Why Can't Contractors Perform Their Own Incurred Cost Audits?

There has been a lot of discussion lately about the state of incurred cost audits and more specifically, DCAA's (Defense Contract Audit Agency) ability to complete them in a timely manner. DCAA for its part, is subject to the unpredictability of Federal budgets, hiring freezes, and attracting qualified workers. In recent Congressional testimony, the DCAA Director worried that recent gains in reducing the backlog of incurred cost audits could evaporate because of hiring freeze imposed on them by the current administration. Recently we've been discussing proposed legislation that would require the Department of Defense to outsource at least 25 percent of incurred cost audits.

But is there another way of getting these audits completed in a timely manner? Perhaps there is. What if contractors were contractually required to perform their own incurred cost audits? Now that sounds like an idea fraught with problems, like letting the fox guard the hen house, right? But wait. The Department of Energy is requiring just that on a cost-type contract worth $900 million per year.

Since 1965, Battelle Memorial Institute (Battelle) has operated the Pacific Northwest National Laboratory under contract with the Department of Energy. This lab performs research and innovations in the areas of environmental protection and clean up, energy resources, and national security.

Battelle is required by it contract to "audit" costs expended under the contract to ensure that only allowable costs are claimed - costs that are reasonable, allocable, and allowable in accordance with the terms of the contract, applicable cost principles, laws, and regulations. To accomplish this, Battelle is required to have an internal audit function. The contract requires the following.

The contractor agrees to design and maintain an internal audit plan and an internal audit organization. The contractor must submit to the contracting officer for approval an internal audit implementation design to include the overall strategy for internal audits. The audit implementation design must describe ... the overall internal audit strategy of this contract, considering particularly the method of auditing costs incurred in the performance of the contract.

Is it working? It seems to be working just fine. The Department of Energy's Office of Inspector General (OIG) recently completed an audit to determine whether Battelle's internal auditors were doing an adequate job of assessing the propriety of incurred costs claimed under the contract. The OIG concluded the following:

Based on our assessment, nothing came to our attention to indicate that the allowable cost related audit work performed by Battelle's Internal Audit ... could not be relied upon. We did not identify any material internal control weaknesses with cost allowability audits, which generally met the Institute of Internal Auditors International Standards for the Professional Practice of Internal Auditing (IIA Standards). During its FYs 2013 and 2014 audits of cost allowability, Internal Audit identified $375,983 in questioned costs, all of which had been resolved.

The IIA Standards referred to above are very similar to GAGAS standards.

So there you have it. Battelle's internal auditors reviewed incurred costs. DOE's IG reviewed what the internal auditors had done and found that the Department could rely on their work as a basis for accepting incurred costs. Its too bad that DCAA and DoD's OIG cannot engage in the same level of cooperative audit strategy.

We do not know how the cost of Battelle's internal audit of incurred cost compares to outsourcing or or reimbursing another Agency's contract auditors (e.g. DCAA) to audit incurred costs. Battelle's internal audit department is certainly not free to the Government - its costs are included in the $900 million per year that is reimbursed by the DOE.

Contractors Pay $125 Million to Settle Safety Concerns

A DOE (Department of Energy) contractor and its primary subcontractor have agreed to pay $125 million to settle allegations that they charged the Government for materials and work that did not meet standards required for nuclear facilities and used Government funds to pay for lobbying expenses. Bechtel National will pay $67.5 million and AECOM Energy and Construction Inc. will pay $57.5 million. AECOM, for its part, is a successor in interest to URS Energy and Construction Inc.and maintains that the events leading to the settlement occurred prior to its acquisition of URS. We wonder if this liability was reflected in the purchase price of URS.

This settlement resolved a qui tam suit (whistleblowwer suit) brought by three former contractor and Government employees. It had been sealed until last week when the Government decided to enjoin that action. When the Government jumped in, the contractors quickly moved to settle. The settlement is not an admission of guilt, it only resolves the issues. Nevertheless, $125 million is a hefty price and the whistleblowers (and their attorneys) will receive a cut of the proceeds, possibly as much as $31 million.

The case involved the construction of a vitrification plant on the Hanford nuclear reservation. The "vit" plan, which began construction in 2002 will process 56 million gallons of radioactive waste into a stable glass form for disposal. According to the lawsuit, Bechtel and URS did not comply with nuclear quality requirements. Examples included the use of grout not formulated to withstand high radiation levels, the acceptance of piping without the required harness to withstand a severe earthquake, and welds and duct work that could not be shown to meet nuclear quality requirements.

Allegations of lobbying effort paid with Government funds included money to pay a lobbyist in 2009 and 2010 to downplay the significance of technical concerns raised by the Defense Nuclear Facilities Safety Board and using funds to secure an extra $50 million in federal money when the company was fearful that the $50 million was in jeopardy because of safety concerns.

You can read the Justice Department's press release here. A local account from the Tri-City Herald can be found here.

Department of Energy Withdraws its Proposed "Business System" Rules

Back in 2014, not to be outdone by the Defense Department, the Department of Energy proposed its own Contractor Business System rules (see 79 FR 18415). These proposed rules were similar in scope to those being considered and ultimately adopted by DoD. They covered five of DoD's six business systems: accounting, estimating, purchasing, EVMS and property management. DOE's contractor business systems did not cover MMAS (Material Management & Accounting Systems), perhaps because DOE's contractors are not typically in the manufacturing business. The proposed rules included compliance enforcement mechanisms that would, like the DoD rules, allow contracting officers to withhold a percentage of payments when one or more of the business systems contained significant deficiencies.

Yesterday's Federal Register included the announcement that the Energy Department has withdrawn its proposed rules (see 81 FR 43971) . It gave no explanation for withdrawing the proposed rules other than a terse statement that read "... the Department has determined that it will not proceed with the rulemaking and, as such, is withdrawing the proposed rule.".

Perhaps DOE learned something from DoD's implementation problems. Although the rules exists, there are scarcely any audits being performed to determine the state of contractor compliance with those rules. DCAA (Defense Contract Audit Agency) is not making such audits a priority and some proposed rules a year or so ago that would require contractors to hire outside audit firms to perform the reviews (under DCAA supervision) was withdrawn as unworkable.

Notwithstanding the starts and stops, DoD has not given up on auditing contractor business systems. Tomorrow, we will discuss a provision in the FY 2017 NDAA (National Defense Authorization Act) that attempts to restore audit coverage of the six DoD contractors' business systems.

Energy Department Bans Overtime for Training

The Department of Energy (DOE) recently issued one of its Acquisition Letters concerning, this time, the allowability of overtime paid for training and education. See Acquisition Letter No. AL 2016-05 dated May 3, 2016, Subject: Determining if an activity is a FAR 31.205-44 training and education activity (and consequently rendering the overtime costs caused by the activity specifically unallowable); and Managing all overtime costs.

We've known about the long-simmering feud between the Department of Energy and some of its major contractors at various clean-up sites throughout the States over contractor overtime payments to employees for training and education purposes. DOE has now taken the step of formalizing its position in a policy that applies to all DOE contractors.

The policy letter itself is long, rambling, repetitious, confusing, and contradictory. But we'll try to explain it.

FAR 31.205-44(a) states that overtime cost incurred during training or education related to the field in which the employee is working or may reasonably be expected to work is unallowable. DOE calls this an "absolute" ban on overtime and compares it to the prohibition on costs of alcoholic beverages at FAR 31.205-51. But perhaps it's not an "absolute" prohibition because the Acquisition Letter then states that if training is a "side effect" of another activity, overtime is okay. Try that logic on alcoholic beverages (my beer was only a side effect of a legitimate business luncheon so it is allowable). Then DOE describes situations where it may be in the Government's best interest to pay overtime for training. If so, contractors can ask for pre-approval from the contracting officer. So, the prohibition doesn't seem to be absolute after all. If it were absolute, a contracting officer could not allow overtime for training under any circumstances. A contracting officer cannot make allowable, costs that are expressly unallowable.

Perhaps the most significant issue in this brouhaha the Acquisition Letter does not cover is training that is a condition of the contract. Some DOE contracts require contractors to maintain minimum certifications and their employees to maintain certain certifications and competencies. Contractors have sought to minimize production interruptions through the judicious use of overtime. The alternative, everyone acknowledges, is to hire additional staff to cover absences due to training, something that would increase costs to the Government. DOE's response to that argument has been ostrich-like.

Another argument contractors have raised is that the "training and education" required as a condition of a contract is not the same definition of "training and education" contemplated in the FAR 31.205-44 cost principle. We would defer to attorneys to argue that position but it does seem to have merit.

Fortunately, this DOE Acquisition Letter only applies to DOE contracts and then, only until it is challenged and tossed out.