Independent Audits of Contractor Business Systems - Part 2

Big changes may be coming in the way that the Government conducts oversight of its larger contractors. Yesterday we began a series on a proposed rule that will require DoD contractors to hire independent CPAs to conduct compliance reviews of three major business systems; estimating systems, accounting systems, and material management and accounting systems (MMAS). Heretofore, these audits have been conducted, albeit irregularly, by the Defense Contract Audit Agency (DCAA) and/or the Defense Contract Management Agency (DCMA). One thing for certain, this proposal, if it is enacted in its current form, is certain to cost contractors a lot of money. Audits don't come cheap and the process imposed by the new rule, where Government auditors must review planning documents and risk assessments before independent audits can proceed, will certainly impede efficiency and further increase costs to the contractor. And, there is no certainty that these costs can be allocated exclusively to Government contracts. Most likely, the Government will argue that these costs be allocated over a contractor's G&A base.

The stated purpose of this new regulations is to improve efficiency and effectiveness of audit:

To improve the efficiency and effectiveness of auditing contractor business systems, DoD is proposing to amend the DFARS (DoD FAR Supplement) to entrust contractors with the capability to demonstrate compliance with DFARS system criteria for contractors' accounting systems, estimating systems, and material management and accounting systems, based on contractors' self-evaluations and audits b y independent Certified Public Accountants (CPAs) of their choosing. Government auditors will perform overviews of the results of contractor self-evaluations and CPA audits.

The applicability of the standards are not changed. Contractors subject to the business system criteria now will still be subject to those standards under the new regulations. For example, contractors, other than small businesses are subject to the estimating system disclosure and maintenance if they received $50 million in (certified cost or pricing data) DoD prime contracts and subcontracts the previous year. That threshold drops to $10 million if the contracting officer determines it to be in the best interest of the Government.

What does change are added requirements for annual reporting and triennial CPA audits.

Annual reporting. Each year, within six months after the end of the contractor's fiscal year, the contractor must provide the contracting officer and the Government auditor, a report regarding compliance with the system criteria. The report is to be signed by an individual at a level no lower than VP or CFO. The report for each of the three business systems covered by this proposed regulation varies slightly in content depending on the system covered. For estimating systems, the report must include:

1. a statement that the contractor has evaluated the estimating system's compliance with the system criteria contained in the DFARS.
2. the contractor's assessment of the estimating system's compliance with the system criteria, including a statement as to whether or not the system complies in all material respects, and disclosure of any significant deficiencies with sufficient information for the Government to understand the deficiencies; and
3. the status of any significant deficiencies disclosed as part of the contractor's assessment, or, if applicable, in the CPA's triennial audit. This mus include a corrective action plan with milestones and actions to eliminate any significant deficiencies that have not bee corrected as of the date of the report.

Click here for Part 3 of this series where we discuss the triennial CPA audit requirements.