Who's Watching the Purse? Turns Out No One Is

NASA spent $15.6 billion in fiscal year 2013, more than half of that on cost-type contracts. Cost-type contracts pose a financial risk to NASA (and the Government, and the taxpayer) because they do not promise delivery of goods and services at set prices. To mitigate the risk associated with the use of cost-type contract, FAR requires contractors to submit annual incurred cost submissions. These submissions are then audited (or should be audited) to assess whether costs are properly applied to contracts, sufficiently supported, and allowable.

NASA (and all Government agencies) generally has six years to recover any unallowable costs from the date an adequate incurred cost proposal is submitted. Heretofore, the Defense Contract Audit Agency (DCAA) has been performing the incurred cost audits under a reimbursable agreement. According to NASA estimates, there are 1,153 incurred cost proposals waiting to be audited, 39 percent of which predate 2009.

Yesterday, the NASA Office of Inspector General (NASA-IG) issued a report on an audit intended to assess whether NASA had adequate procedures to ensure that costs passed on to the Agency are supportable, allowable, reasonable, and allocable. The report disclosed that NASA is at increased risk of paying unallowable, unreasonable, and unallocable incurred costs and of losing the opportunity to recoup improper costs because NASA contracting officer rely too heavily on DCAA's incurred cost audit process. Under DCAA's new risk-based methodology, DCAA has significantly decreased the number of contractor proposals it audits in an effort to reduce its six-year backlog of incurred cost proposals awaiting review.

The NASA-IG determined that NASA had not strengthened its internal controls to account for the significant reduction in DCAA oversight of NASA cost-type contracts. The IG also concluded that NASA's reliance on DCAA is inhibiting the Agency's efforts to timely close out contracts.

To remedy these deficiencies, the IG recommended that NASA revise its FAR Supplement to allow independent public accounting firms to provide supplemental audit coverage for NASA contracts where DCAA cannot be responsive to NASA's need for an audit. This change would be consistent with what other Agencies have done recently - i.e. rely on independent CPA firms to perform incurred cost audits. NASA agreed with the recommendation and provided a plan to revise the NASA FAR Supplement so as to allow outside firms to supplement DCAA audits.

It seems that not every Agency is enamored with DCAA's new risk-based approach to auditing - an approach that pretty much ignores any proposal under $5 million. That high of a threshold is too much in the eyes of some for protecting the Government's interests. This new plan of NASA's heralds yet more diminution of DCAA's workload and influence in the contract audit environment.

GAO Report on DoD Initiative to Reduce Audit Backlog

The GAO (Government Accountability Office) issued a report yesterday to the Senate Committee on Armed Services that looked at DoD's initiative to address the backlog of incurred cost audits and closing out old contracts. The entire report can be found here.

To reduce the backlog of incurred cost audits, DCAA implemented an initiative to focus its resources on auditing incurred cost proposals that involve high dollar values or are otherwise determined to be high risk. Under this initiative,

• DCAA raised the dollar threshold that triggers an automatic audit on a contractor's incurred cost proposal from $15 million to $250 million, 
• revised the criteria used to determine a proposal's risk level and 
• significantly reduced the number of low risk audits that will be randomly sampled.

Go here to read more about the new DCAA policy for incurred cost audits

The GAO reported that DCAA's new initiative "appears promising" but DCAA has not developed measures by which it will assess whether the initiative reduces the backlog in a manner that protects the taxpayers' interests. Specifically, the GAO found that DCAA does not have a plan for how it will determine whether key features of the initiative, such as the revised risk criteria and the revised sampling percentages, should be adjusted in the future.

Already, the number of proposals determined to be high risk is 250% higher than anticipated. That means more audits and more audits is going to jeopardized DCAA's ability to eliminate the incurred cost backlog by 2016.

Reducing the backlog of incurred cost audits will ease one obstacle to closing old contracts. The Army recently announced a goal of closing over 475 thousand contracts by September 2014. Unless it can quick-close some of those, it will need DCAA's audits to achieve that goal. The GAO report was somewhat critical of the Navy and Air Force for not establishing similar goals.

Incurred Cost Proposals - Inadequacy Letters from DCAA

Recently, DCAA offices from around the U.S. that have been assigned the responsibility for clearing out the backlog of incurred cost proposals (ICPs), have been making assessments as to the proposals' adequacy. In many cases, the auditors have identified one or more deficiency and have returned the proposal to the contractor with a punch list of items requiring correction. Here in the Seattle area, DCAA brought the auditors together for what they termed a "get it done" day to review the adequacy of contractor ICPs that have been stacking up. Following are a few comments and observations.

1. Extensions of the requested due date for revising your ICP is usually obtainable. For convenience sake, requests should be addressed to the contracting officer with a copy to the cognizant auditor (see FAR 52.216-7(d)(2)(i)).
2. Most of DCAA's required corrections are understandable to accountants with contract costing experience. However, sometimes, DCAA rationale for calling something a deficiency is not clear at all. Do not hesitate to call the DCAA point of contact  for clarification. Sometimes they are helpful but they can only provide limited explanations before they cross the line and impair their independence. That's where firms like PNWC and other government contracting consulting groups can be helpful. 
3. One common misconception among contractors is to assume the ICP audit is over once DCAA accepts the ICP as meeting the requirements of an adequate submission. This is incorrect. DCAA uses a two-step approach that culminates in a rate agreement letter. The first step is to test the ICP to determine if it is likely to be adequately prepared. The second step is to perform an audit or a review, based on risk assessment. This second step could range from simple "desk" procedures to a full audit. Although the Government reserves the right to subsequently review and question direct costs, it is very rare for them to re-visit or re-audit your claimed incurred costs once both you and DCAA have signed the rate agreement letter. 
4. Sometimes the basis for inadequate claims are without merit. FAR 52.216-7(d)(2)(iii) lays out the data that constitutes an adequate claim; 15 items (and not all of those 15 items will be applicable). If it is not on that list, it cannot be used by DCAA or anyone else to claim that a proposal is inadequate. We saw one letter from DCAA last week claiming that a proposal was inadequate because the contractor did not provide copies of its IRS Forms 941. Those forms are not on the listing of data necessary for an adequate claim.

If you've received one of these letters and would like to talk to someone about it, contact David Koeltzow ("Kelso") at 866-849-4887, extension 6.

Incurred Costs and Statute of Limitations

Yesterday we discussed a six-year statute of limitations provision that may or may not be applicable to incurred cost audits. This was based on news accounts of DCAA's growing backlog of incurred cost audits and the concern that the statute of limitation will kick in and the Government will be precluded from recovering any unallowable costs that it finds. Since then, we've dug a little deeper into this subject. Here's what we found.

The six-year statute of limitations was a provision included in the Federal Acquisition Streamlining Act of 1994. It requires each claim by a contractor against the Federal Government relating to a contract and each claim by the Federal Government against a contractor relating to a contract shall be submitted within six years after the accrual of the claim. It works both ways, Government against the contractor and contractor against the Government.

FAR 33.201 defines the "accrual of the claim" as

The date when all events, that fix the alleged liability of either the Government or the contractor and permit assertion of the claim, were known or should have been known. For liability to be fixed, some injury must have occurred. However, monetary damages need not have been incurred.

So, what does this mean in the context of indirect rate proposals? We think that it means that the Government's claim to disallow indirect costs "accrues" when a contractor first claims and the Government reimburses the unallowable cost and the contractor submits its final indirect cost rate proposal for the fiscal year in which the cost was first incurred.

Here's an example. Let's say that a contractor submitted its 2005 incurred cost proposal in a timely manner on June 30, 2006. The final rates were higher than the billing rates so in July 2006, the contractor adjusted billings for 2005 to reflect the final rates. The Government reimbursed the contractor for the higher rates in August 2006. The statute of limitations clock starts ticking on August 2006. That means the Government must assert any claims related to the 2005 indirect costs by August 2012.

Contractors with unaudited incurred cost submissions from 2005 and prior (there are definitely some contractors in that category) should discuss statute of limitations concerns with the auditor to avoid spending a lot of unnecessary time to support an audit engagement.

This statute does not prevent DCAA from performing an audit. It simply provides that any findings on the auditor's part, cannot be pursued as a claim against the contractor.

Caveat - this is not legal advice. If you believe it may apply to your situation, we suggest you consult legal counsel.

Statute of Limitations on Incurred Costs?

Those who follow the Government contracting industry are no doubt aware that DCAA (Defense Contract Audit Agency) is significantly lagging in its audit production. There were some revelations last week that helped put some of this in perspective. POGO (Project on Government Oversight) followed by a number of other news organizations reported that the backlog of incurred cost dollars waiting to be audited now sits at $560 billion. the Commission on Wartime Contracting estimated this backlog will approach $1 trillion by fiscal year 2016.


DCAA has a five-year plan to address this deficiency. By the end of fiscal year 2016, it plans to have the backlog all but eliminated. However, judging from comments by current and former DCAA auditors, DCAA will need to drastically change the way in which it conducts audits if that goal is ever to be achieved. They believe that given the existing culture, the audit programs and procedures, the inordinate number of supervisory/managerial reviews, and the unrealistic demand for perfection, will conspire against the Agency ever achieving that goal.


There were some intriguing comments pertaining to a statute of limitations in the various news articles on this subject. According to the POGO source:

If DCAA audits occur more than six  years after a cost has been incurred and paid, the government may lack a basis for disallowing the costs even if it should not have been paid.

DCAA is evidently aware of this statute of limitations because the same article quoted a DCAA spokesperson saying that DCAA does not agree with the interpretation:

DCAA disputes this definition of the six-year limitation. In some cases, the exact nature of the charges cannot be determined until DCAA examines the underlying records.

There must be something to this six-year limitation because this same DCAA spokesperson adds:

DCAA is prioritizing the oldest audits to reduce the chances of exceeding the limitation.

If you've got incurred cost submissions pushing this six-year mark, it might be beneficial to consult with legal counsel to determine the propriety of DCAA performing an audit on costs for those years.

Adequacy Checklist for Incurred Cost Proposals

Yesterday we mentioned that DCAA (Defense Contract Audit Agency) recently revised its adequacy checklist for incurred cost proposals. It represents a major rewrite of the previous adequacy checklists (there have been several over the years). This one is organized so that it closely corresponds to the requirements of FAR 52.216-7. However, in some cases, the checklist requirements go beyond the FAR requirements.

For example, FAR 52.216-7 requires a schedule that shows claimed G&A (General and Administrative) expenses by element of cost as identified in accounting records. DCAA takes this requirement much further by requiring explanatory notes for any adjustments from booked expenses. Now the auditor will certainly need to have this information in order to conduct his/her audit. Its a valid inquiry. However, the contract clause simply does not require the information as part of an adequate claim. There are several other checklist items that require information or analyses beyond what FAR requires.

We would advise contractors to provide the information identified in the checklist. Its a "provide it now or provide it later" situation. It will expedite things to provide it now and not face the prospect of having your incurred cost proposal returned as inadequate.

As you review the checklist, if you have any questions about the propriety of a checklist item or just want clarification, call us or drop us an email.

Are You High Risk or Low Risk?

DCAA has a method for determining whether contractors' annual incurred cost proposals (sometimes called ICE) are high risk or low risk.

Low risk proposals are grouped together and a few are selected for audit based on statistical sampling. Assuming no audit issues are disclosed, the proposals not sampled are simply closed with no further work. DCAA will send contractors a rate agreement letter for signature and the process is complete.

High risk proposals are subjected to a full audit.

Once a proposal has been determined to be "adequate", the Government will proceed to classify it as high risk or low. DCAA has a new checklist for determining whether a submission is adequate. We will discuss that in a subsequent post.

The criteria for determining whether an annual incurred cost proposal is low risk include the following:

1. Is it less than than $ 15 million? In other words, did the contractor incur less than $15 million on Government flexibly priced contracts?
2. Are there audit leads or other significant risk identified (e.g. any known business system deficiencies that would have a significant impact on the final indirect rate proposal for this fiscal year, significant risk identified by the contracting officer, etc.)?
3. Is this a new “incurred costs” contractor? (i.e., a contractor where DCAA has no incurred cost audit experience).
4. Were there significant questioned costs in the prior year’s audit? Significance is defined as $15 thousand for proposals under $1 million and $25 thousand for proposals under $15 million.

An answer of  "yes" to any one of the four questions sends the proposal to the high risk pool and subject to full audit.

Multi-Year Auditing

The Defense Contract Audit Agency (DCAA) is carrying a tremendous backlog of incurred cost proposals that require auditing. It has prioritized these audits in fiscal year 2012. Now that fiscal year 2012 is half way over and DCAA has not made significant progress in reducing the backlog, it will no doubt become a priority for next fiscal year as well.

One of the techniques that DCAA will be using to help reduce the backlog is to conduct multi-year audits. Under the multi-year audit concept, auditors can review from two to five years simultaneously. Savings are achieved by having to prepare a single set of working papers and issue a single audit report. They hope to gain other efficiencies as well but the Agency admits that it is not sure whether additional efficiencies and effectiveness are achievable.

Although multi-year auditing is not new to DCAA, it is now being aggressively encouraged. DCAA introduced new procedures for conducting the audits in guidance issued last month. For starters, multi-year auditing does not apply to contractors with more than $250 million charged to flexibly priced contracts. Second, before entertaining the idea, auditors need to determine and document that the contractor's business and organization structure for the years being audited has been relatively stable and consistent.

Transaction testing must cover all years. The auditor cannot look at transactions in one year and apply the results to other years. However, the auditor can choose to use random sampling, judgmental sampling or a combination as long as they can document that the selection results in adequate audit coverage.

If you company is chosen for a multi-year audit, we would like to hear of your experiences.

On Getting Paid for Work Performed

Ever have one of those days when you just want to smash your head against the wall. We have.

Obtaining Indirect Cost Proposals - Part 2

Yesterday, we discussed the Government's process for obtaining annual incurred cost proposals. It starts with a reminder before the due date and progresses to a recommendation to the contracting officer to make a unilateral determination of rates.

The contract auditor does not have the authority to make unilateral determination of rates. The auditor's role in this process is to make recommendations to the contracting officer that will preclude reimbursement of potentially unallowable costs.

Sometimes its very difficult for the auditor to conjure up rates. The auditor has to look to  a variety of sources of information and data and make a best guess.

When recent relevant historical data exists, the auditor can develop recommended rates based on that history. Recent relevant data exists when all the following criteria are met:

• The prior fiscal year has been audited
• All contractor submissions received have been audited and settled.
• The indirect cost pool and base data for the subject fiscal year is readily available in the contractor books and records
• There have been no significant changes in the contractor's business base between last year and this year.
• There has been no significant reorganization of the contractor between last year and this year
• There have been no changes in the indirect cost rate structure between last year and this year.

When recent relevant historical data does not exists, things get brutal. The auditor will recommend a 20 percent decrement to total contract costs (both direct and indirect).

Keep in mind that these are only auditor recommendations and the contracting officer is free to accept, modify, or reject the recommendations. There is usually significant reluctance on the part of the contracting officer to invoke unilateral rates due mostly to the fact that it significantly increases everyone's workload with little, if any, benefit. Once the contractor submits its incurred cost proposal, the Government will have to pay it all back anyway.

There is one other downside for contractors who do not submit their incurred cost submissions in a timely manner. They could have their authority to "direct bill" removed, thereby increasing the length of time for getting paid.

Obtaining Indirect Cost Proposals

Contractors with flexibly priced contracts (e.g. CPFF, CPIF, T&M, etc) are required by FAR 52.216-7 to submit annual incurred cost proposals within six months of the close of their fiscal years. Contracting officers may grant extensions for "exceptional circumstances" but has historically been reluctant to grant extensions. Although its the contracting officer who has the responsibility to obtain these annual submissions, DCAA (Defense Contract Audit Agency) has taken the lead in obtaining them and in determining whether the proposals are adequate.

The process goes something like this:

1. Three months after the end of the contractor's fiscal year, the auditor will remind the contractor of its contractual responsibility to submit an indirect cost rate proposal.
2. When a contractor submission is 30 days overdue (i.e. seven months after the fiscal year end) the auditor will notify the contractor that its submission is past due.
3. When a contractor submission is three months overdue (i.e. nine months after the fiscal year end), the auditor will request the contracting officers assistance in obtaining the submission.
4. When a contractor submission is five months overdue, the auditor will notify the contractor that its submission is past due and advise the contractor that it will unilaterally establish indirect rates.
5. When a contractor submission is six months or more overdue, the auditor will recommend the contracting officer unilaterally establish indirect cost rates. The auditor will provide the contracting officer its recommendation on what those rates should be.

Tomorrow, we will discuss how the auditor (namely DCAA) develops "unilateral" rates.

DCAA's Goal to Work Off Incurred Cost Audit Backlog

Although we have not seen anything official, we have heard from a number of sources that DCAA' (Defense Contract Audit Agency) is prioritizing incurred cost audits in Fiscal Year 2012. As many contractors can attest to, the Agency has virtually ignored incurred cost audits at smaller contractors for several years and the backlog has grown accordingly. Many contractors are owed significant sums of money for completed contracts but cannot bill for those costs until the incurred cost audits are completed. DCMA could authorize payment without audit but has been unwilling to do so.

Recently, many contractors have been receiving correspondence from DCAA asking for additional data prior to starting the incurred cost audits. These letters vary according to Region and Field Audit Office but here is a composite of data requests from several of these letters.

1. Comparative analysis of indirect expense pools with prior years
2. Executive compensation information for top five executives
3. List of ACOs and PCOs for each flexibly priced contract
4. Identification of and information on prime contracts under which the contractor performs flexibly priced effort as a subcontractor.
5. List of work sites and the number of employees assigned to each site.
6. Description of accounting system.
7. Procedures for identifying and handling unallowable costs.
8. Certified financial statements or other financial data
9. Management letter from outside CPAs concerning any internal control weaknesses
10. Actions that have been and/or will be implemented to correct the weaknesses described above
11. List of internal audit reports issued in the fiscal year
12. Annual internal audit plan of scheduled audits to be performed in this fiscal year
13. Federal and state income tax returns
14. SEC 10-K report
15. Minutes from Board of Directors meetings
16. Listing of delay and disruption and termination claims submitted which contain costs relating to this fiscal year.
17. Contract briefs

Of course, not all of these items will be applicable to most contractors. If you receive one of these letters and you have reservations about one or more of the items requested, you might seek advice from counsel. At a minimum, you should ask the auditor for his/her authority for requesting a particular item, if not obvious. For example, some companies have refused to provide board of directors meetings as there is no clear nexus between those minutes and costs charged to Government contracts. Other contractors have allowed auditors to review the minutes but not take copies.

Many of these items are documents that the auditor will be requesting during the audit. To that extent, providing them ahead of time might facilitate the audit once it begins. We don't recommend that contractors spend a lot of time creating data. For example, there is no contractual requirement for contractors to prepare a comparative analysis of indirect expense pools with prior years. If a contractor has that information readily available, it should be no problems to provide it. On the other hand, if the data is not readily available, let the auditor perform the analysis - its their job.

Updated Checklist for Determining Adequacy of Incurred Cost Proposal

DCAA (Defense Contract Audit Agency) recently updated its checklist for determining the adequacy of contractors' annual incurred cost proposals. This represents a major and more comprehensive update to the previous checklist and the first revision since FAR 52.216-7 was revised last June. That particular FAR revision was the first time that "adequacy" was defined in Regulations.

It will be interesting to see how auditors use this checklist to determine adequacy. Although the checklist cautions auditors to use "professional judgment in determining whether any specific missing/inadequate data or combination of missing/inadequate data is sufficient enough to warrant the submission as inadequate", there are many elements of the checklist that are not required by regulation. For example, checklist item E concerning indirect cost allocation bases (first bullet) states "Ensure an explanation of each base is included." The Regulation does not require "explanations" of bases and pools in order for an incurred cost proposal to be considered adequate. Or item M concerning decisions, agreements, approvals, and descriptions of accounting/organizational changes, the checklist states that contractors are required to provide a negative response if not applicable. The Regulations however, make no such requirement.

All things considered however, contractors preparing annual incurred cost proposals would do well to use this revised checklist to perform its own self-assessment prior to submission. It should help reduce the number of instances proposals are returned as inadequate.

Incurred Cost Proposal Adequacy

Contractors' annual incurred cost proposals are to be completed and sent to the contracting officer and cognizant audit agency (usually DCAA) within six months of the end of the fiscal year. When those proposals arrive, the audit agency conducts an adequacy review. DCAA has an "offical" checklist for performing adequacy reviews of incurred cost proposals. The latest version can be found here. The checklist is pretty straight forward and essentially verifies that the "mandatory" schedules (but not the optional schedules) have been included in contractor submissions.

We've noticed and certainly many of you have noticed that adequacy reviews have become much more extensive and detailed than the steps indicated on the checklist. These added steps vary by field office. Some offices are requiring contractors to send in specific data to support information in the various schedules. For example, it is common now for DCAA to request copies of the IRS Forms 941 used to prepare Schedule L, Reconciliation of Total Payroll to Total Payroll Distribution. Additionally, many offices are requesting copies of the trial balance, presumably to see if amounts in pools and bases trace back to the accounting system. By the way, we strongly recommend against providing trial balances since it includes information to which audit agencies have no statutory rights of access - like revenues.

If you feel you're being asked to provide more data than you should, or an auditors request seems unreasonable, pull out this checklist and ask the auditor to refer you to the specific adequacy step he/she is trying to accomplish.

Annual Incurred Cost Submissions - Adequacy

Effective June 30, 2011, the FAR Councils modified the requirements for the annual incurred cost proposal required under FAR 52.216-7, Allowable Costs and Payments. Up until now, FAR required contractors to submit a certified incurred cost submission within six months of fiscal year end (e.g. June 30^th for calendar year contractors). These submissions are used by the Government to settle indirect rates, as well as other things. With this new change, the requirement was expanded to require an “adequate” certified incurred cost submission. The revised rule also defines what an “adequate” submission must contain.

To be considered “adequate”, the annual incurred cost submission must contain the following schedules (as applicable):

• Summary of all claimed indirect expense rates, including pool, base, and calculated indirect rate.
• General and Administrative expenses (final indirect cost pool). Schedule of claimed expenses by element of cost as identified in accounting records (Chart of Accounts).
• Overhead expenses (final indirect cost pool). Schedule of claimed expenses by element of cost as identified in accounting records (Chart of Accounts) for each final indirect cost pool.
• Occupancy expenses (intermediate indirect cost pool). Schedule of claimed expenses by element of cost as identified in accounting records (Chart of Accounts) and expense reallocation to final indirect cost pools.
• Claimed allocation bases, by element of cost, used to distribute indirect costs.
• Facilities capital cost of money factors computation.
• Reconciliation of books of account (i.e., General Ledger) and claimed direct costs by major cost element.
• Schedule of direct costs by contract and subcontract and indirect expense applied at claimed rates, as well as a subsidiary schedule of Government participation percentages in each of the allocation base amounts.
• Schedule of cumulative direct and indirect costs claimed and billed by contract and subcontract.
• Subcontract information. Listing of subcontracts awarded to companies for which the contractor is the prime or upper-tier contractor (include prime and subcontract numbers; subcontract value and award type; amount claimed during the fiscal year; and the subcontractor name, address, and point of contact information).
• Summary of each time-and-materials and labor-hour contract information, including labor categories, labor rates, hours, and amounts; direct materials; other direct costs; and, indirect expense applied at claimed rates.
• Reconciliation of total payroll per IRS form 941 to total labor costs distribution.
• Listing of decisions/agreements/approvals and description of accounting/organizational changes.
• Certificate of final indirect costs (see 52.242-4, Certification of Final Indirect Costs).
• Contract closing information for contracts physically completed in this fiscal year (include contract number, period of performance, contract ceiling amounts, contract fee computations, level of effort, and indicate if the contract is ready to close).

Essentially these schedules mirror what DCAA has been requiring for years. They mirror the form and substance of the model incurred cost submission found in DCAA Pamphlet 7641.90, Information for Contractors and the Excel based version of the pamphlet called ICE (Incurred Cost Electronically). Both the pamphlet and the Excel model are available on the DCAA website.

Most government contractors (with cost type contracts) are already well aware of the DCAA incurred cost process/models and will find it easy to comply with the new requirement. Although DCAA never had a regulatory basis to require contractors to follow their models, most contractors found it expedient to do so. With this new regulation, DCAA has the regulatory backing that they have been seeking.

DCAA’s incurred cost models are divided into “required” schedules and “optional” schedules. The optional schedules are listed in the new FAR definition as "not required" but "may be required during the audit process", leaving the decision to provide the optional schedules up to individual contractors. In our practice, we typically leave out the optional schedules. Most of the optional schedules are of little value to an audit and if the information does become necessary, the auditor can develop it during the audit.

After receipt of contractor incurred cost submissions, DCAA performs an “adequacy” review of the submission. It is only after the submission has passed an adequacy review that it gets thrown into the hopper for an eventual audit. During the adequacy review, DCAA typically requests additional documentation. Most often, DCAA requests the trial balance so that it can trace amounts in the submission to the accounting records and copies of the IRS Forms 941 so that it can compare labor cost books with labor costs reported to the IRS. (The labor reconciliation is a required schedule but the actual forms are not required).

New Rules Now in Effect for Payment of Fee

A significant change regarding the payment of fees (profit) to contractors became effective last week. The three contract clauses (FAR 52.216-8, -9, and -10) regulating how the Government will pay fees under CPFF and CPIF contracts now requires mandatory rather than discretionary withholds. Under the old rules, contracting officers had the discretion of withholding fee if he/she thought it was necessary to protect the Government's interests. For contractors awarded after June 30th, that contracting officer discretion is taken away in favor of mandatory withholds.

For example, FAR 52.216-8(b) formerly read as follows: 

(b) Payment of the fixed fee shall be made as specified in the Schedule; provided that after payment of 85 percent of the fixed fee, the Contracting Officer may withhold further payment of fee until a reserve is set aside in an amount that the Contracting Officer considers necessary to protect the Government’s interest. This reserve shall not exceed 15 percent of the total fixed fee or $100,000, whichever is less.

Effective June 30, 2011, FAR 52.216-8(b) now reads:

(b) Payment of the fixed fee shall be made as specified in the Schedule; provided that the Contracting Officer withholds a reserve not to exceed 15 percent of the total fixed fee or $100,000, whichever is less, to protect the Government's interest.

This change will likely have significant cash flow ramifications for many contractors.

The other significant change to this clause affects the timing for releasing a portion of the amount of fee withheld. Under the old clause, the contracting officer shall release 75 percent of the fee withholds after receipt of a certified final indirect cost rate proposal covering the year of physical completion of the contract. Under the new clause, the word "adequate" was added. We will discuss that change tomorrow.

Unilateral Determinations for Delinquent Incurred Cost Proposals

Over the past two days, we have been discussing the importance of submitting timely annual incurred cost proposals. We mentioned the inconsistencies within the Government in granting extensions, some contracting officers freely grant extensions while others do not. Our advice is that unless there is some mitigating circumstance, contractors should prioritize work to ensure timely submission. We also cautioned that the contracting officer, based on audit recommendations, is authorized by FAR to reduce billings for contractors who are late in submitting their incurred cost proposals.  Today we want to discuss how the Government determines the deepness of those cuts.

Contracting officers make their unilateral determinations based on advice from the contract auditor (usually DCAA). The basis for the auditor's recommendation depends upon whether there is relevant historical data available for the particular contractor. Where relevant historical data is available, the auditor will develop the rates. However, as a practical matter, this almost never happens because the definition of "recent, relevant historical data" is tough to meet. Recent, relevant historical data exists when all of the following criteria are met:

1. The prior year has been audited (almost never occurs)
2. All submissions received have been audited and settled (almost never occurs)
3. The indirect cost pool and base data for the delinquent year is readily available in the contractor's books and records.
4. There have been no significant changes in the contractor's business base from the last year audited.
5. There have been no significant reorganization of the contractor since the last year audited.

Where recent, relevant historical data does not exist, the auditor is directed to Plan B and this is where the auditor usually camps. When a contractor is more than six months delinquent, the auditor is directed by guidance to recommend the ACO apply a 20 percent decrement factor to total contract costs, both direct and indirect, for any physically completed contract and all active contracts. This is quite punitive and would adversely affect most contractors. Obviously, contractors should not let things get this far.

Annual Incurred Cost - Consequences for Late Submission

Yesterday we discussed the importance of submitting timely annual incurred cost submissions and why it is in everyone's interest to submit them by the due date. The due date is six months following the close of the contractor's fiscal year (usually the calendar year).

Contractors who do not submit timely proposals may have their billing rates unilaterally "set" (that means 'reduced') by the contracting officer. FAR 42.703-2(c)(2) gives the contracting officer the authority to unilaterally reduce rates when contractors fail to certify their final incurred cost rates. That provision states that rates established unilaterally should be based on audited historical data or other available data as long as unallowable costs are excluded and set low enough to ensure that unallowable costs will not be reimbursed.

DCAA, acting on behalf of the contracting officer is the organization tasked with keeping track of due dates and submissions. This is an administrative task that DCAA seems to excel at. DCAA sends out alerts 90 days prior to the submission due dates and contractors who fail to submit rates by the due date will receive a letter, generally within two weeks, advising them of the potential for unilateral rate reduction.

DCAA also make recommendations to the contracting officer on the unilateral rate reductions. Tomorrow we will discuss how these unilateral rate determinations are determined. The reductions could be significant and could place great strains on contractor cash flows.

Requesting Extensions to Due Date for Submitting Annual Incurred Cost Proposals

FAR 52.216-7.d requires contractors to submit adequate final indirect cost rate proposals to the Contracting Officer and auditor within six months following the end of its fiscal year. The same clause also provides for extensions to that date under certain circumstances. Specifically, FAR states:

Reasonable extensions, for exceptional circumstances only, may be requested in writing by the Contractor and granted in writing by the Contracting Officer. The Contractor shall support its proposal with adequate supporting data.

It has been our experience that contracting officers are inconsistent in applying the "exceptional circumstances" criteria. We have seen contracting officers agree to extensions for no stated reason to cases where contracting officers have probed and queried contractors on their stated justification and supporting data (and in some cases, ultimately denying the request). There is no consistency here at all. One recent DCMA denial for extension contained these words:

(Our) policy is not to grant extensions but simply to require Contractors to get their submissions in as soon as possible. The requirement for incurred cost submissions is very clear and (contractor) is not unfamiliar with this requirement.

The reason the Government is so insistent in receiving these proposals in a timely manner is not because they are chomping at the bit to start their audit. The Government is significantly in arrears in reviewing incurred cost claims - three and fours years behind. The primary purpose in getting these claims submitted timely is so they can compare final indirect rates with provisional billing rates and adjust billings as appropriate. If the final rates are significantly less than the provisional billing rates, the Government will expect contractors to process adjustments to their billings. Conversely, if final rates are significantly higher than provisional billing rates, contractors should process billing adjustments to recoup their additional costs.

Don't count on receiving extensions to the due date for submitting your final incurred cost submission. Work to complete them in a timely manner. Tomorrow we will discuss some of the implications for contractors who are significantly delinquent in submitting their claims.

Deadline Looming for Submitting Your Incurred Cost Proposal

For calendar year contractors with flexibly priced contracts, the deadline for submitting the annual incurred cost submission is June 30th.  If you need more time, submit a written request to your ACO and the Defense Contract Audit Agency. If you haven't prepared one before, the Government is rather particular on the format and the content. DCAA has a couple of good resources to help you out - both available on their public website. Go to http://www.dcaa.mil/. On the left hand pane toward the bottom, there are links to the ICE Model and the Information for Contractors Pamplhet.

Chapter 6 of the Information for Contractors contains guidance for preparing the Incurred Cost Claim. The "Incurred Cost Electronically" is an Excel-based (but not user friendly) template for preparing your claim.