Penalties on Unallowable Costs - Part V

Today we will conclude our series on penalties on unallowable costs by with one last look at the guidance that DCAA (Defense Contract Audit Agency) has given its auditors for computing penalties and interest on unallowable costs. If you missed the previous segments, read them here: Part I, Part II, Part III, and Part IV. Most of this information can be found in more detail in DCAA's Contract Audit Manual (DCAM) Section 6-609.

Contract clause. Auditors are directed to request that contractors identify all contracts that contain the "penalty clause" (i.e. FAR 52.242-3). Usually this information is contained on Schedule I of the Annual Incurred Cost proposal required by FAR 52.216-7. However, DCAA points out that the absence of the penalty clause in a contract does not prevent the Government from assessing the penalty. "A contractor is bound by the required clause even though the clause is inadvertently omitted, because the statutes make it a mandatory clause." Some clauses are required by Statute and some by regulation. Those that are required by statute, apply even if they have been inadvertently omitted. This is the substance of the so-called Christian Doctrine.

Reporting requirements. The amount of detail required in an audit report to identify, support, and calculate penalties is rather extensive and time consuming for the auditor. Although the auditor has no authority to waive penalties, when it is clear that the penalties will be less than $10 thousand (requiring the contracting officer to waive them), there is a greatly truncated version of the information required in the audit report.

Statistical Sampling. Often times, auditors will utilize statistical sampling techniques to sample transactions and project the results to a larger population. Audit guidance requires that the portion of the sample subject to penalty shall be projected to determined the total recommended costs subject to penalty. Any such projections made by the auditor should be closely scrutinized by contractors as DCAA's track record in applying statistical sampling techniques has been less than stellar.

Final comments

Just because an auditor identifies an unallowable cost as "expressly unallowable" does not make it so. Often times, judgment is required and auditors will err on the aggressive side. Additionally, the Agency is not always correct in identifying what is and is not expressly unallowable. Consider recently where DCAA directed its auditors to classify medical payments/insurance for "unauthorized" dependents as expressly unallowable. It was only after DoD stepped in and told them that such a position was nonsense that DCAA had to revise its guidance.

The auditors' calculations of penalties and interest should be an iterative process where both parties finally agree on the numbers. The parties don't need to agree on the substance, but the impact should be factual. Auditors are going to need help to make accurate calculations, especially in determining interest. Contractors should help them as much as possible, thereby preventing subsequent and avoidable arguments.


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Read our complete series on penalties for unallowable costs by following these links.
Part I - Regulatory Authority
Part II - Levels I and II Penalties, and interest
Part III - Waivers
Part IV - Calculating
Part V - Audit Guidance