Tuesday, February 10, 2015

Incurred Cost Audit Coverage at Department of Energy Contractors

Last week, the Department of Energy (DOE) Office of Inspector General (IG) issued a special report on the state of contract auditing at many of its contractors. The report describes how at one time, DCAA (Defense Contract Audit Agency) performed most of the required audits of incurred costs for Energy but for the past several years, DCAA has been unable to perform its audits on a timely basis. As a result, the backlog of audits of contracts and subcontracts has reached "billions of dollars". To illustrate, the IG reported that of the 16 largest DOE contractors, seven had never had an incurred cost audit, six were behind by more than four years and only three were relatively current with incurred cost audits covering 2012 or later. The report noted that:
DCAA has been unable to meet the ... contract audit needs of the Department and has asserted that it simply does not have the resources to meet all Department of Defense and civilian agency audit requests. As it pertains to the Department, this situation was exacerbated by the fact that the Department lacked a comprehensive strategy to ensure that ... contractor costs were subjected to necessary audits. Instead, the Department employed alternative means for conducting a portion of required audits. In several instances, (the Department) contracted with independent public accounting firms for these services. At least some effort to fill the void lefty by declining DCAA audit coverage had also been made by one large ... contractor that expanded its internal audit function to conduct audits of costs incurred. (One organization within the Department) had also explored the possibility of developing its own audit capability. While laudable, these efforts were not well coordinated, in some instances did not comploy with professional audit standards, and do not, in our judgment, close the significant gap in audit coverage for ... contractors.
 The IG report goes on to explain that given the billions of dollars committed to contracting, the intricacies of contractor accounting systems, and the inherent inability of Federal contracting/reviewing officials to gain complete transaction level knowledge of contractor operations, comprehensive periodic audits are critically important. Timely incurred cost audits are an essential part of the system of safeguards to identify internal control weaknesses and detect and prevent reimbursement of unallowable costs.

To put the situation into perspective, the IG reported that at contracts where there have been systematic reviews of incurred costs (22 contractors), questioned costs as a result of those reviews have totaled $1.1 billion. It is important to note that "questioned costs" is not the same as "sustained questioned costs". Just because costs are questioned, doesn't mean that those costs are unallowable under FAR cost principles or contract terms. It could be that the auditors couldn't satisfy themselves through audit means as to the propriety of claimed costs. It is just as likely that questioned costs are ultimately settled in the contractor's favor as it is that they are settled in the Government's favor.

DCAA wants it job back

Because of DCAA's inability to provide timely audits, DOE has begun to rely upon outside CPA firms to conduct its audits. However, as the report explains, these options for supplementing DCAA audit coverage "are not inexpensive". DCAA audit coverage is not inexpensive either but probably much more cost effective than outsourcing. The report states that DCAA wants to continue providing audit support to DOE and will work with the Department to develop a viable solution to reduce the backlog. DOE doesn't necessarily believe that bringing DCAA back into the fold is a short term solution. "DCAA's ling-term intentions notwithstanding, it does not appear that any resolution of this problem is likely for a number of years.

DOE has initiated discussions with DCAA to implement a strategy for reducing the backlog of unaudited incurred costs. However, no one is confident that whatever plan they come up with will quickly and efficiently reduce the backlog of unaudited contractor incurred costs. In recognition of DCAA's inability to fulfill DOE requirements, the IG has recommended that the Department develop a comprehensive strategy to ensure necessary audit coverage until such time as DCAA can catch up.

DOE management supports the idea however they are cautious to assume any significant changes to the way DCAA operates.
We fundamentally agree with the report's recommendations ... however it is important to recognize that whatever good intentions DCAA has, its track record makes it prudent to avoid assuming a marked change in DCAA's support.
The IG report is available for downloading and reading here.

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