Monday, October 31, 2011

Another One Bites the Dust

Companies that wish to enter the Government contracting arena and companies who wish to continue working in that arena, must ensure that they have internal control systems in place that meet basic Government expectations. We frequently discuss these requirements in this blog - especially requirements for accounting systems. Contractors need to establish adequate accounting systems to obtain a contract and they need to maintain those systems to receive future awards. This fact is illustrated (yet once again) in a Comptroller General's "bid protest" decision handed down last month (KMS Solutions, LLC, B-405323.2; B-405323.3, October 6, 2011).

A Government solicitation provided that "[a]n offeror's accounting system shall be adequate for determining costs applicable to the contract," and directed each offeror to "provide evidence of their accounting system being adequate in accordance with FAR and in compliance with FAR [Part] 31, Contract Cost Principles and Procedures." 

In responding to these solicitation provisions, KMS's proposal directed the agency's attention to a Defense Contract Audit Agency (DCAA) audit, performed in September 2006, which had concluded that KMS's cost accounting system was adequate for performing cost reimbursement contracts. The problem here, as the contracting office found out when it contacted DCAA for an update on the 2006 audit report, was that DCAA had performed a subsequent audit in 2010 that concluded just the opposite - that there were significant deficiencies  that are considered to be material weaknesses in the contractors system that could result in misstated costs. The audit stated that the accounting and billing systems were inadequate and went further by recommending suspension of progress payments and billings under cost reimbursable contracts. 

KMS's proposal made no reference to any subsequent DCAA audit.

Based on this updated information, the Government threw out KMS's bid. KMS protested that the agency's determination of inadequacy was improper for various reasons. The Comptroller General disagreed. One of the challenges had to do with the contractor's stated disagreement with the DCAA position. However, the Comptroller General found that "In pursuing this protest, KMS has not meaningfully challenged the substance of the DCAA's findings of deficiencies and inadequacies." 

Ultimately, the Comptroller General found that the Government reasonably rejected KMS's proposal. 

Friday, October 28, 2011

Allowability of Incurred Costs due to Contractor Errors

The Department of Energy (DoE) issued a new Acquisition Letter (No. AL-2012-03) this week concerning the allowability of incurred costs due to contractor errors. Acquisition Letters (ALs) from DoE are issued to provide specific guidance for implementing FAR and DEAR (the DoE FAR Supplement). AL's from DoE function similar to PPGs (Policies, Procedures, and Guidance) issued by the Department of Defense. 

This particular AL provides guidance to DoE contracting officers who need to make decisions on the allowability of costs charged to Government contracts. It first distinguishes between explicitly unallowable costs as defined in the FAR Part 31.205 and costs that are not explicitly unallowable but may not necessarily be reasonable. Determining whether costs are reasonable requires contractors and contracting officer to exercise judgment. According to the AL, contractor “errors” could fall into the “reasonableness” arena.

The example given in the AL is a situation where a contractor employee rents a car and inadvertently, but contrary to company policy, failed to decline the optional insurance. The cost of the extra insurance would be an allowable cost according to DoE.

The AL also distinguishes between “errors” that happen infrequently and those that happen all the time. If these kinds of errors happen frequently, the cost is no longer reasonable because it is obvious that the contractor does not have an adequate system of internal controls to prevent their occurrence. The AL states:
 If it were possible for a contractor to operate a zero error financial system at no cost, no incurred cost due to error would be allowable because it would be unreasonable. Since this is not possible, the cost-reimbursement contractor and the government must make prudent business judgments about the benefit versus cost of the contractor's financial system. It would not generally be prudent, for example, to spend $100,000 to save $10 in cost.

We believe this is a good policy. It should preclude some of the endless discussions between contractors and auditors/contracting officers about whether certain relatively immaterial costs can be claimed on Government contracts. Although not applicable to other Governmental agencies, it might nevertheless be useful to drag it out to buoy your position, if you find yourself in this situation.

Thursday, October 27, 2011

Limitation of Costs and Limitation of Funds - Part IV

Today we finish up our series on Limitation of Costs and Limitation of Funds clauses found in cost-reimbursable contracts. These clauses are more than perfunctory. Contractors that take them lightly or fail to consider them at all are at risk for incurring costs that will not be reimbursed. As we will illustrate in a moment, the courts typically side with the Government in disputes involving the application of these clauses.

The Government is not obligated to reimburse a contractor for any cost in excess of the costs and/or funds allocated to a contract. Nor is the contractor obligated to continue performance or incur any costs in excess of the estimated contract costs and/or funds allocated. The purpose of the Limitation of Costs/Funds clauses are designed to give the Government advance notice of potential cost overruns. Boards of contract appeals as well as the Court of Claims have ruled in numerous cases that an inadequate accounting or management information system is not a valid excuse for not providing the notice required by the clause.

For example, in Datatex Inc., the contractor asserted that it was unaware when contract costs exceeded 75 percent of total estimated costs because actual overhead rates could not be determined until after contract completion and Government audit. No notice was give to the Government until settlement of final overhead rates (10 months after contract completion), at which time the contractor requested a contract modification to fund the contract overrun. The contractor's request was rejected. In concluding that the contractor should have been able to foresee that its costs would exceed the contract ceiling, the ASBCA (Armed Services Board of Contract Appeals) stated that a contractor is obligated to maintain an accounting and financial reporting system adequate to apprise the contractor of a possible overrun before the overrun occurs.

A similar case involved SAI Comsystems who claimed that the Government's failure to make a timely audit excused the contractor's lack of notice and thus obligated the Government to provide additional funding. The Board did not agree, noting that a contractor has a responsibility to maintain reasonable records, in order to be able to ascertain when costs will approach the contract ceiling and to be able to cease performance in an orderly manner prior to reaching that level.

Although these clauses explicitly relieve the Government from any obligation to reimburse costs incurred in excess of the estimated (or funded) cost, that does not mean that such overruns are never paid. The contracting officer has discretionary authority to do so. In cases where the overrun is clearly a result of unforeseen circumstances or the Government has a great need for the "product", contracting officers can sometimes be prevailed upon to add additional funding to the contract. However, this should be considered a "long shot" insofar as seeking funding. In a case involving Research Applications, Inc., the board stated that "it was not the circumstances but appellant's own choice that produced the cost overrun as well as the lack of information on which a proper notice could have been based".

Wednesday, October 26, 2011

Limitation of Costs and Limitation of Funds - Part III

For the past couple of days, we've been discussing the Limitation of Costs and Limitation of Funds clauses that appear in cost reimbursable Government contracts. In Part I, we discussed the fundamental requirements of the two similar clauses. In Part II, we discussed the data and analysis required to comply with clauses. We also indicated that the ability to comply is one of the evaluation factors when the Government comes in to perform a pre-award accounting system survey of your company. Failure to demonstrate the ability to comply can make the difference between winning and losing a bid.

Today we want to address the issue of indirect rates. Indirect rates are used in determining historical costs and in estimating the monthly "spend rate". One question we're asked frequently concerns the appropriate rate to use in these calculations. Contractors typically have different indirect expense rates for different purposes. There's nothing wrong with this practice. It's not like having multiple sets of books. Its simply necessary given the vagaries of Government contracting. For example:

  • Actual rates - these are the final year-end rates or the rates calculated at some interim period. It could be a monthly, three, six, or nine month period.
  • Forecasted rates - these are rates used in estimating future contracts. These rates are heavily influenced by the size of a particular bid. A large contract will typically reduces indirect rates. Forecasted rates should not be used to book or bill costs.
  • Billing rates - these are rates that have been approved by the Government for billing purposes. They should represent the contractors best estimate of the final year-end rates. Contractors have a duty to monitor these rates and revise them as appropriate.
  • Booking rates - In a perfect world, booking rates and billing rates should be the same. However, the process for adjusting billing rates and obtaining Government approval is cumbersome, time consuming, and subject to the whims of auditors (like when they make arbitrary reductions to "protect the Government's interests"). Sometimes contractors find that the billing rates no longer reflect the best estimate of the final year-end rates but, for various reasons, cannot get the Government to approve revised billing rates. In these cases, contractors must use a more realistic set of rates in order to reasonably estimate contract costs for Limitation of Costs and Limitation of Funds purposes.
There's a certain amount of judgment involved in determining which rates should be used for Limitation of Costs/Limitation of Funds analyses. Commonly for purposes of calculating incurred costs, completed years should be calculated using "actual rates" while current year costs should be calculated using "billing rates" or "booking rates", whichever is the most accurate estimate of the final year end rates. Future year costs should be calculated using "forecasted rates" where the allocation bases can be estimated with a reasonable degree of certainty.

Tuesday, October 25, 2011

Limitation of Costs and Limitation of Funds - Part II

In yesterday's posting, we introduced two clauses that appear in cost-type contracts that require contractors to notify the Government as it's actual cost approach the amount that has be funded for work under the contract. Under a cost-reimbursable contract, the Government has no liability to reimburse costs that exceed the amount funded and the contractor has no responsibility to continue performance once contract funds are exhausted.

In order to make meaningful comparisons of actual costs to the amount(s) funded, contractors need systems that can provide that information. The accounting software cannot do it all unless contractors are prepared to shell out big bucks for an "enterprise" system (e.g. Deltek Costpoint). For small contractors however, the cost of those systems is prohibitive. The good news is that most accounting software plus Excel plus discipline will work just fine

Lets take a look at what it takes to meet the requirements of the Limitation of Costs clause. The clause requires that contractors notify the Government 90 days before incurring 75 percent of estimated contract costs. Calculating 75 percent of contract costs is easy. Figuring out when you will arrive at that figure is more challenging. There are a number of approaches one could take. Any approach however requires the following data:

  • the monthly budget for the contract
  • incurred cost to date
  • schedule of commitments (open purchase orders), including subcontracts
  • future "spend" rate

The purpose of the monthly budget for this analyses is to track "actual" costs against budgeted costs so that variances can be analyzed and corrective actions can be taken if needed. Variances will affect future spending, one way or another.

"Commitments" are often overlooked by contractors. Businesses issue purchase orders for goods and services. The cost of purchases made under those orders however, are not booked until an invoice is received. Therefore, contractors need to factor unfilled orders (or, commitments) into their analyses.

The future spend rate should be calculated by month and reflect management's best estimate of how progress is to proceed on the contract. It is perhaps one of the most challenging aspects of the Limitation of Cost analysis.

Tomorrow we will look at the impact that indirect expense rates have on this analysis.

Monday, October 24, 2011

Limitation of Costs and Limitation of Funds

All cost-reimbursable contracts contain the Limitation of Costs clause (FAR 52.232-20) or the Limitation of Funds clause (FAR 52.232-22) or usually both clauses. They are similar; the former applies to fully funded contracts and the latter applies to incrementally funded contracts.

Limitation of costs applies to fully funded cost reimbursement contracts. The clause requires a contractor to notify the Government when it expects in the next 60 days to have spent 75 percent of the estimated cost, or expect expenses to be greater or substantially less than previously estimated. The clause allows variations in the number of days, between 30 and 90 days and variations in the percentage between 75 and 85 percent.

Limitation of funds applies to incrementally-funded cost-reimbursement contracts. Contractors must notify the Government that it is coming to the end of obligated funding, and send notification to the contracting officer that obligated funds will be spent within the next 60 days.

In order to comply with these clauses - to know when the specified thresholds have been met - contractors must have an adequate accounting system. An adequate accounting system must meet many criteria but insofar as these clauses are concerned, the accounting data must be current, "booked" indirect expense rates must be reasonably accurate and someone must be monitoring actual costs against estimated costs.

The SF Form 1408, Preaward Survey of Prospective Contractor Accounting System, is used by the Government to assess the adequacy of contractor accounting systems. One of the elements on this form asks whether the accounting system provides the financial information necessary to comply with these clauses. If not,   there is a strong likelihood that the contractor will be disqualified from bidding on contracts.

Friday, October 21, 2011

Evaluation Criteria used for Awarding Government Contracts

When awarding contracts, FAR (Federal Acquisition Regulations) require agencies to consider firms' past performance records to help ensure that taxpayer dollars go to capable contractors. The FAR also provides agencies with broad discretion in deciding how they will consider firms' prior experience. Prior experience refers to whether the firms have done similar work before, and past performance describes how well they have done that work. As firms without prior federal contracting experience seek to gain entry into the federal marketplace, some potential contractors, especially small firms with limited prior experience, consider these factors to be impediments to entering the federal marketplace.

Agencies consider prior experience and past performance during three key phases in the award of contracts:
  1. preparing solicitations
  2. evaluating proposals
  3. making responsibility determinations as to whether firms have the ability and capacity to successfully perform.
Agencies have broad discretion under FAR in deciding the acquisition method, evaluation factors and their relative weights, as well as what prior experience and past performance they will consider relevant.

The GAO (Government Accountability Office) recently published the results of a study they conducted to determine (i) how agencies consider prior experience and past performance in awarding contracts and (ii) the resources available to assist firms in gaining entry to the federal marketplace. The study focused on construction contracts but the findings would also apply more broadly to all federal acquisition.

The GAO study found that the consideration of prior experience and past performance varied by agency. In general, these factors were considered to a greater degree in procurements in which agencies weighed price and nonprice selection factors and to a lesser degree in procurements in which price was the determining selection factor. No surprises there.

The consideration of prior experience and past performance is not limited to work performed under prior contracts with the government. Instead, agencies are to consider work performed on all contracts: federal, state, local, and private sector. GAO did not identify any instances in which an agency limited its evaluation of offerors' experience or past performance to only work performed on prior federal government contracts. The GAO study found that in almost all procurements, contracts were awarded to the offerors that received the highest rating for nonprice factors, such as prior experience or past performance.

The GAO study concluded that consideration of prior experience or past performance is not an impediment to winning government contracts as prospective contractors generally cite their prior work. However, the GAO noted that small firms seeking to win federal contracts face challenges in building up relevant work experience, financial resources, and bonding capacity to compete for large contracts.

Finally, the GAO study listed various resources that are available from federal agencies to help firms without relevant experience or past performance gain entry to the federal marketplace, including outreach and education, subcontracting opportunities, mentor-protege programs, and SBA programs specifically designed to assist small businesses.

The entire GAO report is available on-line. Click here.

Thursday, October 20, 2011

Contract Disputes Overview - Part III

Today we conclude our short overview on contract disputes. It is not our intent here to go into a lot of detail on  the processes and procedures available to contractors or the Government when disputes arise. Rather, we are simply informing readers of the methods available to resolve contract disputes. One piece of advice that we can offer based on experience on both sides of disputes is to try and settle disputes quickly and as efficiently as possible, even if it nets results that are less than desired. Protracting the resolution process is very costly in terms of time and resources.

Usually when contract disputes are discussed, it is the contractor disputing a Government position. However, the Government also makes affirmative claims against contractors. These claims include unallowable costs charged to contracts (either directly or indirectly), defective pricing allegations, defective parts, CAS (Cost Accounting Standards) noncompliances, etc. When the Government is making the claim, the demand must be in writing and

  1. state an amount certain
  2. make a demand for payment,
  3. provide an address for payment,
  4. notify the contractor of any deferment processes available to it.

The Government's claim is typically made as soon as the contracting officer has (i) determined that an actual debt is due the Government and (ii) has determined the amount or refund or payment. Often it is not a simple matter to calculate the amount so the contracting officer seeks assistance and advice from auditors and other technical experts. Regardless, the "sum certain" requirement demands that the Government's claim be fairly precise.

Finally, contractors should be aware of the statute of limitations. There is a six-year statute of limitations upon claims by either party for contracts awarded after October 1, 1995 (that should be just about all contracts by now). However, determinations of when a claim accrues can be a very complicated issue of law and we recommend consultation with legal counsel if it appears that a claim is outside the statute of limitations.

Wednesday, October 19, 2011

Contract Disputes Overview - Part II

There are several ways of handling contract disputes ranging from the informal and inexpensive (negotiations) to the formal and very expensive (going to court). Naturally, both contractors and the Government want to and generally seek to resolve disputes at the lowest cost possible. However, sometimes the stakes are so great or one side or the other becomes so entrenched that resolution by negotiation or by ADR is not possible. The decision to elevate disputes to the ASBCA or the COFC is largely a business case judgment where one or both of the parties calculate that the potential benefits outweigh the risk (i.e. cost). Yesterday we introduced the subject of contract disputes - today we will focus on the event that occurs when resolution is not possible through negotiations or ADR (Alternative Disputes Resolution) procedures. The first thing that must happen when a dispute is not resolved at the contracting officer level is the preparation of the contracting officer's "final decision".

When a claim cannot be satisfied or settled by mutual agreement and a decision upon the claim is necessary, the Contracting Officer must prepare a final decision (see FAR 33.211). A final decision represents the independent decision and determination of the ACO (or TCO). This decision may be based on information and assistance of auditors and technical specialists but the ultimate decision is that of the contracting officer after thoroughly reviewing all facts and recommendations (see FAR 33.211). The actual final decision document may contain copious information and legal jargon but must, at a minimum,
  • Contain a describe the claim or dispute
  • Refer to the pertinent contract terms
  • State the factual areas of agreement and disagreement
  • Set forth the contracting officer’s decision (along with supporting rationale).
  • Notify the contractor of its right to appeal to the ASBCA within 90 days or the Court of Federal Claims within 12 months.
For claims of $100 or less, the contracting officer must issue a final decision within a reasonable time (see FAR 33.211(c)(1)). For claims greater than $100 thousand, contracting officers must issue a final decision within 60 days or provide written notification within 60 days or provide written notification with 60 days as to when such a decision will be issued. Even if the 60 day target cannot be met, contracting officers are still required to issue a final decision in a "reasonable time". Reasonable time is not defined and we have seen situations where final decisions can take a year or longer to issue.

Tuesday, October 18, 2011

Contract Disputes Overview - Part I

A dispute between the Government and contractor may arise in a variety of situations. These include, but are not limited to:

  • Inability to agree upon an equitable adjustment
  • Inability to agree upon the amount due following a contract termination
  • Disallowance of costs
  • Noncompliance with Cost Accounting Standards (CAS)

There are three principal means of disputes resolution between contractors and the contracting officer. These are

  • Unassisted negotiation
  • Alternative Dispute Resolution (ADR), and
  • Appeal of a contracting officer final decision to the 
    • ASBCA (Armed Services Board of Contract Appeals) or
    • United States Court of Federal Claims (COFC)
The Government's policy is to try to resolve all contractual issues in controversy by mutual agreement at the contracting officer's level (see FAR 33.204). Both parties are encouraged to make reasonable efforts to resolve controversies prior to the contractor submitting a claim. Agencies are encouraged to use ADR procedures to the maximum extent practicable. Certain factors, however, may make the use of ADR inappropriate. For example agencies are encouraged to avoid ADR when

  • a definitive or authoritative resolution of the matter is required for precedential value and such a proceeding is not likely to be accepted generally as an authoritative precedent
  • the matter involves or may bear upon significant questions of Government policy that require additional procedures before a final resolution may be and, and such a proceeding would not likely serve to develop a recommended policy for the agency
  • maintaining established policies is of special importance, so that variations among individual decisions are not increased and such a proceeding would not likely reach consistent results among individual decisions
  • the matter significantly affects persons or organizations who are not parties to the proceeding
  • a full public record of the proceeding is important, and a dispute resolution proceeding cannot provide such a record
  • the agency must maintain continuing jurisdiction over the matter with authority to alter the disposition of the matter in the light of changed circumstances, and a dispute resolution proceeding would interfere with the agency's fulfilling that requirement.

When resolution cannot be accomplished by negotiation or by ADR proceedings, contractors may file a formal claim. The claim must be in writing (see FAR 33.206(a)). It must request a "sum certain" or a decision concerning contract terms. In addition, contractors must certify claims over $100 thousand (see FAR 33.207). Uncertified claims will be rejected and returned to contractors.

To be continued...

Monday, October 17, 2011

Contract Line Item Pricing

The Department of Defense has issued instructions to its acquisition personnel regarding the integrity of contract line item pricing. This was prompted by a recent review that found during the first five months of fiscal year 2011, about 38 percent (1.7 million out of 4.4 million line items) of contract line items contracted for, had no unit of measure or used "lump sum" as the unit of measure. According to DoD, contracts must define clear requirements that reflect supplies and services acquired in order to enable accurate contract completion and payment. Historically, analysis of what the Government is actually buying has been hampered because too many supplies and services lack any unit of measure that corresponds to the quantity required.

DoD has now mandated that no contract action can be issued using "lump sum" or "dollars" as a unit of measure. Contract pricing arrangements should ensure prices are proportional to work performed and that actual deliveries can be traced to the prices.

This change could affect the timing and frequency of contractor reimbursements (e.g. public vouchers and progress payments). Contracting officers (and contractors) often use "lump sum" pricing as a means of aligning reimbursement/payments with work performed. In the futures, reimbursements will need to be more closely aligned with deliverables.

Friday, October 14, 2011

FAR to Require Contractors to Conduct Privacy Training

The FAR Councils are proposing to amend the Federal Acquisition Regulations (FAR) to add a new section related to privacy training. It will require contractors to identify employees who require access to a Government system of records, handle personally identifiable information, or design, develop, maintain, or operate a system of records on behalf of the Federal Government, and then to ensure that those employees complete privacy training immediately upon award of the procurement and at least annually thereafter. In addition, contractors are required to keep records indicating that employees have completed the required training and, upon request, provide those records to the Government.

The proposal specifies the minimum privacy training coverage as follows:

  1. The protection of privacy, in accordance with the Privacy Act (5 USC 552s)
  2. The handling and safeguarding of personally identifiable information
  3. The authorized and official use of a Government system of records
  4. Restrictions on the use of personally-owned equipment to process, access, or store personally identifiable information
  5. The prohibition against access by unauthorized users, and unauthorized use by authorized users, of personally identifiable information or systems of records on behalf of the Federal Government
  6. Breach notification procedures (i.e., procedures for notifying appropriate individuals when privacy information is lost, stolen, or compromised) to minimize risk and to ensure prompt and appropriate actions are taken should a breach occur
  7. Any agency-specific privacy training requirements.

The FAR councils estimate that this requirement will affect about 1,500 small businesses in additions to an unknown number of other firms but does not expect that impacted contractors will find the requirement burdensome.


Thursday, October 13, 2011

How Auditors Assess Internal Controls

Audits by Governmental Organizations are generally conducted in accordance with Generally Accepted Government Auditing Standards (GAGAS), also known as the GAO Yellow Book. In order to comply with GAGAS, auditors are required to be familiar with these standards and apply them in the particular audit. One of the standards, found in section 601.46 requires auditors to obtain an understanding of the design of specific controls. Suggested methods of satisfying this requirement include;

  • Question: inquiries of appropriate management, supervisory, and staff personnel
  • Read: inspection of the contractor's documents
  • Look: observation of the contractor's activities and operations.

The nature and extent of procedures performed vary from contractor to contractor and are influences by factors such as the following:

  • the newness and complexity of the specified requirements
  • the auditor's knowledge of internal control over compliance obtained in previous assignments (e.g. reported deficiencies)
  • the nature of the specified compliance requirements
  • an understanding of the industry in which the contractor operates
  • judgments about materiality

"Materiality" is always a big factor in assessing internal control adequacy.

Any policy and procedure or other internal controls that may have a material impact on the significant elements/areas being audited and the procedures for obtaining an understanding of those will depend on the nature of the elements/areas under audit and the basis for their development.  For each element/area selected for evaluation, contractors will be expected to explain the processes and related policies and procedures or other internal controls related to the development of those elements or areas identified for evaluation.  For the most part, auditors will try to obtain and document their understanding of those during an initial walk-through (probably as part of an entrance conference).

The auditor's objective is to gain an understanding of the applicable key processes and the related policies and procedures (formal or informal) or other internal controls so that they can be considered in designing/tailoring audit procedures to meet the objectives of the audit.  Good internal control systems pay dividends in reduced audit oversight.

Wednesday, October 12, 2011

Subcontract Costs Based on Commercial Item Pricing

A couple of weeks ago, we ran a three part series dealing with the Government's purchases of commercial items and some of the factors that the Government considers in determining whether items meet the precise definition of "commercial items". Today we want to focus on prime contractor responsibilities when they include subcontract costs based on commercial item pricing in a proposal or public voucher.

When a prime/higher-tier contractor includes proposed subcontract costs for commercial items in its proposal, the prime/higher-tier contractor is required to make a commercial item determination (CID) and perform the appropriate cost or price analysis to establish a fair and reasonable price, in accordance with Department of Defense FAR Supplement (DFARS) 244.402 and Federal Acquisition Regulation (FAR) 15.404-3. The Government auditor (e.g. DCAA) or the price analyst/contracting officer (e.g. DCMA) will review the adequacy of the prime/higher-tier contractor’s CID and associated cost/price analysis as a basis for opining on the adequacy of the CID and the reasonableness of the proposed subcontract costs included in the prime/higher-tier contractor’s proposal.

Prime contractors and all of their subcontractors are required to purchase supplies and services from responsible sources at fair and reasonable prices, including those determined to be commercial items. DFARS 244.402(a) states "Contractors shall determine whether a particular subcontract item meets the definition of a commercial item.” Prime/higher-tier contractors are expected to exercise reasonable business judgment in making the CID and documenting its determination. In addition, FAR 15.404-3(b) states that the prime contractor shall conduct appropriate cost/price analyses to establish the reasonableness of proposed subcontract prices and include these analyses in its proposal.

An adequate CID clearly identifies and supports how the item meets the commercial item definition in FAR 2.101. Generally, support for a CID would include market analysis and sales history. Failure to include adequate support could result in an estimating system deficiency and possible withholds on billings.

In some cases, the contracting officer may not agree with a prime contractor/higher-tier subcontractor's CID. FAR 15.403-1(c)(3) states in part, “If the contracting officer determines that an item claimed to be commercial is, in fact, not commercial and that no other exception or waiver applies, … the contracting officer shall require submission of certified cost or pricing data.”

Tuesday, October 11, 2011

DCAA Discontinues Audits of Contractor Purchasing Systems

On September 30, 2011, DCAA (Defense Contract Audit Agency) instructed its audit staff to no longer initiate audits on contractors' internal controls over purchasing systems. DCAA will continue to audit the costs as part of proposal evaluations and incurred cost audits but will no longer be concerned with "purchasing systems" per se. That responsibility will be turned over to DCMA (Defense Contract Management Agency)

DCAA stated that the switch in policy it part of its "continued effort to identify and eliminate areas of potential overlapping responsibilities, while looking for opportunities to improve efficiencies within DCMA and DCAA to ensure the appropriate use of resources while protecting the taxpayers' interest." DCMA meanwhile, has established a Purchasing System Review Center and will increase both the number of analysts and the number of reviews to be performed.

This is another in a string of audit area that DCAA is abandoning following the appointment of its new Director. Other areas the Agency has abandoned recently include EVMS (Earned Value Management Systems), Financial Capability Reviews, Forward Pricing Indirect Rates, Cost-reimbursable proposals under $100 million, and Fixed-price proposals under $10 million.

Monday, October 10, 2011

Lobbying Costs Related to Legislative Earmarks

The Defense Contract Audit Agency (DCAA) recently issued guidance to its auditors to be on the lookout for lobbying costs related to legislative earmarks. This guidance from September 2011 is actually a reiteration of guidance first published about three and a half years ago. The new guidance however, adds links to Governmental and non-governmental available sources of information on historical and current lobbying and earmark activities. We recommend that contractors peruse these databases in order to anticipate and prepare for possible auditor queries in this area.

A legislative earmark refers to a Congressional provision directing funds to be spent on specific projects. Typically, a legislator seeks to insert earmarks in spending bills that direct a specified amount of money to a particular contractor, organization, or project in his or her home state or district. Earmarks are still alive and well in D.C. The Office of Management and Budget reported that in the 2010 Defense Appropriations Act alone, there were 1,759 earmarks totaling $4.3 billion.

Some contractors, seeking earmarks, might expend a significant amount of effort including professional services for the purpose of influencing or attempting to influence Government officials in connection with earmarks. Auditors are being instructed to evaluate contractor's procedures for properly identifying and accounting for costs associated with lobbying activities and legislative earmarks. Auditors are being instructed to question these costs under FAR 31.205-22, Lobbying and Political Activity Costs. The new DCAA guidance states that FAR 31.205-22  applies to "... costs incurred associated with any attempt to influence legislation (e.g. earmark) ...". Actually FAR 31.205-22 makes no reference to "earmarks". This is a DCAA editorial insert and we've seen a legal opinion that makes a contrary case that FAR 31.205-22 does not apply to earmarks. A stronger case could be made citing FAR 52.203-12, Limitation on Payments to Influence Certain Federal Transactions, which prohibits the cost of activities to influence the award, the extension, continuation, renewal, amendment or modification of a contract.

Notwithstanding the merits of DCAA's position on this matter, the fact is that most companies already voluntarily remove any costs related to "earmark" activities from any claim for reimbursement from the Government. The costs are usually immaterial in that whether claimed or not, an indirect rate is not significantly affected. And, since immaterial, the risks of becoming embroiled in a dispute with the Government have limited potential payback.

Friday, October 7, 2011

SBA Crackdown on Size/Status Scofflaws

Congress and the Small Business Administration (SBA) are getting ready to crack down on companies who do not play by the rules when it comes to size and status. In 2010, Congress passed the Small Business Jobs Act of 2010 (Jobs Act). Included in this Act were a number of provisions that pertain to small business size and status integrity.

The Jobs Act provides that if a concern willfully seeks and receives an award by misrepresenting its small business size or other socioeconomic status, there is a presumption of loss to the United States equal to the value of the contract, subcontract, cooperative agreement, cooperative research and development agreement or grant. The Jobs Act also provides that certain actions, such as submitting an offer in response to a solicitation set aside for small business concerns, will be deemed a representation of small business size or status. The Act also requires the signature of an authorized official of a concern making a small business size or status representation in connection with certain actions, such as submitting an offer. The amendments further provide that concerns must update their size and status certifications in ORCA (Online Representations and Certifications Application) at lease annually, or the status will be lost until such time as the update is made.

On October 7, 2011, SBA published the following proposed regulations to implement these provisions of the Jobs Act. SBA is proposing to amend its program regulations to

  • implement statutory provisions establishing that there is a presumption of loss equal to the value of the contract or other instrument when a concern willfully seeks and receives an award by misrepresentation.
  • implement statutory provisions that provide that the submission of an offer or application for an award intended for small business concerns will be deemed a size or status certification or representation.
  • implement statutory provisions that provide that an authorized official must sign in connection with a size or status certification or representation for a contract or other instrument.
  • implement statutory provisions that provide that concerns that fail to update their size or status in ORCA at least annually shall no longer be identified in the database as a small or some other socioeconomic status, until the representation is updated.
  • clarify when size is determined for purposes of entry into the 8(a) Business Development and HUMZone programs.

SBA hopes that these regulations will prevent and deter fraud and misrepresentation in small business government contracting and other programs. In fiscal year 2010, SBA found approximately 200 firms to be ineligible for the contract (or other award type) for which they were awarded. There were undoubtedly many others that were not investigated.

Thursday, October 6, 2011

Executive Compensation Cap for 2011 - Not Yet

The allowability of compensation costs for the top five executives of Government contractors is capped by statute (10 USC 2324(e)(1)(p) and 41 USC 256(e)(1)(p)). The benchmark amount does not limit what contractors can pay their executives but only the amount that can be claimed under Government contracts.

The Administrator, Office of Federal Procurement Policy (OFPP) determines the benchmark amount each fiscal year and published in the Federal Register. From 2004 through 2010, these determinations were published as early as March 25th but no later than May 14th. However, the OFPP has not yet published the compensation cap for 2011.

A few senators and congressmen have taken notice of OFPP's inaction on this matter. In a letter last month, Senators Boxer and Grassley and Representative Tonko called on OFPP to issue its determination before the end of the current fiscal year (September 30th). OFPP did not comply.

In 1998, when the statute became effective, the cap was $340,650. In 2010, it was $693,951. According to the aforementioned letter, this cap has grown 53 percent faster than inflation. The letter concludes by stating "The American people deserve to know exactly how much government contractor executives will charge the taxpayer for their salaries this year".

Wednesday, October 5, 2011

Cost Accounting Standards - Revision to Existing Exemption

There are ten categories of contracts and subcontracts that are exempt from all CAS (Cost Accounting Standards) requirements. Some of the more common ones include sealed bids, contracts under $700 thousand, and contracts to small businesses. One category, often referred to as the "b15 exemption", exempts Firm fixed price contracts or subcontracts awarded on the basis of adequate price competition without submission of cost or pricing data.

The CAS Board is now proposing to amend the wording of this exemption to include the term "certified" before the phrase "cost or pricing data". The Board believes that a clarification is required because of the Government's emerging use of "data other than certified cost or pricing data" to negotiate contracts is causing some confusion. "Data other than certified costs or pricing data could still be construed as cost or pricing data, just not certified. Thus, some contractors and contracting officers have inappropriately excluded such contracts from CAS requirements.

When the exemption was first drafted in 2000, there was no category called "data other than cost or pricing data" so that the CAS Board believed that "certified" was presumed in the definition.

Tuesday, October 4, 2011

Cost Realism Reviews

When the Government evaluates proposals for the award of a cost-reimbursement contract (e.g. CPFF, CPIF, and CPAF), a prospective contractor's proposed estimated cost of contract performance is not considered controlling since, regardless of the costs proposed by the contractor, the Government is bound to pay the contractor its actual costs (as long as those costs are allowable, allocable, and reasonable). Consequently, a cost realism analysis must be performed by the agency awarding the contract to determine the extent to which an offeror's proposed costs represent what the contract costs are likely to be under the offeror's technical approach, assuming reasonable economy and efficiency (see FAR 15.305(a)(1), and (2).

A cost realism analysis is the process of independently reviewing and evaluating specific elements of each offeror's cost estimate to determine whether the estimated proposed cost elements are realistic for the work to be performed, reflect a clear understanding of the requirements, and are consistent with the unique methods of performance and materials described in the offeror's proposal (see FAR 15.404-1(d)(1)).

The Government will adjust an offeror's proposed costs when appropriate based on the results of the cost realism analysis (see FAR 15.404-1(d)(2)(ii)). Herein lies the basis for many bid protests. Sometimes, the Government will increase the estimated cost of an offeror's bid, sending it out of the competitive range. Appeals to the GAO (Government Accountability Office) usually question the propriety of the Government's adjustments by maintaining they were inappropriate, undocumented, or fundamentally changed the proposed technical approach. Most of the time, these appeals are unsuccessful. Because, FAR requires the Government to conduct cost realism reviews and adjust proposed prices if necessary, the GAO limits is review to determining whether the cost analysis was reasonably based and not arbitrary.

For more information on cost realism reviews, see our previous posts on the subject.

Monday, October 3, 2011

Commercial Items - Part III

In our previous two posts on this subject, we described the Government's penchant for buying goods and services commercially and provided a bit of regulatory guidance on what does and does not constitute commercial items and commercial practices. As we conclude this short series today, we will be discussing some general policies and practices the Government uses to make those purchases.

The basic policies and procedures are contained in FAR Part 12. Most agencies have supplemental regulations. For DoD, its DFARS 212. Additionally, each agency has specific policies and procedures that implement the regulations. For DoD, its PGI 212 (Procedures, Guidance, and Instructions). Fundamentally, commercial item policies and procedures rely heavily on the education, training, and professional expertise of Government acquisition personnel. Government acquisition personnel are trained and instructed to use flexibility and exercise sound business judgment in its interpretations and application of policies and procedures.

The decision to use a commercial item to meet the Government's requirements for a specific acquisition is based on market research and an analysis of the marketplace. Contracting officers must ensure that the contract files fully and adequately document the market research and rationale supporting a conclusion that the commercial item definition (described in Part I) has been satisfied. Failure to do so risks having awards overturned if losing bidders appeal to the GAO (Government Accountability Office).  Under DoD rules, commercial items over $1 million must have a written determination that the item(s) satisfy the commercial item definition.

While the documentation requirements on contracting officers are extensive, they are even more cumbersome  for determinations involving modifications of a type customarily available in the commercial marketplace and items offered, but not yet sold, leased, or licensed to the general public. In these situations the documentation must clearly detail the particulars of the modifications and sales offers. When such items lack sufficient market pricing information, contracting officers must support determinations that prices are fair and reasonable by other means. The fact that a price is included in a catalog does not necessarily mean that it is fair and reasonable.

If the contracting officer cannot determine whether an offered price is fair and reasonable, even after obtaining additional information from sources other than the offeror, the contracting officer must require the offeror to submit information other than cost or pricing data to support further analysis. In extreme cases, when "other than cost or pricing data" is still not adequate to support the reasonableness of the offered price, certified cost or pricing data may be required.

Contractors who desire to sell commercially, should be prepared to assist the contracting officer in his/her documentation efforts.