DCAA Re-formats its Contract Audit Manual

The Defense Contract Audit Agency (DCAA) has significantly reformatted its on-line version of the Contract Audit Manual (CAM).The on-line version of CAM is the only version currently available - DCAA discontinued the print version several years ago. The previous on-line versions were simply .PDF copies of the printed version. The new formatting takes advantage of web-based navigation (e.g. hyperlinking) so that the reader, looking at the table of contents in one of the chapters, can navigate directly to the selected section by clicking within the table of contents. Additionally, there are copious hyperlinks within the text itself that take you directly to a FAR (Federal Acquisition Regulation) section, or other regulations or statutes, etc. Clicking on a double asterisks will take you back to the table of contents for that chapter. The topical index, although sharing the formatting style used throughout CAM, does not contain hyperlinks. Hopefully DCAA will remedy that omission shortly.

We don't know whether DCAA incorporated any substantive changes to the newly re-formatted version. Previously, changes were identified by shading the changed passages. Our cursory review of the new format however did not disclose any shading.

Access DCAA's Contract Audit Manual by clicking here.

The Auditors are Starting to Ask Contractors Whether They Have Engaged in Fraudulent Activity

In a policy memorandum issued late July, DCAA announced a major policy shift in detecting and reporting fraud. GAGAS (Generally Accepted Government Auditing Standards) have long required auditors to consider the risk of fraud when designing audit steps. DCAA made it a little more formal about a year ago when it made a policy to require team-planning meetings to discuss the risk of fraud and other noncompliances with applicable laws and regulations that could have a material effect on the audit. Now, DCAA is expanding on its previous efforts to provide, what the Agency terms, a comprehensive approach to detecting and responding to the risk of fraud.

This new guidance is already controversial and you will be hearing a lot about it in the coming months as contractors assess what is being asked and determining whether they will or should respond. Here's the controversial matter:

The audit team should make the following inquiries of contractor management responsible for the subject matter under audit:

• Whether management has knowledge of any fraud or suspected fraud affecting the subject matter under audit;

• Whether management is aware of allegations of fraud or suspected fraud affecting the subject matter under audit, for example, received in communications from employees, former employees, regulators, or others;

• Management’s understanding about the risks of fraud relevant to the subject matter under audit, including any specific fraud risks the contractor has identified or account balances or classes of transactions for which a risk of fraud may be likely to exist.

The audit team should make these inquiries in every audit. The audit team should use information obtained at annual planning meetings about the contractor’s programs and controls that mitigate fraud risk in order to facilitate additional inquiries related to the subject matter under audit. When possible, the audit team should conduct inquiries as part of face-to-face discussions. 

Now as far as we know, there is no contractual or regulatory requirement that contractors respond to these kinds of questions. Our sense is that DCAA is out-of-line in making such requests. It wouldn't surprise us if DCAA will have to retract it sooner rather than later. In the meantime, we suggest you consult with counsel as to the advisability of responding to these series of questions.

What are "walk-through's"?

Government contractors are becoming increasingly familiar with one of DCAA's (Defense Contract Audit Agency) new buzzwords; the "walk-through". The term is being integrated into many of DCAA's standard audit programs as they go through their periodic updates. A "walk-through" is simply a meeting where the contractor identifies the basis and the supporting data/documentation for whatever proposal it has submitted or for an internal control system, or for any other "assertion" the contractor has made. It is nothing new. Its not a different approach to audit. It is certainly not innovative as auditors have been asking for these kinds of briefings ever since Senator Harry S. Truman drove his Plymouth around the country looking for waste at Military contractors. The only difference now is the requirement is being codified into standard audit programs.

In a forward pricing proposal situation, the purpose of a walk-through of the proposal is to gain an understanding of the basis of the proposal and related supporting documentation. As part of the walk-through, a contractor might be asked to

• explain the basis of estimate for significant costs, indirect rate pools and allocation bases, and cost elements
• explain the process used to develop estimates and the internal controls/policies and procedures related to those areas
• demonstrate how the number/amounts for the significant areas of costs are derived
• demonstrate how historical trend data was considered
• demonstrate the homogeneity of pool costs and allocation bases used are appropriate

Prospective contractors should plan on putting a fair amount of effort into these walk-throughs for the simple reason that it should help expedite the audit process. Listen carefully to auditor questions and any feedback they might provide. These might indicate potential weaknesses in your proposal or in the level of supporting detail that might need to be addressed.

When Auditors Don't Agree

There are many times when auditors do not agree with one another on the significance of an audit finding, questionable cost, or internal control weakness. Disagreements among peers can usually be worked out amicably but disagreements between auditors and supervisors and/or managers can become quite delicate to resolve. "Independence" and the exercise of "auditor judgment" are two key bywords/phrases in the auditor lexicon. Questioning an auditor'sjudgment or calling into question his/her independence is crossing a very critical line. There are legitimate reasons why a supervisor might disagree with the audit conclusions and recommendations of a subordinate. There are less defensible reasons as well.

Before an audit report is issued, every effort is made to reconcile differences in opinion. If the difference of opinion cannot be reconciled and the auditor's position is changed, the respective positions are still retained as part of the official file. At this point, an auditor can choose to remove his association with the audit. Contractors may be able to tell when there has been a disagreement between auditor and management by looking at the audit report to see if the auditor's name is listed as a point of contact. If it is not listed, there might have been dissension in the clubhouse.

Health Benefit Costs

In recent guidance to its audit staff, DCAA noted that some contractors were inappropriately charging the Government for health benefit costs for dependents that are no longer eligible for those benefits under the terms of the contractors’ health benefit plans. DCAA is claiming that any such costs are specifically unallowable and subject to penalty if disclosed during an audit. While we would be the first to agree that the costs are not allowable under Government contracts, we believe that DCAA’s position that such costs carry a penalty is somewhat far-reaching. As far as we know, DCAA’s position has not yet been tested through the appeals process.

Internal Controls. The guidance further states that a contractor’s failure to exclude ineligible dependents from health benefit coverage is a reportable accounting system internal control deficiency.  We recommend that contractors establish procedures to ensure that ineligible dependents are excluded from coverage. The easiest method for doing this is to make certain that all employees understand the limits on coverage (training), have them certify annually that they comply with the restrictions and limitations, and perform internal audit tests to ensure compliance.

Third-party Service Providers. Some companies utilize outside service providers to perform eligibility reviews. In those cases, DCAA will most likely want to review their work to the same extent they would in situations where contractors utilize in-house personnel. Your third-party service providers need to be aware of this requirement and be prepared to provide appropriate documentation.

Cost. In some cases, health insurance premiums are unaffected by small changes in the number of eligible dependents. Thus, it is not necessarily true that ineligible dependents will automatically increase costs to the Government. Assuming this ever becomes an issue with your company, you need to have a thorough understanding of how your premiums are computed. It may help your defense.