Contract Auditors to Work Under New Professional Practice Guide

Government contractors (and subcontractors) should become familiar with DoD's 'Professional Practice Guide for Audits and Oversight of Defense Contractor Costs and Internal Controls (First Edition - January 2019). We've covered this guide previously (see for example Section 809 Panel - Recommendation to Adopt an Audit Professional Practice Guide). This guide is intended to provide consistency in the way DCAA and Independent Professional Accounting (IPAs) firms consider risk and materiality in the conduct of their audits and other oversight activities. The PPG is included in the Panel's Third Report beginning on Page 79).

How does DCAA intend to use the Guide? DCAA provides that answer in its latest Annual Report to Congress. DCAA states:

This guide will provide consistency in the way DCAA and Independent Professional Accounting Firms consider risk and materiality. The guide will be important to IPAs when they perform select incurred cost audits for contractors previously audited by DCAA. Internal to DCAA, we plan to use the PPG to meet Congressional requirements to establish, codify, and implement these new materiality thresholds.

What are these new materiality standards that DCAA, and by extension IPAs, must adhere to? The new materiality standards are addressed in the PPG and include 'materiality' in audits of incurred costs and 'materiality in audits of internal controls. This is where the quantification of materiality becomes complex and formulaic driven. But since they are formula driven, contractors (and subcontractors) should be able to replicate materiality thresholds calculated by contract auditors.

The PPG however cautions that the application of quantified materiality is not limited to certain thresholds as "auditor judgment  with consideration of qualitative factors, risk, and variability have an impact".

You can learn more about quantifiable risk or materiality factors in Chapters 2 and 3 of the PPG.

NDAA 2020 - Study the Applicability of Section 809 Panel Recommendations to Energy Department

This is another installment of our coverage of the 2020 NDAA (National Defense Authorization Act). The Senate and House have passed their respective versions of the 2020 NDAA and differences in the two bills are now being reconciled in conference committee. Although there is no certainty that the provisions we have been highlighting, including this one, will make it to the President's desk, they do not seem overly partisan so we think they will likely make it to the final legislation.

A lot of the provisions in both the Senate and House bills call for more studies including the following study to determine whether the recommendations from the Section 809 committee can be applied to the Department of Energy.

The Section 809 Panel was established under the 2016 NDAA to study and make recommendations on streamlining and codifying acquisition regulations for the Department of Defense. The Panel issued three reports containing recommendations related to improving the defense acquisition process. While these recommendations were not aimed at the Department of Energy (DOE), the Panel believed that DOE faces a number of the same acquisition challenges. Therefore, the Senate included a provision in the 2020 NDAA that directs the Government Accountability Office to assess the application of some of the recommendations.

First, GAO is to review issues affecting DOE's acquisition workforce. Specifically, the Senate is interested in DOE's workforce planning efforts, particularly related to (i) how it determines the number of acquisition professionals needed and the skills and training required for those positions, (ii) whether DOE's acquisition professionals attain the needed training and skills, (iii) any challenges in recruitment and retention of DOE's acquisition workforce and (iv) any systemic challenges for those professionals in performing their acquisition oversight responsibilities.

Second, the Senate finds the portfolio management framework recommended by the Section 809 Panel compelling and therefore directs GAO to study whether it can be ported over to DOE.

Finally, the Section 809 Panel provided examples of essential audit and non-audit services provided by DoD agencies across the contract life-cycle. Most of these services are performed pursuant to FAR requirements which are generally applicable to all agencies, including DOE. The Senate directs GAO to review how DOE obtains the required audit and non-audit services and whether there are any opportunities for improvement or efficiency in how DOE obtains these services.

DoD Professional Practice Guide (Audit) - Part 2

This is the second in our series of unpacking the draft Professional Practice Guide (PPG) published by the Section 809 Panel to assist Government and commercial auditors in conducting audits of Government contracts. If you missed Part 1, click here. Yesterday's post discussed the risk assessment phase. Today we will look at the concept of 'materiality', and specifically, materiality as it relates to audits of incurred cost.

Contractors with flexibly priced contracts are required to submit annual incurred cost proposals (see FAR 52.216-7). The risk to the Government is that amounts are materially misstated due to contractors' noncompliance with contract terms or federal regulations (e.g. the Cost Principles in FAR Part 31).

The concept of materiality in the context of incurred cost audits expressly acknowledge that some degree of imperfection is acceptable to the users of financial information. There is an acceptable level of imprecision when determining or settling fair and reasonable contract prices.  This concept is often foreign to DCAA auditors who feel that no level of imprecision is acceptable - they want to audit everything and try to achieve absolute assurance.

One significant concept that auditors will need to comprehend is 'quantified materiality'. This is the numeric representation of materiality that is calculated based on the total audit subject matter. It is used in planning to identify significant cost elements. So, for example, what is the threshold over which a misstatement will effect economic decisions. On a $100,000 contract, five percent ($5,000) will unlikely influence economic decisions whereas the same percentage on a $1 billion contract ($50 million) such a misstatement would likely influence economic decisions of users.

Tomorrow we will look at how 'quantified materiality' affects the scope of audit.

DoD Professional Practice Guide (Audit) - Part 1

Back in January when the Section 809 Panel issued its third and final report, we briefly touched on their recommendation to develop a PPG (Professional Practice Guide) to guide Government auditors and commercial audit firms in conducting audits of Government contractors. This week we will dig deeper into the new guidance to see what it may portend for Government contractors. The guide itself is included in Vol 3 of the Section 809 Panel's report.

The PPG is intended to supplement existing guidance for auditors involved in DoD Procurement contract auditing. It provides additional information regarding how to interpret and apply specific auditing concepts for Government contract audits to assist auditors, contracting officers, and other stakeholders involved in the audit process.

Eventually, the PPG will address seven areas although the current draft version contains just coverage of the first three. Due to its limited statutory term, the Panel did not have time to address them all.

1. Risk assessment
2. Materiality
3. Audits of Internal Controls
4. Independence
5. Objectivity
6. Sufficient evidence
7. Reliance on the work of others

Risk Assessment

The risk assessment framework provides incentives for contractors to achieve and maintain compliant cost accounting and internal controls over Government contract compliance. It also provides disincentives for those contractors who have not.

The framework provides for three levels of risk: low, medium, and high risk strata based on a contractor's ADV (auditable dollar volume). ADV is the total costs charged to flexibly priced (i.e. CPFF, CPIF, FPI, T&M, etc) each year. For contractors with ADV of $1 billion or more, an annual incurred cost audit is mandatory. At the other end of the spectrum, contractors with ADV of less than $5 million, get dumped into a sampling pool if there were no significant questioned costs in the last completed incurred cost audit and there are no "concerns" expressed by someone in the Government acquisition community concerning the particular submission. Contractors with ADV between $5 and $100 million are also in the low-risk sampling pool if they have approved accounting systems. Contractors who don't make it to the "sampling pool" are audited.

Medium risk strata include contractors with ADV between $100 million and $500 million. To make it to the sampling pool, the contractors must meed the three criteria previously discussed  plus not have any business system deficiencies on the books, nor have had any accounting practice or organization changes. Contractors in this strata, even if they make it to the sampling pool, must be audited every four or five years.

The high risk strata includes contractors with ADV between $500 million and $1 billion. It uses the same criteria as the previous strata to determine whether it makes it to the sampling pool. The only difference is that contractors in this strata must be audited at least every other year.

Tomorrow we will discuss the PPG concept of materiality.

Section 809 Panel - Replace Single Deficiency with Tiered Approach to Better Describe Severity

Today we are continuing our discussion of the recently released Volume 3 report published by the Section 809 Panel. We have been focusing on recommendations 71 through 73 which sare the common theme of adopting a Professional Practice Guide (PPG) to assist oversight agencies and independent public accountants (IPAs) to better meet the needs of contracting officials who rely on oversight activities. Today we are covering Recommendation No. 73; replace the DFARS (DoD FAR Supplement) definition of "business system deficiency" with a tiered rating system to more closely align with generally accepted auditing standards (GAAS).

As most Defense contractors know, there are six business systems that the Government considers essential to protecting its interests and essential for contractors to ensure good internal control systems are in place. These are (i) accounting system (ii) purchasing system, (iii) estimating system (iv) property management, (v) material management and accounting system (MMAS), and (vi) earned value management system (EVMS). Various oversight agencies (usually DCAA and DCMA) will take the lead in reviewing internal controls for these systems and issue reports as to their conclusion on the adequacy of those controls. If the controls are found to be deficient, the Government will expect corrective action  plans and perform follow-up reviews to ensure those plans are in place and effective.

The definition of the term significant deficiency for contractor  business systems (based on Section 893 of the Fiscal Year 2011 NDAA (National Defense Authorization Act) and carried over into the DFARS (DoD FAR Supplement)) does not align with generally accepted auditing standards for evaluating and reporting on internal control deficiencies. This lack of consistency creates confusion regarding the identification, severity, meaning and resolution of deficiencies.

According to DFARS, a significant deficiency describes it as materially affecting DoD officials' and contractor's ability to rely on information produced by the business system that is needed for management purposes.

The term in GAAS for a weakness of this severity is a "material weakness. GAAS also uses the term "significant deficiency" but in a way to describe a deficiency that is less severe than a material weakness. The use of the same term to mean different levels of severity of a deficiency creates confusion about the meaning of significant deficiency among contractors, independent public accountants performing internal control audits, government auditors, and the acquisition community.

The Section 809 Panel believes that contractor business systems could have a number of deficiencies that range from trivial to severe. Reporting deficiencies by different levels of severity, and in a manner that aligns with established auditing standards, will allow contracting officers to make informed decisions on the acceptability of the business system.

• Material weakness: A deficiency, or combination of deficiencies, in internal control over risks related to Government contract compliance or other shortcomings in the system, such that there is a reasonable possibility that a material noncompliance will not be prevented, or detected and corrected, on a timely basis. A reasonable possibility exists when the likelihood of an event occurring is either reasonably possible, meaning the chance of the future event occurring is more than remote but less than likely, or is probable.
• Significant deficiency: A deficiency, or combination of deficiencies, in internal control over risks related to Government contract compliance or other shortcomings in the system that is less sever than a material weakness yet important enough to merit the attention of those charged with governance
• Other deficiency: A deficiency or combination of deficiencies, in internal control over Government contract compliance or other shortcomings in the system that have a clearly trivial or inconsequential effect on the ability of the business system to prevent or detect and correct, material noncompliances on a timely basis.

The "other deficiency" acknowledges the possibility that a business system deficiency, or combination of system deficiencies, may have a clearly trivial effect on the quality of information produced by the contractor's business systems. The Section 809 Panel believes that "other deficiencies" should not impact the audit opinion or be included in the audit report. Such deficiencies would be communicated to the contracting officer via email or other method of communication. It should be noted that trivial deficiencies sometimes turn into significant deficiencies if not corrected.

Section 809 Panel - Recommendation to Enhance Risk Assessments

Yesterday we began a discussion on the recently released Volume 3 report published by the Section  809 Panel. For now, we are focusing on recommendations 71 through 73 which share the common theme of adopting a Professional Practice Guide (PPG) to assist oversight agencies and independent public accountants (IPAs) contracted to perform oversight activities, to better meet the needs of contracting officers who rely on oversight activities.

One of the primary areas of focus that the Panel hopes to clarify is that of the concept of "materiality". The draft (or, proposed) PPG (professional practice guide) correctly notes that "materiality" is paramount when considering risk. The PPG then sets forth clear materiality guidelines that help oversight professionals (i.e. DCAA, DCMA, and IPA (independent public accountants) plan their work and provide the information contracting officers need in order to make reasonable business decisions. We will discuss those guidelines later. The reports itself states:

What may be material to a particular business decision will be influenced by a variety of qualitative and quantitative considerations, recognizing that the contracting officer's role is to manage DoD's risk, rather than avoid it. The cost of DoD's oversight including adverse effects on the timeliness of decision making, must be balanced with the expected benefits of that oversight.

One of the knocks against oversight agencies is the "in for a penny in for a pound" mentality where once an audit begins, it must adhere to the totality of professional auditing standards or else it is considered deficient. There is little room for the exercise of professional judgment when assessing risk and for reassessing risk during the course of audit. This ends up squandering a tremendous amount of resources that could be better spent on audits where risk is assessed higher.

The PPG provides a risk model that should be employed by DCAA. Although DCAA has historically used a risk-based approach to determine which contractors are subject to incurred cost audits, as part of the PPG working group, DCAA has embraced an expanded risk model to include additional risk factors that further refine and improve the process. We will be discussing the new risk model in a later posting but for now, just note that the model is intended to "incentivize" contractor compliance.

Section 809 Panel - Recommendation to Adopt an Audit Professional Practice Guide

This month, the Section 809 Panel released Volume 3 of its report on streamlining and codifying acquisition regulations. Volume 1 issued in January 2018 contained 24 recommendations (as well as many more sub-recommendations). Volume 2 issued in June 2018 contained an additional 10 recommendations. Volume 3, the Panel's final volume, contains 59 recommendations and more than 1,000 pages. We have written covered, what we think were highlights in Volumes 1 and 2 (search this blog for 'Section 809 Panel'). You can download all three volumes at the Section 809 Panel Website.

We are not going to attempt to digest all 59 recommendations on these pages but we will focus on a few recommendations that will be of interest to Government contractors and the potential for being subject to contract audit (namely audits by the Defense Contract Audit Agency (DCAA)).

Recommendations 71 through 73 share a common theme of adoption of an audit professional practice guide (PPG). Today we will cover Recommendation 71. Coverage of Recommendations 72 and 73 will come later.

The Section 809 Panel is recommending that DoD adopt a professional practice guide to support the contract audit practice of DoD and the independent public accountants DoD may use to meet its contract audit needs, and to establish a working group to maintain and update the guide. The Panel believes that existing audit guidance is too insular. It framed its concern like this:

Although professional standards are common in the auditing profession, none of them have been developed or interpreted for the unique purpose of federal government contract oversight. DCAA's Contract Audit Manual provides a good foundation, but it lacks the collaborative inputs, perspectives, and interpretations of knowledgeable professionals outside DCAA and the government. This point is important because IPAs (Independent Public Accountants) and other qualified professional services firms are playing an increasingly important role in the  government's oversight of federal government contracts.

According to the Panel, professional standards of importance that require a collaborative interpretation on how to apply the standards in the contract oversight environment include:

• materiality
• risk
• internal controls
• independence
• objectivity
• sufficient evidence
• reliance on the work of others

The Panel included a draft Professional Practice Guide for Audits and Oversight of Defense Contractor Costs and Internal Controls in its report. The team that developed the Guide consisted of representatives of the Section 809 Panel, DCAA, DCMA, GAO, AICPA and industry.

Tomorrow we will continue discussion of the draft PPG.

Does CAS Compliance Require Companies to Depart from Generally Accepted Auditing Standards (GAAP)?

Last week, the CAS Board (Cost Accounting Standards Board) published an agenda for its November and January meetings. There are four topics on the agenda (see CAS Board Meeting) including a couple that we have decided to cover in more detail for its potential impact on small businesses. Even though small business contractors are exempt from CAS, most of the 19 existing standards have been folded in part or in whole into the FAR (Federal Acquisition Regulations) over the years. Yesterday we covered Agenda Topic #4 which consists of a discussion on the Section 809 Panel's recommendation to eliminate the Defense CAS Board, a Board that was created by the 2017 NDAA but has yet to organize (see Will the Newly Created Defense CAS Board Survive?). Today we will cover Agenda Topic #2, Conforming CAS to GAAP (Generally Accepted Accounting Principles).

Agenda topic #3 reads as follows:

Conformance of CAS to Generally Accepted Accounting Principles (GAAP). Section 820 requires the CAS Board to review and conform CAS, where practicable, to GAAP. The Board intends to discuss development of an SDP (Staff Discussion Paper) addressing conformance of CAS 404, Capitalization of Tangible Assets, and CAS 411, Accounting for Acquisition Costs of Material, to GAAP. This is the second SDP addressing CAS-GAAP conformance and will build on the first SDP (under final review for publication and public comment) that (i) lays out a proposed conceptual framework and guiding principles to prioritize the evaluation of whether and to what extent CAS may be conformed to GAAP and (ii) presents an initial comparison of CAS 408, Accounting for Costs of Compensated Personal Absence, and CAS 409, Cost Accounting Standard Depreciation of Tangible Capital Assets, for public comment. The Board intends to receive and review public comment on the first SDP before publishing the second SDP.

The Board has already identified four CAS standards that may or may not require deviation from GAAP. Two of them, the capitalization and depreciation standards (CAS 404 and 409), are not inconsistent with GAAP. It just that GAAP allows companies to be more flexible than CAS in their capitalization and depreciation practices. Whatever issues there are involving capitalization and depreciation however have very little impact on Government contracts. Its a "pay me now or pay me later" situation. If a contractor expenses something, it is reimbursed in the year of expenditure. If a contractor capitalizes an asset, it is reimbursed for the cost over a period of years through depreciation. But what about the time value of money, you ask? In theory, the Government benefits from capitalization because it defers the cost to future years. However, whatever imputed time value of money may accrue to the Government, is offset by FCCM (Facilities Capital Cost of Money) where Contractors earn interest on the undepreciated value of assets. So its a wash. One just doesn't see any capitalization/depreciation disputes brought to the Boards of Contract Appeals for that reason - there is no significant cost impact.

The Board identified two other CAS standards for discussion on aligning them with GAAP - material costs and employees absences - without any explanation as to how compliance might require deviation from GAAP.  We were unaware that these standards (409 and 411) involved departures from GAAP. Guess we'll have to wait for the SDP to learn the Board's concerns.

Will the Newly Created "Defense CAS Board" Survive?

We ended last week's blog with a news article about the CAS (Cost Accounting Standards) Board's upcoming meetings and the agenda topics for the Board's November and January meetings (see CAS Board Meeting). Today and tomorrow we want to take a closer look at two of the agenda topics for their potential impact on small Government contractors.

Agenda topic #4 reads as follows:

Review of Section 809 Panel Recommendation on Defense Cost Accounting Standards Board (Defense CAS Board). The Board will discuss the analysis and recommendation made by the Panel (in Volume 2 of its report) to repeal the provisions in Section 820 of the FY 2017 NDAA (National Defense Authorization Act) that created the Defense CAS Board. See Section 820(b), which amends title 10 by adding a new section 190.

Section 820 of the 2017 NDAA had several purposes:

• Revive the Cost Accounting Standards Board
• Establish a Defense Cost Accounting Standards Board (Defense CAS Board), and
• Privatize some of the audit work being performed by the Defense Contract Audit Agency (DCAA)

With respect to item no. 2, the Defense CAS Board enumerated duties include (see Defense Cost Accounting Standards - Part 2 for more detailed information):

1. review cost accounting standards established by the CASB and recommend changes to such cost accounting standards to the CASB
2. has exclusive authority with respect to the Department of Defense to implement such cost accounting standards to achieve uniformity and consistency in the standards governing measurement, assignment, and allocation of costs to contracts with the DoD, and
3. shall develop standards to ensure that commercial operations performed by Government employees at the DoD adhere to cost accounting standards that inform managerial decision-making.

Last June, the Section 809 Panel (officially the Advisory Panel on Streamlining and Codifying Acquisition Regulations) issued Vol. 2 of this three volume report. In that report, the Panel recommended abolishing the Defense CAS Board (even before it had a chance to organize). Concerning the Defense CAS Board, the report concluded:

Creation of the Defense CASB is an attempt to solve the problem of the non-functioning CASB. Adding another regulatory organization is the wrong solution. Government and industry representatives who spoke with the Section 809 Panel expressed they do not support creation of a Defense CASB. Stakeholders are concerned by the many unanswered questions raised by creating this board, including whether the new board will be biased toward DoD issues, and if the two boards will create competing sets of CAS. Creation of a Defense CASB would almost certainly be counter-productive.

We're not sure what the current CAS Board might discuss with respect to its new sibling, the Defense CAS Board other than give credence to and endorse the recommendation of the Section 809 Panel. The creation of the Defense CAS Board was statutorily derived so another statute will be necessary to abolish the Board. Its not something that the CAS Board can do on its own.

What? The Moribund CAS Board is Meeting?

The OFPP (Office of Federal Procurement Policy (OFPP), Cost Accounting Standards Board (CAS Board) published notification of planned meetings this month and January 2019. The public notification is required but the meeting itself is closed to the public. The last meeting of the CAS Board was more than seven years ago - October 5th, 2011.

The current slate of CAS Board members include three Government reps, one industry rep and one rep from academia:

• Lesley Field, Chair, Acting Administrator, OFPP
• Anita Bales, Director DCAA
• Laurie Schmidgall, Director of Cost Policy, Boeing
• Evan Farley, CFO for GSA
• Yvonne Hinson, Senior Director & Academic in Residence, Association of International CPAs

The agenda topics include the following:

1. Review of Advanced Notice of Proposed Rulemaking for Pension Adjustments for Extraordinary Events - such as CAS pension segment closing adjustment requirements.
2. Conformance of CAS to GAAP (Generally Accepted Accounting Principles) - The 2017 NDAA requires the CAS Board to review and conform CAS, where practicable, to GAAP.
3. CAS Applicability Threshholds - Consider the recommendation by the Section 809 Panel to increase certain CAS Applicability thresholds.
4. Eliminate the Defense CAS Board - Consider the recommendations made by the Section 809 Panel to eliminate the Defense CAS Board. The Defense CAS Board was created by the 2017 NDAA.

What Contractors Might Expect with the New Democratic Controlled House

It should be clear to everyone that given the divided control of Congress, there will not be much legislating during the 116th session. Perhaps that's a good thing. However, that doesn't mean things will be peaceful. With Democrats taking control of the committees, we could see a significant amount of activity in the committees tasked with Government oversight. In fact, certain individuals have already promised to shake things up a bit. While Government oversight doesn't necessarily mean contractor oversight, contractor representatives are often drug into these matters - especially if it involves a scandal where some Government agency has dropped the ball in its own administration and oversight responsibilities.

One recent article by the Federal News Network discussed the expected changes likely to occur. Rep. Cummings who is the likely chairman of the House Oversight and Government Reform Committee has requested 64 subpoenas over the past two years for more agency information about a variety of topics. The Republican majority hasn't upheld any of them. Expect that floodgate to open. Cummings plans to "shine a light" on waste, fraud and abuse in the Trump administration.

Democrats will also focus on Government reform including strengthening whistleblower statutes, reversing the trend that makes it harder for federal employees to be represented in the workplace and other advocacy effort on behalf of federal employees. Cummings also wants to be more involved in Executive Agency reorganizations.

One major concern right now involves the recommendations coming out of the Section 809 Panel that require statutory changes to effect. Without bipartisan support, many of these recommendations may not even be brought to the table, much less implemented.

Government Contractors No Longer Need to Accept and Dispense Sacajaweas

Did you know that there is a clause in most Government contracts that require contractors involved in business operations (including vending machines) on any premises owned by the United States or under control of any agency  or instrumentality of the United States to be fully capable of:

1. accepting $1 coins in connection with such operations; and
2. dispensing $1 coins in connection with such operations

Why is it there? Because in 2007, Congress passed a law designed to remove barriers to the circulation of $1 coins. As part of that law, Congress made it mandatory for any business operating on Government premises to accept and dispense $1 coins, hence the FAR clause.

The Section 809 Panel, a congressionally mandated panel to streamline and improve the acquisition process by identifying and eliminating outdated acquisition provisions, made a recommendation to eliminate the requirement because the intention of the Act was to increase circulation of the $1 coin and was not directly related to agencies' missions. 

Congress acted on the Section 809 Panel's recommendation as part of the 2018 NDAA and exempted contractors, when performing under a Government contractor, for the requirements to accept and dispense $1 coins.

This week, the FAR (Federal Acquisition Regulations) councils acted and removed the requirements from FAR (Parts 37.116 and 52.212-5). 

Well, that's one useless regulation out of the way. Hopefully, Congress will begin adopting many of the other recommendations of the Section 809 Panel.

Section 809 Panel - Government's Acquisition Workforce Needs Reforming

Why should Government contractors care about the Government's acquisition workforce? Well, for one, the acquisition workforce (AWF) is pivotal to acquisition and the efficiency of Defense acquisition depends on and is determined by the people who are responsible for all phases of the acquisition. Long-time Government contractors know - they know that acquisitions, be they easy or long drawn-out affairs, are greatly influenced by the competency of the Government's AWF.

The Section 809 Panel recently released its second of three reports on streamlining acquisition regulations and the Panel was specifically requested to address the needs of the AWF. Here's a paraphrase of their assessment and the things that need to be done to ensure that the workforce is capable of implementing much-needed acquisition reforms in the 21st Century.

Challenges faced by the acquisition workforce (AWF) are well known. They include a cumbersome hiring process, budgetary constraints that hinder recruitment incentives, training and development and a professional certification process that is increasingly disconnected from the practical skills and experience requirements. There are cultural challenges as well that include a personnel system that fails to incentivize success, political and administrative decisions that promote adherence to process and procedure instead of creativity and innovation, and a lack of authority on on the part of key players in the acquisition system to properly perform their duties. Underlying all of these challenges are rigid, bureaucratic rules, overly prescriptive regulations, and a slow process of integrating new technologies into existing processes. DoD recognizes these problems and has called for a new emphasis on critical thinking, risk management, flexible decision-making that would constitute a significant cultural shift away from existing regimented process and zero-risk mentality.

In this report, the Section 809 Panel made several AWF recommendations and promised more recommendations in its third report. These recommendations include:

• Simplify and expedite hiring authority - right now it takes seemingly forever to bring someone on board and the Government is not necessarily attracting the best qualified candidates.
• Convert a pilot project that provides DoD with greater control over personnel processes and functions that enable DoD to attract and retain employees who contribute most to successful organizational mission outcomes to a permanent personnel system.
• Enhance the Defense Acquisition Workforce Development Fund - monies used for recruitment, training, and retention of acquisition personnel.

These recommendations do not seem to address the Panels main criticism, that being the adherence to process and procedure instead of creativity and innovation. As long as there are IG (Inspector General) organizations running around beating up on workforce personnel for not complying with some obscure and unimportant procedure, innovation will always take back seat to adherence to procedures. Perhaps the additional recommendations promised in the Panel's third report will be to redirect the IG's activities.

Section 809 Panel Issues Report No. 2 - CAS Thresholds

We reported yesterday that the Section 809 Panel (the Advisory Panel on Streamlining and Codifying Acquisition Regulations) had just issued is second of three reports with recommendations on streamlining the acquisition process. Yesterday, we began our coverage of the report with the Panel's recommendations to significantly enhance the functionality of the Cost Accounting Standards Board (CASB). If you missed that post, you can go back and read it by clicking here.

The Panel made a second recommendation concerning Cost Accounting Standards. They have recommended that certain monetary thresholds be raised. Recently, as a result of the 2018 NDAA (National Defense Authorization Act), the CAS-covered contract threshold was significantly increased from $750 thousand to $2 million. The CAS-covered contract threshold is tied into the requirement for certified cost or pricing data so that is why the threshold increased. The increase became effective just a few days ago; July 1, 2018. The Panel recommended that the CAS be de-coupled from the TINA threshold and set at $35 million.The Panel also made increased threshold recommendations to the "trigger contract", the full-coverage, and the disclosure statement events.

Trigger Contract. The trigger contract threshold is now $7.5 million. CAS does not apply until a contractor receives a CAS-covered award of $7.5 million or more. Once that threshold is reached, all CAS-covered contracts subsequently awarded to that contractor are subject to CAS. The Panel recommends eliminating this threshold entirely since it would no longer be necessary with the CAS covered contract monetary threshold were raised to $25 million.

Full CAS Coverage. The current full CAS-coverage threshold is a CAS-covered contract of $50 million or more. Contracts below this threshold are subject to modified CAS-coverage (Standards 401, 402, 405, and 406). The Panel recommends increasing this threshold to $ 100 million.

Disclosure Statement. Presently, the threshold for requiring a disclosure statement is $50 million in total CAS-covered contracts. A disclosure statement is not required, however, for individual business segments of a contractor that have CAS-covered contracts that are valued at less than $10 million and represent less than 30 percent of sales. The Panel is proposing to increase this threshold to $100 million and also eliminate the $10 million / 30% exemption.

The Panel estimates that these increased threshold would remove about 10 percent of DoD procurement dollars from CAS coverage but would remove a significantly higher percentage of contractors out of CAS requirements.

Section 809 Panel Issues Report No. 2 - Cost Accounting Standards

The Section 809 Panel (officially the Advisory Panel on Streamlining and Codifying Acquisition Regulations) has issued Vol. 2 of its three volume report. This report builds on the Panel's commitment to making "actionable" recommendations and providing the language necessary to implement those recommendations. Volume 2 contains recommendations addressing the acquisition workforce, commercial source selection, the Cost Accounting Standards Board, and service contracting. Volume 3 is schedule to be released later this year.

We thought that the Panel would recommend that the moribund Cost Accounting Standards Board be abolished. It hasn't done anything significant since 2011. We were wrong. The Panel want to revitalize the Board, move it our from under OFPP (Office of Federal Procurement Policy) and make it an independent board with adequate staffing and funding. The report summarizes:

The Cost Accounting Standards Board (CASB) and cost accounting standards (CAS) need to be restructured to provide necessary guidance and minimize the burden for government and contractors. The CASB should be reinvigorated by extracting it from the Office of Federal Procurement Policy and making it an independent Executive branch organization. The CAS program requirements should be modified to include raising the thresholds for full CAS coverage and the disclosure statement and adding guidance for CAS applicability to hybrid contracts and indefinite delivery contract vehicles.  

The report concludes that the CAS Board's current configuration within OFPP is ineffective at proficing for application of CAS to federal government contracts. CASB has only rarely met in recent y ears, and member positions often go unfilled for long periods. Meanwhile, changes to Government contracting require ongoing updates to the standards and resolution of question s about CAS applicability. Because CASB has not been responsive to these changes, contractors are overly burdened by the need for added layers of compliance to many rules that have not kept pace with new business models. CASB needs to be reinvigorated as an independent organization and removed from OFPP.

How long has this conditions existed? The panel says its been going on for 30 years. "For the past 30 years, CASB has failed to address urgent issues in a timely way." The most pressing problem with the current CASB formulation is the administration of the Board at the OFPP, partly due to a lack of leadership and subject matter expertise. The OFPP administrator position changes frequently and is often vacant, leaving the role in the hands of an acting administrator, most often a career civil servant versed in procurement policy, but without the requisite authority or experience in accounting and contract management to push forward needed CAS reforms (the current OFPP administrator position has been vacant since January 2016).

The Panel made several recommendations including the placement under GSA (rather than OFPP), a permanent staff, independent of any other agency, mandatory meetings, among a few others. The Board should consist of five members; a chair with extensive experience in administering and managing as a senior government official of major CAS-covered contracts, two members from the Government (not auditors or investigators), one member from a government contractor and one member from the accounting profession.

The full report is available here.

Section 809 Panel Wants DCAA to Reduce the Scope of Its Incurred Cost Audits

We are returning once again to our coverage of the Section 809 Panel's first of three reports. The first one was issued back in January of this year. Volume 2 is scheduled to be released in June and the final report, Volume 3 is scheduled for January 2019. Previous coverage of Volume 1 recommendations can be found at the following links.

• Section 809 Panel Issues First Report
• What Gets Measured, Gets Done
• Statutory Due Dates for DCAA Audits
• Outsourcing Contract Audits

The Panel's Recommendation #15 is to clarify and streamline the definition of and requirements for an adequate incurred cost proposal to refocus the purpose of DoD's oversight.

The term "incurred cost proposal is not defined in FAR. The term has become the government contracting community's shorthand way of referring to a contractor's "final indirect cost rate proposal", the elements of which are defined in FAR 52.216-7(d). A "final indirect cost rate proposal" is necessary for the contractor and the Government to establish final indirect cost rates for the purposes of settling provisionally billed indirect costs on flexibly priced contracts. A "final indirect cost rate proposal" however, is not a claim for direct costs incurred and billed during contract performance.

Recently, DCAA began auditing direct costs as well as indirect costs during its audits of "final indirect cost rate proposals". That was never the intent and has increased the time it takes DCAA to complete incurred cost audits and has increased the time it takes contracting officers to address and resolve the DCAA audit findings.

The Panel believes that the timeliness of final rate settlements and consequent contract closeouts will substantially improve if DCAA refocus its oversight on the purpose of the final indirect cost rate proposal to reasonably ensure the allowability of contractors' actual indirect costs, not direct costs. DCAA should not be auditing direct contract costs unless requested to do so by the contracting officer.

The Panel further recommended that several mandatory schedules under FAR 52.216-7(d)(2)(iii) be made optional because they have no bearing on evaluating or settling final indirect costs rates. These schedules include:

• Schedule I - Schedule of cumulative direct and indirect costs claimed and billed by contract and subcontract.
• Schedule J - Subcontract information
• Schedule K - Summary of each time-and-materials and labor-hour contract information
• Schedule L - Reconciliation of total payroll per IRS Form 941 to total labor cost distribution
• Schedule M - Listing of decisions/agreements/approvals and description of accounting/organizational changes
• Schedule O - Contract closing information for contracts physically completed during the fiscal year.

The problem with this recommendation, as we see it, is that without assurance that direct costs are properly stated and allocable, allowable, and reasonable, there can be no assurance as to the propriety of the indirect expense rates since direct costs are integral to rate calculations.

Outsourcing Contract Audits

DCAA (Defense Contract Audit Agency) is not the only organization capable of performing audits of incurred costs and other types of audits designed to support Government procurement. DCAA's activities are not an inherently governmental function - a function so intimately related to the public interest as to require performance by Federal Government employees. Consider the Energy Department and to a lesser extent NASA who routinely outsource their contract audit requirements.

Recommendation #9 from the Section 809 Panel's recently released report wants DCAA to use IPAs (Independent Public Accountants, i.e. CPA Firms) to manage resources to meet time limits - to augment their current staffing with non-Governmental firms.

Here's why.

DCAA cannot eliminate its current backlog of unaudited final indirect cost rate proposals (i.e. incurred cost audits) while providing timely financial oversight and advisory services to contracting officers. DCAA needs additional resources to get and stay current with its oversight responsibilities.

Although DCAA has reduced the backlog of incurred cost audits from more than 20,000 to around 4,500, the Agency still has a sizable number of current incurred cost audits in its inventory. According to a recent GAO report, DCAA possesses nearly 10,000 unaudited final indirect cost rate proposals that are not currently included in its backlog, many of which will be subject to an audit in accordance with DCAA's risk assessment approach.

It currently takes DCAA an average of 747 days to begin its work on a final indirect cost rate proposal once it is received. GAO concluded in its report that “the primary reason for the delay is due to the availability of DCAA staff to begin the audit work.” Because DCAA lacks sufficient capacity to perform the current needs of DoD contracting officers and eliminate its backlog of unaudited final indirect cost rate proposals, the time it is taking for DCAA to start its nonbacklogged incurred cost audits is growing. Due to the backlog and previous legislation that prohibited DCAA’s provision of audit services to nondefense agencies, NASA now allows its contracting officers to use IPAs to conduct incurred cost audits as well as other financial services.

The Section 809 Panel concluded that DCAA should use IPAs to provide timely audit and advisory services in accordance with statutory time limits (discussed yesterday). This approach will assist DCAA in eliminating its final indirect cost rate proposal backlog and provide better coverage and more responsiveness in other audits and advisory services. The contracting community will benefit from increased use of IPAs by DCAA to perform oversight functions. Timely performance of necessary risk management activities allows oversight professionals and contracting officers to gain insights into current contractor operations. This insight facilitates faster corrective actions (if necessary), which, in turn, reduces risks of noncompliance and DoD’s oversight burden.

The Panel foresees a time when IPAs will no longer be necessary to augment DCAA resources. For that to happen, DCAA must first:

• embrace a more robust risk assessment process,
• adopt commercial engagement management and materiality approaches, and
• focus on the contracting officer as its customer.

Statutory Due Dates for DCAA Audits - A Recommendation

We've been discussing some of the recommendations coming out of the Section 809 Panel for the past few days and we want to continue in that vein by highlighting another recommendation for re-making DCAA (Defense Contract Audit Agency) into a vital component of the Defense acquisition process. This one deals with the timeliness of audits, or the timeliness any any advisory services provided by DCAA.

The Panel's 8th recommendation is to establish statutory time limits for defense oversight activities. Note that the recommendation regards statutory time limits, not a lesser regulatory provision or a policy or another form of guidance. That's an important distinction

According to the Panel, financial and business system oversight of DoD's contractors often starts too late and takes too long (no one can argue with that observation). These delays cause problems for both contracting officers and defense contractors and reduce the utility of oversight findings. To be effective and efficient, DoD's system of internal controls must operate in a timely manner.

Time limits are commonplace in both private industry and the Federal Government concerning performance of audits and other forms of advisory engagements. Independent Public Accountants (IPAs) must complete audits by financial reporting deadlines established by the SEC. Auditors for federal agencies must complete agency financial statement audits under deadlines established by the Chief Financial Officers Act of 1990. GAO must also complete congressional-requested audits and reviews in accordance with statutory due dates. These professional service providers both in and out of Government complete their work in accordance with professional standards within time-frames established before work begins.

Not so with DCAA. DCAA's work is untimely, which causes delays in contract awards, as well as other negative effects on the contract life cycle, through and including contract closeout. For example, in fiscal year 2016, DCAA did not begin work on final indirect cost rate proposals until more than two years after contractors' submissions. Contracting officers need DCAA's work to close out flexibly priced contracts.

DoD's system of acquisition internal controls operates most effectively when controls are applied in a timely way. Statutory time limits for various oversight activities will improve their effectiveness.

The Panel's recommendations goes on to suggest due dates for the various types of audits performed by DCAA. Although the recommendations would be an improvement overs DCAA's performance, they are still very generous and not likely to satisfy many procurement professionals.

What Gets Measured, Gets Done

In's an old cliche, to be sure: "What gets measured gets done" but the message is clear: measuring something gives you the information needed to make sure you actually achieve what you set out to do.

Last Friday, we briefly discussed the Section 809 Panel's recommendations concerning the Defense Contract Audit Agency (DCAA). See "Section 809 Panel Issues First Report". Today we want to go into more detail on the Panel's second recommendation (Recommendation #6 Overall) concerning DCAA: Revise the elements of DCAA's annual report to Congress to incorporate multiple key metrics. Most of the following is taken verbatim from the Panel's report.

Congress’s reporting requirement for DCAA lacks critical metrics to adequately measure DCAA’s performance. To alter the conduct of the DoD’s financial and business system oversight functions, success must be defined to be consistent with improving mission focus, valuing time, and simplifying compliance. 

Congress currently emphasizes the number of audit reports completed, and recovering or sustaining questioned costs, over measurements on the other advisory services DCAA provides—which are not mentioned in the report requirements today. DCAA’s annual report to Congress requires some measurements of delayed audits; however, the current report emphasizes the number of audits and questioned costs.  

If DCAA is operating effectively, its success cannot be measured only in questioned and sustained costs. As DoD and contractor internal controls improve, there may be fewer costs to question and sustain. In contrast, worsening DoD and contractor internal controls may increase costs questioned and sustained. Similarly, DCAA’s success as an organization cannot be measured by the quantity of audits at the expense of quality. Congress’s current emphasis on questioned costs and DCAA’s emphasis on return on investment alone do not adequately demonstrate performance. DCAA is not, and should not, be considered a profit center. Most importantly, the current DCAA report has no measure of DCAA’s primary customers’ (contracting officer or acquisition team) satisfaction with the quality and timeliness of DCAA’s work.

Congress must measure DCAA’s success in a manner that helps DoD meet contract objectives. Although detecting contractor noncompliance is important, preventing noncompliance through education and training of contractors and contracting officers is DCAA’s original mission and the best use of its resources.   Questioned costs and sustained costs should remain part of DCAA’s report to Congress; however, these metrics alone are misleading and should not be viewed in isolation of the other key parts of DCAA’s mission regarding service to the contracting offer and the acquisition team. The current report makes no mention of contracting officer or acquisition team satisfaction with the quality and timeliness of DCAA’s work, yet they are DCAA’s primary customer. Congress should measure DCAA using a balanced scorecard consisting of multiple key metrics to include the following:

• A description of the regulatory requirements that create compliance difficulties for contractors, including an analysis of how those regulatory requirements affect contractors of different sizes and industries.
• The total number of new audit or advisory engagements, by type (preaward, incurred cost, other postaward, and business system), with time limits expiring during the fiscal year that were completed or were awaiting completion, as compared to total audit and advisory engagements completed or awaiting completion during the year.
• On‐time performance relative to time limits for each type of audit or advisory engagement (shown separately for the DCAA and qualified private auditors retained by the agency).
• The time limit (expressed in days) for each type of audit or advisory engagement, along with the shortest period, longest period, and average period of actual performance (shown separately for the DCAA and qualified private auditors retained by the agency). 
• For preaward audits and advisory engagements of contractor costs, sustained costs as a total number and as a percentage of total questioned costs, where questioned costs are expressed as the impact on negotiable contract costs (shown separately for the DCAA and qualified private auditors retained by the agency).
• For postaward audits and advisory engagements of contractor costs, the questioned costs accepted by the contracting officers and contractors as a total number and as a percentage of total questioned costs, where questioned costs are expressed as the impact on reimbursable contract (shown separately for the DCAA and qualified private auditors retained by the agency).
• The aggregate cost of performing audits, set forth separately by type of audit.
• The ratio of sustained questioned costs to the aggregate costs of performing audits, set forth separately by type of audit.
• The total number and dollar value of postaward audits that are pending for a period longer than 1 year as of the end of the fiscal year covered by the report, and the fiscal year in which the qualified proposal was received, set forth separately by type of audit.
• A summary of the reasons for the difference between questioned and sustained costs shown in the statistical tables.
• A description of outreach actions towards industry to promote contract compliance and professional development of the DCAA workforce (shown separately for collaborative outreach actions and other outreach actions).
• A statistically representative survey of contracting officers from DoD buying commands and the DCMA and representatives of small and large businesses to measure the timeliness and effectiveness of audit and advisory services provided by the DCAA (shown separately for the DCAA and qualified private auditors retained by the agency).

You will no doubt have noted that the focus of this recommendation is designed to move DCAA back to supporting its primary customers; contracting officers and the acquisition community.

Section 809 Panel Issues First Report

The Section 809 Panel released its first of three reports this week. This 642 page tome can be downloaded here. The Section 809 Panel, you will recall, was named for Section 809 of the 2016 NDAA (National Defense Authorization Act) from which it gained its status and authority. Its objective is to make recommendations that will enable DoD to more consistently buy what it needs in a timely and cost-effective manner.

The Panel stated that its research "unequivocally" proved that the cumbersome, and often one-size-fits-all acquisition process is an obstacle to DoD's ability to access a marketplace that has moved far beyond the captive industrial base of the Cold War era.

This report contains numerous recommendations to update the process by which DoD acquires IT business systems, streamline DoD's cumbersome auditing requirements, address challenges in how the small business community and DoD interact, update commercial buying, clarify definition of personal and non-personal  services, remove statutory requirements for 13 acquisition-related DoD offices, and repeal 20 acquisition-related statutory reporting requirements.

There's plenty of material in this report to keep us busy writing for a long time. But today, we want to focus on recommendations impacting the Defense Contract Audit Agency (DCAA), the Agency that has taken more than its fair share of criticisms lately - some justified, most not - for a lot of the inefficiencies in the current process.

The recommendations concerning DCAA fall into three categories; re-focus on assisting contracting officers, use commercial standards rather than home-grown ones, and find better ways to be more effective and efficient in oversight activities. Here they are.

Enhance DCAA's Focus on the Contracting Officer and Acquisition Team

• Align DCAA's mission statement to focus on its primary customer, the contracting officer
• Revise the elements of DCAA's annual report to Congress to incorporate multiple key metrics
• Provide flexibility to contracting officers and auditors to use audit and advisory services when appropriate.
• Establish statutory time limits for defense oversight activities.
• Permit DCAA to use Independent Public Accountants (IPAs) to manage resources to meet time limits.

Use Accepted Commercial Standards and Practices with Objective and Standardized Compliance Criteria

• Replace system criteria from DFARS 252.242-7006, Accounting System Administration, with an internal control audit to assess the adequacy of contractors' accounting systems.
• Develop a Professional Practice Guide for DoD's oversight of contractor costs and business systems.
• Require DCAA to obtain peer review from a qualified external organization

Provide More Effective and Efficient Contract Compliance Oversight

• Increase coverage of the effectiveness of contractor internal control audits by leveraging IPAs
• Incentivize contractor compliance and manage risk efficiently through robust risk assessment.
• Clarify and streamline the definition of and requirements for an adequate incurred cost proposal to refocus the purpose of DoD's oversight.

Many of these are excellent recommendations. We'll unpack some of them in later posts.