011

Now That's a Lot of Water

The Department of Justice announced yesterday that an Army contracting officer pleaded guilty to accepting $400 thousand in bribes from a company in exchange for awarding that company a two-year contract to supply bottled water to U.S. troops in Iraq. You can read the entire press release here. Although the press release did not indicate the value of the contract, we can assume that it was substantial if the contractor was willing to spend that kind of money in order to secure the contract. This particular contracting officer now faces 10 years in prion, must pay back the $400 thousand, and also pay fines.

The DoJ announcement does not give the fate of the contractor. Presumably the contractor has been at least debarred - prevented from obtaining future Government work. Its possible, but doubtful, that the acts were perpetrated by rogue elements within the organization without management knowledge. The announcement does not indicate how the kickback scheme was uncovered. Since this incident was part of a wider scheme that involved other parties and more than $9 million in bribes, there could have been a whistle-blower involved or perhaps a company that didn't appreciate being shook-down came forward.

Government contractors are required to develop and maintain ethics programs. One of the fundamental elements of such a program is for management to set a proper "tone at the top". When management does not set and adhere to ethical principles, employees notice and soon begin to believe that it is fine to bend rules. Employees might even find there are rewards to bending rules in the form of promotions, recognitions, and bonuses.

Wednesday, May 11, 2011

Responsibility Determinations - Other

Today we conclude this series on responsibility determinations. FAR requires that contracting officers make affirmative determinations on seven criteria with respect to prospective contractors' ability to perform work responsibly. So far we've covered financial, schedule, performance, integrity, resources, and equipment and facilities. The seventh, and final criteria is a catch-all for any concerns about prospective contractors' responsibility that doesn't fall within one of the other six criteria.

The seventh criteria, found in FAR 9-104.1(g) simply states that to be determined responsible, a prospective contractor must be otherwise qualified and eligible to receive an award under applicable laws and regulations. In reviewing comptroller general appeals cases and perusing the FAPIIS database, we were unable to locate any cases where prospective contractors were determined non-responsible based on this criteria. Perhaps ineligible contractors bidding on contracts set aside for small businesses, minority-owned, woman-owned, or HUBZONE firms would fall in this category. Prospective contractors refusing to comply with statutorily required certifications (e.g. TINA) might be another possibility.

It is important for contractors to understand that not only will their proposals be evaluated for price, technical merit, or any number of other evaluation factors, but various aspects of the company will be evaluated as well in order for the Government to ensure they are dealing with responsible contractors. Knowing these evaluation factors ahead of time allows prospective contractors to be better prepared.

Tuesday, May 10, 2011

Responsibility Determinations - Equipment and Facilities

We have been discussing the requirement for contracting officers to make affirmative determinations on prospective contractors' responsibility prior to awarding contracts. Affirmative determinations are differentiated from passive determinations. A passive determination would read something along the lines of "we are not aware of any information that would lead us to believe this particular company is not responsible". An affirmative determination requires that the contracting officer develop and document support for each of the seven responsibility criteria. Today we are discussing the sixth of the seven criteria, equipment and facilities.

According to FAR 9-104-1(f), prospective contractors must have the necessary production, construction, and technical equipment and facilities, or the ability to obtain them. This criteria could almost be coded a "not applicable" for service contracts, where, for example, the scope of work called for the contractor to provide labor in support of base services and does not require any investments in capital facilities or equipment. But for manufacturing, construction, and certain research and development, the need for facilities and equipment is paramont.

If a company does not have the requisite facilities or equipment, they are not necessarily disqualified from the competition. The standard allows for prospective contractors to demonstrate that they have the ability to obtain resources. This demonstration must include "acceptable evidence" in the eyes of and the opinion of the contracting officer. Acceptable evidence normally consists of a commitment or explicit arrangement, that will be in existence at the time of contract award, to rent, purchase, or otherwise acquire the needed facilities, equipment, other resources, or personnel. If you fall into this category, it is extremely important to prepare and submit (or have ready to submit) documentation that will satisfy this requirement.

Friday, May 6, 2011

Responsibility Determinations - Resources (non financial)

Today we continue our series on responsibility determinations. FAR (Federal Acquisition Regulations) requires that contracting officers make an affirmative determination of a prospective contractors "responsibility" prior to awarding any contract. There are seven areas that the contracting officer must address. These seven standards are listed in FAR 9.104-1. Last week we covered the first four. Today we discuss the fifth standard; organization, experience, accounting and operational controls, and technical skills.

A prospective Government contractor must have the necessary organization, experience, accounting and operational controls, and technical skills, or the ability to obtain them. This listing includes EVMS (earned value management system), production control procedures, property control systems, quality assurance measures, and safety programs when appropriate and required by the solicitation. 

The Government often uses the Preaward Survey series of forms to document its assessment. These forms (Standard Forms 1402 through 1409) cover general aspects, technical production, quality assurance, financial capability and accounting systems. We've discussed the accounting system form (SF 1408) previously on this blog. The contracting officer typically assigns these surveys to different organizations. For example, DCAA typically performs the accounting system survey, while DCMA performs the financial capability and probably some of the technical aspects.

For companies that do not have the required systems in place at the time it submits its proposal, this standard includes the provision "...ability to obtain resources". If a prospective contractor does not currently have sufficient resources in place (and is not proposing to subcontract out that work), the contracting officer will require acceptable evidence of the ability to obtain those resources. Acceptable evidence normally consists of a commitment or explicit arrangement, that will be in existence at the time of contract award, to rent, purchase, or otherwise acquire the needed facilities, equipment, other resources, or personnel. If you fall into this category, it is extremely important to prepare and submit (or have ready to submit) documentation that will satisfy this requirement.

Responsibility Determinations - Integrity

Before awarding any contract, the contracting officer must make an affirmative determination of responsibility with respect to the prospective contractor. FAR 9-104-1 contains seven standards that a contracting officer must address in making the determination. Today we discuss the fourth standard; integrity and business ethics.

The fourth standard simply states that prospective contractors must have a satisfactory record of integrity and business ethics. Generally, the contracting officer will rely on information readily available in its files and Government databases  and the various certification requirements that prospective contractors must sign. FAR 52.213-3 requires a number of certifications regarding integrity matters that prospective contractors must complete for every contract over the simplified acquisition threshold (currently $150 thousand).

These certifications include representations that the contractor and its principals
  • Are not presently debarred, suspended, proposed for debarment or declared ineligible for the award of contracts by any Federal agency.
  • Have not, within a three-year period preceding this offer, been convicted of or had a civil judgment rendered against them for: commission of fraud or a criminal offense in connection with obtaining, attempting to obtain, or performing a Federal, state or local government contract or subcontract; violation of Federal or state antitrust statutes relating to the submission of offers; or commission of embezzlement, theft, forgery, bribery, falsification or destruction or records, making false statements, tax evasion, violating Federal criminal tax laws or receiving stolen property.
  • Are not presently indicted for, or otherwise criminally or civilly charged by a Government entity with, commission of any of these offenses enumerated above.
  • Have not, within a three-year period preceding this offer, been notified of any delinquent Federal taxes in an amount that exceeds $3 thousand for which the liability remains unsatisfied.
Contractors that cannot certify to these matters, need to provide explanations to the contracting officer so that an assessment can be made regarding its significance to the solicitation in question. Prospective contractors are not automatically disqualified, they'll just have to submit more paperwork. Contractors that submit false certifications, face potentially greater sanctions. The Government's databases are getting better, more comprehensive, and commonly shared among Agencies. The chances of flying under the radar when a company has "issues" (e.g. income tax liens) is very slim these days.

Thursday, May 5, 2011

Responsibility Determinations - Performance

Before awarding any contract, the contracting officer must make an affirmative determination of responsibility with respect to the prospective contractor. FAR 9-104-1 contains seven standards that a contracting officer must address in making the determination. Today we discuss the third standard; satisfactory performance record.

A prospective contractor must have a satisfactory performance record. It is for the purpose of determining contractor compliance with this standard that the Government collects past performance information. FAR 42.15 states:

Past performance information is relevant information, for future source selection purposes, regarding a contractor’s actions under previously awarded contracts. It includes, for example, the contractor’s record of conforming to contract requirements and to standards of good workmanship; the contractor’s record of forecasting and controlling costs; the contractor’s adherence to contract schedules, including the administrative aspects of performance; the contractor’s history of reasonable and cooperative behavior and commitment to customer satisfaction; the contractor’s record of integrity and business ethics, and generally, the contractor’s business-like concern for the interest of the customer.

Although the Government's past performance database is not available to the public, contractors have the right to examine the information concerning themselves. If you haven't seen it, ask your contracting officer for a copy of information he/she wrote about you. Be sure to correct any erroneous or misleading information.

A prospective contractor that is or recently has been seriously deficient in contract performance shall be presumed to be nonresponsible, unless the contracting officer determines that the circumstances were properly beyond the contractor's control, or that the contractor has taken appropriate corrective action. Past failure to apply sufficient tenacity and perseverance to perform acceptably is strong evidence of nonresponsibility. Failure to meet the quality requirements of the contract is a significant factor to consider in determining satisfactory performance.

A prospective contractor shall not be determined responsible or nonresponsible solely on the basis of a lack of relevant performance history.

Wednesday, May 4, 2011

Responsibility Determinations - Schedule

Before awarding any contract, the contracting officer must make an affirmative determination of responsibility with respect to the prospective contractor. FAR 9-104-1 contains seven standards that a contracting officer must address in making the determination. Yesterday, we looked at the first of these seven, the contractors financial capability to perform. Today we will discuss the second standard, the ability to meet the delivery or performance schedule.

A prospective contractor must be able to comply with the required or proposed delivery or performance schedule, taking into consideration all existing commercial and governmental business commitments. Obviously, businesses should not overextend themselves because when they do, quality and timeliness suffers - maybe not for the particular contract in question but in other areas, perhaps on other governmental business commitments.

Most companies respond to multiple solicitations, knowing that they won't win them all. If they were to be successful at a higher than normal "win" rate, they could face a situation of too much work for their available capacity. 

We do not sense that this is a significant issue in the contracting community. In reviewing the GAO protest cases involving responsibility determinations, we found no instances where a prospective contractor appealed a negative determination based on its failure to meet this standard. Indeed, it would be unlikely for a contracting officer to have sufficient detailed contractor information to make a determination one way or another. The best they can do in these situations is write something to the effect that no information came to their attention that would indicate the prospective contractor would be unable to comply with the standard. 

In making responsibility determinations, contracting officers are vested with a wide degree of discretion and, of necessity, must rely upon his or her business judgment in exercising that discretion. Although the determination must be factually supported and made in good faith, the ultimate decision appropriately is left to the agency since it must bear the effects of any difficulties experienced in obtaining the required performance.

Tuesday, May 3, 2011

Responsibility Determinations - Financial

Yesterday we led off this series with a listing of the seven criteria that potential contractors much meet in order for the Government to consider them "responsible" and therefore eligible to receive work from the Government. Beginning today, we will be looking into more detail on those seven attributes, beginning with "financial capability".

Potential contractors need to demonstrate that they have sufficient financial resources to perform the contract from beginning to end. So, what does this mean in practical terms? It means that contractors must have enough cash to pay its bills from the time the bills become due, until payment is received from the Government. Consider a cost-reimbursement contract. A contractor pays bills during the month, submits a voucher at the end of the month, and receives payment from the Government in 30 days or less. That works out to a two month float. If the contract has a burn rate of $100 thousand per month, the contractor should have $200 thousand ($100 thousand times two months) in working capital earmarked for the contract. Its that easy.

The Government, as is their bent, will make a much bigger deal out of performing financial capability reviews. They'll ask for historical financial statements, cash flow projections, org charts and reams of other data but at the end of the day, they're simply trying to figure out if the contractor has enough working capital to see the contract through to completion. Contractors can sometimes expedite the review process by helping Government analysts (DCMA employees for DoD contracts) focus on cash flow forecasts rather than historical records and other tangential matters.

Monday, May 2, 2011

Responsibility Determinations - General

Before awarding any contract, the contracting officer must make an affirmative determination of responsibility with respect to the prospective contractor. The award of a contract to a supplier based on lowest evaluated price alone can be false economy if there is subsequent default, late deliveries, or other unsatisfactory performance resulting in additional contractual or administrative costs. While it is important that Government purchases be made at the lowest price, this does not require an award to a supplier solely because that supplier submits the lowest offer.

It is crucial for contractors and prospective contractors to assist contracting officers in that determination by providing all of the information requested. According to FAR 9.104, in the absence of information clearly indicating that the prospective contractor is responsible, the contracting officer shall make a determination of nonresponsibility.

In order to be considered “responsible”, prospective contractors must meet seven criteria. Failure to affirmatively demonstrate even one of these, will, if the Government is following its own regulations, cause a supplier to be determined nonresponsible. These seven criteria are,

1.     Have adequate financial resources to perform the contract, or the ability to obtain them.

2.     Be able to comply with the required or proposed delivery or performance schedule, taking into consideration all existing commercial and governmental business commitments;

3.     Have a satisfactory performance record. (However, a prospective contractor shall not be determined responsible or nonresponsible solely on the basis of a lack of relevant performance history).

4.     Have a satisfactory record of integrity and business ethics.

5.     Have the necessary organization, experience, accounting and operational controls, and technical skills, or the ability to obtain them

6.     Have the necessary production, construction, and technical equipment and facilities, or the ability to obtain them

7.     Be otherwise qualified and eligible to receive an award under applicable laws and regulations

As you might expect, the contracting officer must exercise a fair amount of judgment in making responsibility determinations. However, these judgments are often based on factual data and information that, in many cases, only the prospective contractor can provide.

Over the next few days, we will examine some of these criteria in more detail and provide some real-life cases where contractors were determined nonresponsive.