Here's a "heads-up" for Government contractors that are about to go through an incurred cost audit by DCAA (Defense Contract Audit Agency) or another contract audit organization. The auditors will probably be asking for copies of the 1099s you issued.
As we've reported on these pages a number of times, the Government considers consulting costs to be a high risk audit area. The sensitivity of this area hearkens back to the 80s when several major contractors were caught up in scandals involving consulting costs and other were hard-pressed to demonstrate allocability of many consultant costs to Government contracts. This sensitivity resulted in a revision to the FAR cost principle governing consultant cost allowability (FAR 31.205-33) by adding a "minimal support" requirement. Whereas formerly the principle required "evidence of the nature and scope of the service furnished", the revised principle specifically required details of agreements, invoices, and work products.
Auditors, being the clever people that they are, have been using these requirements ever since to question any consulting costs that are not supported by the three-legged support test. And for many years, this are represented "easy-pickens'" as contractors worked to improve their internal control systems over the sufficiency of supporting data. It remains a lucrative area for questioned costs even today. The backlog of incurred cost audits are problematic in many ways for contractors (e.g. delayed payments). One issue facing contractors is employee turnover, upgraded accounting systems, and record retention. Although contractors may have been able to provide adequate support when the costs were booked, i.e. in 2005 and 2006 and 2007, it is always more difficult to find today. You can almost be certain that any audit will include testing of consultant costs.
Auditors will typically ask contractors for a listing of consulting costs, either as part of an initial data request or perhaps during the "walk-through". Now, auditors are being instructed to compare the consultant listing provided by contractors to the 1099s issued during the year and look for discrepancies. Specifically, the instructions read:
Obtain vendor listing and 1099-Misc. (block 7) forms and review for possible consultants not included on the listing provided by the contractor.That's actually not a bad audit step and one that contractors can do themselves prior to the auditors' arrival to insure the completeness of any consultant listing provided the Government.