Inspector General Finds Billing Irregularities at EPA

The Office of Inspector General (OIG) for the Environmental Protection Agency (EPA) received a hotline complaint regarding possible irregularities with contract invoicing and payments on a particular contract that provided EPA with a broad range of information technology and information management technical and professional services (Task Order 12). This was a large cost plus fixed fee task order that grew from $100 million to over $1.2 billion by the time it ended in 2017.

 As a result of the hotline tip, the OIG conducted an audit to determine whether Task Order 12 had effective controls over billing and funding to prevent fraud, waste and abuse. The audit found a number of deficiencies including:

• Required contractor performance reports were not finalized
• There were no official contract or task order modifications for some of the Contracting Officer (CO) and Contracting Officer Representative (COR) changes
• COR appointment memorandums were missing
• COs did not perform required periodic invoice reviews.

The last cited deficiency, failure to perform invoice reviews, gets the most attention and has the highest potential for overbilling the Government. FAR and EPA regulations require that invoices be thoroughly reviewed prior to payment. Despite this requirement, there was not documentation to show that invoices were adequately reviewed prior to payment. As a result, the OIG concluded that EPA did not have reasonable assurance that costs or fee billed under Task Order 12 were allowable, allocable and reasonable. In fact, in its limited sampling, the OIG found more than $5 million in overbilling. Some of the overbilling issues would have been caught had EPA done its required invoice reviews such as where fee was billed at eight percent when the contract limited fee to six percent.

The OIG made seven obvious recommendations (e.g. do a better job, follow regulations, etc) to which the EPA concurred (obviously). The full OIG audit report is available here.

Is Your DSO Too High?

Days Sales Outstanding (DSO) is a metric that measures the average number of days it takes for accounts receivable to be collected. DSO can be calculated by dividing the total accounts receivable during a certain period (e.g. month, quarter, year) by the total credit sales multiplied by the number of days in the time period. Note, there are other more precise ways to calculate DSO but this one is the most widely-used. Best-Possible Days Sales Outstanding (BPDSO) is a related metric that measures what DSO should be if all credit customers paid exactly according to the terms of their invoice. So, for example, for a Government contractor with one cost-type contract, the Government should pay an "adequate" invoice within 30 days. The BPDSO in this case would be 30 days. If payment were received in 40 days, the DSO would be 40 days. The 10 day spread between DSO and BPDSO is where contractors should  be concerned.

The Government is usually pretty efficient in paying invoices (these days). Initiatives designed to assist small businesses has significantly reduced the time it takes for payment to be made - some reports as quickly as ten days. The Government however measures the time it takes to pay an invoice once an adequate invoice is received. And there is the rub. When an invoice does not match contract terms or omits certain required information and/or attachments, the invoice is rejected, payment is delayed and DSO increases. To correct a rejected invoice, involves hours of time from multiple departments to manually locate the missing information needed to "correct" the invoice - causing further inefficiencies within the company.

Some of you might be thinking, 30 days or 40 days, what's the big deal? Eventually we'll get paid. If that's your situation, congratulations. You are in a minority. Most contractors operate with lines of credit that come with interest payments. Adding 10 days over and over and over will result in increased interest payments that impact their bottom lines.  Run DSO metrics periodically and plot the trends. You might be surprised and you might find that a few changes to your billing system can bring down your DSO.

Improper Payment Acts - DoD's Implementation

Last week we discussed GSA's (General Services Administration) progress toward compliance with the Improper Payments Acts citing a report by the Agency's Office of Inspector General that identified deficiencies in reporting and evaluating improper payments (see Improper Payment Acts - Government Efforts to Reduce Improper Payments). The Acts require federal agencies to review their programs and identify those that are susceptible to significant improper payments.

The Department of Defense Office of Inspector General (DoD-IG) recently issued their report on DoD's compliance with the Improper Payment Acts (see The DoD Did Not Comply With the Improper Payment Elimination and Recovery Act in FY 2016). As the report title implies, the DoD-IG found significant room for improvement in DoD's compliance with the statutory requirements of the Acts.

The DoD identified 10 programs that are at high risk for improper payments. Among the 10 are four at-risk areas affecting payments to contractors. These are,

1. Defense Finance and Accounting Service (DFAS) Commercial Pay - This is where most DoD contractors send their public vouchers and progress payments.
2. U.S. Army Corps of Engineers Commercial Pay
3. Navy Enterprise Resource Planning Commercial Pay
4. Navy Commercial Bill Pay - Naples

DoD organizations are required to implement comprehensive systems of internal controls that provides reasonable assurance that programs are operating as intended and to evaluate the effectiveness of the controls. DoD did not perform risk assessments in some cases nor did it publish estimates that were statistically valid, nor did ity publish corrective actions with planned or actual completion dates.

The DFAS Commercial Pay is one of the programs that report improper payments and the testing that was performed for this system excluded billions of dollars worth of transactions. About $3 billion was excluded because DoD inappropriately believed that since the costs were being audited by DCAA, it was of low risk.

The DoD-IG made a number of recommendations which were essentially concurred to by DoD. As a result, some defense contractors may see increased oversight by the Government in its increased efforts to reduce (or eliminate, if possible) improper payments.

Improper Payment Acts - Government Efforts to Reduce Improper Payments

The Improper Payments Information Act of 2002, the Improper Payments Elimination and Recovery Act of 2010, and the Improper Payments Elimination and Recovery Improvement Act of 2012 are collectively referred to as the Improper Payments Acts. The purpose of these Acts is to eliminate and recover payments improperly made by federal agencies. The Acts require federal agencies to review their programs and identify those that are susceptible to significant improper payments. Many Government contractors have felt the impact of these efforts, either through the respective finance (payment) offices, contract administration, and contract auditors. Improper payments can take many forms and do not necessarily mean that anything fraudulent, wasteful, or abusive has occurred. Sometimes timing issues result in temporary improper payments because, for example, contractors have not had time to update their billings to reflect final, rather than provisional, indirect expense rates.

In fiscal year 2015, the Federal Government estimated $136 billion in improper payments - payments that under statutory, contractual, administrative, or other legally applicable requirements should not have been made or were made in an incorrect amount. Such payments are generally believed to be widespread and a significant problem in the Federal Government.

The OMB (Office of Management and Budget) issued guidance on how Agencies should (or could) eliminate improper payments. First, agencies must conduct risk assessments to identify the programs most susceptible to significant improper payments. Then, agencies must come up with corrective action plans and estimate and report improper payments for those programs annually. Most importantly however, agencies must recover funds that were inappropriately expended.

So how are agencies doing in ferreting out and recovering improper payments?

A recent report by GSA's (General Service Administration) Office of Inspector General (OIG) gives us some insight on this issue. The report concluded that GSA's Office of Chief Financial Officer (the department tasked with ensuring compliance with the Improper Payment Acts) was deficient in its reporting and evaluation of improper payments. Specifically, the OIG found:

• GSA did not have adequate internal controls over reporting improper payments. Its fiscal year 2016 report was published with numerous errors.
• GSA was not successful in identifying ineffective controls through its continuous monitoring of vendor payments, and
• GSA did not sufficiently implement corrective action related programs previously identified as high risk.

The GSA experience may or may not be indicative of the Government as a whole however GSA is one of the Government's biggest spenders of taxpayer funds. It is apparent that the emphasis on eliminating improper payments will continue. Contractors can continue to expect increased levels of oversight on public vouchers, progress payments, and other forms of payments from the Government.

Audits of Paid Vouchers

DCAA (Defense Contract Audit Agency) recently implemented a program to systematically review paid interim vouchers. DCAA, of course, has always had that authority and would sometimes endeavor to perform such reviews as part of a larger billing system audit. But now, the program is much more structured. If you haven't yet been subjected to one, you will.

The purpose of paid voucher reviews is to test contractors' compliance with contract terms. The program calls for testing a minimum of one interim voucher per year at every contractor. Larger contractors will have a minimum of one voucher review per quarter. Any known risk areas will most likely increase the number of vouchers to be reviewed. Reviews will be limited to cost billed for the period - usually one month - and not cumulative over the life of the contract.

Paid voucher reviews generally focus on three areas; payables, labor, and Materials & ODCs (Other Direct Costs).

Accounts Payable - The audit program calls for the auditor to verify that the contractor is not delinquent in the payment of costs in the ordinary course of business. The auditor will request an accounts payable aging schedule and make inquiries concerning significant amounts over 30 days old. They usually select five or more items charged direct to the contract and trace the amounts to evidence of payment. If a contractor is delinquent in paying costs in the ordinary course of business, they're not reimbursable.

Labor -  The audit program calls for the auditor to select labor charges billed direct to the contract and trace the amounts from the interim voucher through the labor distribution system to the timecard (or electronic timekeeping system. Auditors are also directed to meet with or speak to the employee(s) and ask them to confirm the time charges. Finally, auditors will verify that direct labor charges agree with the contract requirements.

Materials and ODCs - Auditors are directed to select several ODC charges billed to the contract and trace the amounts from interim vouchers to accounting records and supporting documentation.

As we stated, this is a fairly new program area for DCAA and the auditors seem to still be finding their way on how to specifically address these objectives. Frankly, we've heard of a number of goofy audit requests coming out of these reviews - requests for information that have nothing to do with incurred costs and billing systems. Should you receive such a request, it is very appropriate to request the auditor to explain the purpose of the request and how it ties to their audit objectives. If the auditor cannot explain it to your satisfaction, it would be appropriate to talk with a supervisor.

New Procedures for Submitting Payment Requests on NASA Contracts

NASA has published an interim rule affecting its contractors who submit payment requests under cost-reimbursable contracts. Until the 2016 NDAA (National Defense Authorization Act), oversight of billings by NASA contractors was administered by DCAA (Defense Contract Audit Agency). However, the 2016 NDAA now prevents DCAA from performing any work for non_DoD agencies. As a result, all non-DoD agencies that have been relying upon DCAA to provide contract audit oversight are scrambling to find alternatives to DCAA.

NASA notes that since DCAA discontinued its "voucher support" to NASA, timely payments to contractors for work performed has been jeopardized and that a new mechanism is needed to implement procedural changes to minimize delays to contractors and suppliers and avoid the potential accrual of Government interest payments to contractors.

The new rule designates a centralized payment office where NASA contractors can send their vouchers, instructions for preparing the payment request, and the requirement for backup documentation. The requirement for backup documentation is the aspect that is going to seem most onerous to NASA contractors, who generally, have not had to submit such documentation previously but have only been required to maintain it for when an auditor came looking. This documentation requirements includes:

• Breakdown of billed labor costs and associated contractor generated supporting documentation for billed direct labor costs to include rates used and number of hours incurred.
• Breakdown of billed other direct costs (ODCs) and associated contractor generated supporting documentation for billed ODCs
• Indirect rates used to calculate the amount of billed indirect expenses., 

The rule also covers additional administrative matters such as the rejection of improper vouchers and re-billing for costs that were previously suspended or disapproved.

Presumably someone in NASA's billing office will be reviewing vouchers for accuracy and compliance. There is no provision for audit oversight of contractor billing systems - guess NASA contractors will now be on the honor system.

You can read the interim rule in its entirety here.

Auditor Testing of Paid Vouchers

Back in 2012, the authority for determining a contractor's eligibility for direct billing - submitting vouchers without having them first approved by a contract auditor - was taken away from DCAA (Defense Contract Audit Agency) and correspondingly, all defense contractors were automatically eligible to bill their costs without DCAA pre-approval. This greatly streamlined the billing process, allowed contractors to be paid more quickly, thus ensuring improved cash flows.

While the pre-approval requirement or authority to grant direct billing status was eliminated, DCAA was and continues to be responsible for ensuring that contractors are billing allowable costs and that they comply with the terms and conditions of their contracts. To accomplish this responsibility, DCAA has developed a "paid-voucher" testing program - testing to see whether billings tie back to the books and records and comply with contract terms and conditions.

DCAA is in the process of phasing in its paid voucher review program. By next year at this time, the Agency will require testing on at least one voucher per year at ever contractor that submits vouchers, and more often than yearly at major contractors and those deemed to be high risk. Many contractors are already suffering through paid voucher reviews.

DCAA has developed an audit program for paid voucher testing. It can be downloaded here. Over the next few postings, we will highlight some of the factors that auditors will be considering when testing the propriety of billings. The audit program itself is nine pages but only pages 6 through 8 contain specific analytical steps relating to contractor books and records. Today we begin with a discussion of payments for materials.

FAR 52.216-7, the Allowable Cost and Payment Clause, authorizes the reimbursement of allowable costs for recorded (booked) costs that have been paid for at the time the voucher is submitted. It also authorizes reimbursement of accrued costs provided payment is made in the ordinary course of business - usually 30 days.

The auditor is going to test whether any amounts billed are compliant with these provisions - either actually paid for at the time the billing was submitted or accrued and paid within 30 days. One method of testing this is to review the accounts payable aging schedule and inquire about any significant payables that exceed 30 days. If there are delinquent payables, there could be reasonable explanations as to why payments become delinquent but delinquent payments could also be a risk factor that requires additional audit testing.

Contract auditors will also request a minimum of five material items that have been charged to the contract and test to see whether vendor payments were made prior to voucher submission to the Government or paid within 30 days of the date of the invoice.

If a contractor is delinquent in paying costs in the ordinary course of business, the costs are not (yet) reimbursable under Government contracts and auditors are advised to prepare and issue a DCAA Form 1 to suspend the costs and recoup the overpayment.

The Government is Keeping Track of Billing Rejections

Most Government contractors have had billings rejected by a contract auditor, a contracting officer and/or someone from the paying office. Rejections happen frequently and for many different reasons; an incorrect voucher number, a wrong date, a mathematical error, outdated billing rates, reference to an incorrect contract line item or billing code, Most rejections are administrative in nature, rather mundane and have no impact on the amount claimed and owed the contractor . Sometimes, billings are rejected through no fault of the contractor because someone in the Government's approval chain didn't have the right paperwork. One common example is where contract modifications increasing funding did not get to the person needing that modification so the billing request (e.g. public voucher) is rejected as exceeding contract funding.

Most billing rejections are easy to fix. It might be as easy as changing a voucher number by one number. Perhaps it only requires a file upload to WAWF (Wide Area Work Flow). After fixing whatever it was that needed to be changed, contractors go about their business, ultimately get paid, and put the incident out of their minds.

While contractors might put such events out of their mind however, contract auditors are keeping track of such incidences. In the auditors' view, frequent billing errors may be indicative of systemic billing system deficiencies. It can be somewhat disconcerting for contractors to have three years of billing rejections dropped on them during a billing system audit and prodded for explanations. It may be impossible to explain; contractors do not usually retain and track such information, lack of employee continuity, and the perception that such events are inconsequential.

Sometimes auditors do not believe that anything is inconsequential. The standard audit program for contractor billing system audits contains the following procedure:

Review billings that were rejected by DCAA, other approving officials, and paying offices in order to identify trends and errors which are frequently repeated. Consider the trends and errors when designing the audit procedures to test contractor billings. If there are a significant number of errors (e.g., high percentage of rejected billings) this could be an indication of systemic problems. A deficiency report should be issued when sufficient evidence has been obtained and the auditor can demonstrate compliance with other GAGAS (e.g., adequate planning and supervision).

Whenever a payment request is rejected, contractors should document the situation and preserve it somewhere within the billing system. That way, ready responses are available should anyone inquire.

New Government Policies and Procedures for Billing Oversight - Part 4

This is the fourth and final installment in our series on the new procedures for performing audit oversight of contractor billings under cost-type contracts. Until 2012, DCAA (Defense Contract Audit Agency) reviewed and approved all public vouchers (i.e. billings submitted for reimbursement of costs under cost-type contracts) unless a contractor wanted to go through the laborious process of qualifying for the Direct Billing Initiative. Beginning in 2012, the Department of Defense decided that the audit process was not adding enough value for the cost involved so it made direct billing available to all contractors. In place of the requirement to review every public voucher, the Department came up with a risk assessment approach to reviewing vouchers. This entailed segregating contractors into high risk and low risk categories according to the criteria we discussed in an earlier post on this subject. For low risk contractors, a "sampling" table is loaded up into the WAWF (Wide Area Workflow) system and the system automatically selects a few vouchers for audit review. The system also identifies vouchers that are significantly above the norm and selects those for audit as well. For example, if a contractor has been submitting monthly vouchers for a contract in the $100 - $200 thousand range and all of a sudden submits one for $1 million, the system would probably flag it and send it over to the auditors for a look-see.

For high risk contractors, the auditors must perform a risk-assessment and develop a sampling plan that is unique to each contractor. This risk assessment is updated each year. Auditors are directed to consider the following risk factors:

• Specific concerns of the ACO, the PCO, and the COR (administrative contracting officer, procurement contracting officer and contracting officer's representative)
• Reported accounting or billing system deficiencies.
• Audit leads or other significant risk factors identified in the permanent files within the past two years.
• Improper payments identified in previous reviews of public vouchers.
• Significant number of previously rejected public vouchers attributable to a situation that has not been fixed (e.g. a certain contractor employee that makes lots of mistakes).

After completing the risk assessment, the auditor must then devise a sampling plan. If there are no identified risk factors, the auditor could, presumably, rely on the table used for low-risk contractors. If there are identifiable risk factors, the auditor will need to sample more vouchers than would be required for low-risk contractors.

Contractors should know when one of their public vouchers have been selected for review because one of the review steps requires the auditor to trace the amount claimed back to the contractors accounting records. Unless they have on-line access to the job cost ledgers, the auditors will be knocking at the door. 

It is very important for contractors to accommodate auditor requests to trace billings back to accounting records very quickly. As we mentioned before, the auditors have only five days to perform their voucher reviews. If contractors don't make time available within these five days to accommodate this comparison, the auditor will, in all likelihood, reject the billing. Then it becomes necessary to resubmit the voucher and that will unnecessarily extend the time it takes to receive payment.

The text of the revised procedures can be read or downloaded here.

Previous posts in this series:
     Part 1
     Part 2
     Part 3

New Government Policies and Procedures for Billing Oversight - Part 3

This is the third in our series on the new policies and procedures brought about when DoD eliminated the need for contractors to obtain DCAA's (Defense Contract Audit Agency) provisional approval of billings before they could be submitted for payment. This change occurred in 2012, was long overdue, and there were many both inside and outside of DCAA who questioned whether the audit agency was providing any real value to the process. Under cost-reimbursable contracts, all costs are subject to final audit so the only risk to the Government was the time-value of money on possible overpayments. It was "interesting" and sometimes humorous to watch auditors quibble over a point or two on a provisional indirect billing rate as if they had better insight than the contractor as to what the final rate would be for the year. It was also frustrating as well because billings were sometimes held up pending resolution/agreement of those provisional billing rates.

Even though DCAA has been taken out of the billing loop, so to speak, there is still a need for audit oversight. DCAA has devised a risk-based approach to rendering that oversight. Essentially, it divides contractors into high-risk/low-risk. High risk contractors are those that bill for more than $250 million per year and those that have had questioned costs in previous incurred cost audits (those questioned costs must meet certain percentage thresholds as we explained yesterday). Billings from low-risk contractors are randomly selected for a pre-payment review. For high-risk contractors, billings are also sampled but the process is a bit more complex and there will probably be more billings (percentage-wise) selected at high-risk than at low-risk contractors.

Once an interim public voucher (i.e. a billing or an invoice) is selected, the auditor has only five days to make an evaluation. The steps involved in that evaluation include:

• Does the voucher have the correct contract number and CAGE code?
• Do the contract number, voucher number, and dollar amount on the voucher agree with the attached supporting documentation?
• Are billed costs with the period of performance?
• Does the voucher include current and cumulative billed amounts?
• Does the Contracting Officer or the Contracting Officer's representative have any specific concerns related to the contract or voucher?
• Are costs/fee billed in accordance with contract provisions?
• Did the contractor use appropriate billing rates?
• Do the current and cumulative billed costs reconcile to the contractor's accounting records?
• If the voucher contains significant subcontract or supplies and service costs, are they in accordance with the requirement that the be paid within the terms and conditions of the subcontract or invoice (normally within 30 days)?
• Are the fees and costs claimed within the contract funded and/or ceiling amounts?

From the preceding listing, you can see that there is only one step that involves the contractor;  Do costs reconcile to the contractor's accounting records. Everything else should be on-file in the audit office, including a provisional billing rate approval letter. So that's the substance of the auditors' reviews. Contractors with a single contract that bill monthly can expect one of its public vouchers to be reviewed under this new procedures. That could add up to five days from the time the voucher is submitted to the time it is paid. However, it is also likely that it will not add any time to the process because the five day audit cycle is normally built into the 30 day period in which the Government must pay.

Click here to read Part 4.

Previous posts in this series:
     Part 1
     Part 2

New Government Policies and Procedures for Billing Oversight - Part 2

If you missed Part 1, read it here first.

As we introduced yesterday, the revised DFARS (DoD FAR Supplement) section 243.803 requires the contract auditor to institute a risk-based approach to reviewing public vouchers (also commonly referred to as "interim vouchers", "requests for reimbursement", "requests for payment", or simply "billings"). That means that the auditor must determine "risk" and then make a selection of vouchers based on that risk assessment.

DCAA (Defense Contract Audit Agency), has made the determination very easy. Contractors with ADV (Annual Dollar Volume) of more than $250 million are high risk. Those with less than $250 million of ADV are low risk unless there were certain threshold questioned costs in prior incurred cost audits. We described those questioned cost thresholds in a previous positing (click here to read it). Those thresholds . ADV represents the total costs incurred on flexibly priced contracts (e.g. CPFF, CPIF, FPI, T&M, etc) during a given year.

We will discuss the sampling plan for high-risk contractors in a later posting. For low-risk contractors, the number of vouchers to be reviewed each year is based on the number of vouchers submitted year according to the following table. For example, a contractor with a single cost-reimbursable contract submitting a monthly voucher can expect to have one voucher pulled for pre-screening.

For high-risk contractors, DCAA has developed a "risk determination tool". We will discuss that tool in tomorrow's posting.

Click here for Part 3.

New Government Policies and Procedures for Billing Oversight - Part 1

Back in August 2012, DFARS (DoD FAR Supplement) was revised to eliminate the "Direct Billing Initiative". The Direct Billing Initiative was a program that allowed contractors to submit their public vouchers (i.e. cost reimbursement vouchers) directly to the paying office without having to go though the process of having DCAA (Defense Contract Audit Agency) review and approve the vouchers before payment. The idea was sound policy - if contractors had adequate billing systems, regularly updated their indirect billing rates, and were timely in submitting their annual incurred cost submissions, they could be approved for direct billing, thereby shaving a few days off of number of days it took to get paid. The concept was great but the implementation was horrible. DCAA set an extremely high bar for approving contractors for direct billing. Perhaps they didn't want to see their work volume diminish. For smaller contractors, the bar was insurmountable because their size didn't allow them resources to develop the strong internal control systems demanded by the contract auditors. For other contractors, the additional cost of getting their payments two to five days earlier than normal, was not worth the cost of haggling with the auditors.

Finally, DoD had enough and heard enough contractor complaints so they killed the Direct Billing program entirely. In its place, they authorized every contractor to bill directly - effectively by-passing the auditor.  To protect the Government's interests however, DoD included a provision that allowed for a risk-based sampling process. They idea here is that a risk-based sampling process would be a more effective and efficient approach to validating billings by allowing for the evaluation of selected vouchers on a pre-payment basis. Under the new rule, auditors would need to assess the risk of overbilling and then select a few billings for further review prior to payment. The sampling would be performed within the WAWF (Wide-Area-Workflow) billing system. Contract auditors would go into the WAWF system and intercept vouchers for review prior to their being paid.

Now, more than two years later, DCAA has come up with their new billing oversight plan that corresponds to the new DoD policy. (We're not sure what they were doing in the intervening two years). Essentially, the new procedures requires a determination of whether contractors are considered high-risk or low-risk and a sampling plan that corresponds to that determination. Over the next few days, we will be diving into more of the details of that plan and what contractors can expect when their billings are selected for pre-payment reviews.

Click here for Part 2.

Billing System Adequacy - Part 4

This is our final posting on the attributes that comprise, from the Government's perspective, an adequate billing system. The specific requirements will vary depending upon type of contract but the fundamental requirements are the same, regardless of type of contract. If you missed our other postings on billing systems, it would be useful to read from the start:

• Part 1
• Part 2
• Part 3

Today's postings will cover billing withholds and the necessity for accuracy.

Procedures to ensure that vouchers include appropriate "withholds". There are a number of clauses that may require contractors to voluntarily withhold some of their billings until certain conditions are met. Perhaps the most common one is the 15 percent withhold of fixed fee (up to $100 thousand). The FAR citation for that is found in 52.216-8 which reads:

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. The Contracting Officer shall release 75 percent of all fee withholds under this contract after receipt of an adequate certified final indirect cost rate proposal covering the year of physical completion of this contract, provided the contractor has satisfied all other contract terms and conditions, including the submission of the final patent and royalty reports, and is not delinquent in submitting final vouchers on prior years' settlements. The Contracting Officer may release up to 90 percent of the fee withholds under this contract based on the Contractor's past performance related to the submission and settlement of final indirect cost rate proposals.

The key point here in a billing system review is to determine whether a contractor has processes in place to ensure that only 85 percent of fee is claimed (up to the $100 thousand). In practice, most contractors who submit vouchers through DCAA (Defense Contract Audit Agency) are well aware of this requirement because DCAA is well aware of this requirement and will reject any billing that does not factor in the withhold. But, DCAA is not going to know when the $100 thousand cap is reached nor will they voluntarily release 75 or 90 percent of the withholds once the incurred cost submission for the final year of contract has been submitted. For those things to happen, contractors need to establish policies and procedures.

Another common withhold is the 5 percent of billings not to exceed $50 thousand applicable to T&M and labor hour contracts. That clause, found in FAR 52.237.a.(7) reads:

Unless otherwise prescribed in the Schedule (i.e. the Schedule included in the contract), the Contracting Officer may unilaterally issue a contract modification requiring the Contractor to withhold amounts from its billings until a reserve is set aside in an amount that the Contracting Officer considers necessary to protect the Government's interests. The Contracting Officer may require a withhold of 5 percent of the amounts due ... but the total amount withheld for the contract shall not exceed $50,000. The amounts withheld shall be retained until the Contractor executes and delivers the release required by ... this clause.

This clause is different than the withholding clause for cost-type contracts in that it requires an affirmative action by the contracting officer before any withholds are made - a unilateral contract modification. The fee withhold on cost-type contracts is automatic. In practice, this T&M contract withholding clause is used frequently but by no means universally.

For contractors to which this clause applies, policies and procedures to ensure proper withholds are made from billings, is essential to an adequate billing system.

Mathematical accuracy and error free. As a final check of a contractors billing system, the auditor will determine whether the billings are mathematically correct and error free. This would include quantity time price extensions, proper billing rates or T&M rates, proper dates, voucher numbers in sequence, etc. One would think that with modern spreadsheets and other reporting tools that error rates would be insignificant but they're not. This is still a problem area for small contractors especially.

A billing system with reported inadequacies could render a contractor's accounting system inadequate as well and jeopardize its chances of winning contracts. But it doesn't have to come to that. A little thought and attention now can ensure that billings meet the Government's desired attributes.

Billing System Adequacy - Part 3

Today we will resume our series on the attributes of billing systems for small and medium-sized Government contractors and subcontractors. These attributes would also apply to large (major) contractors but the Government's expectations for such contractors are much more involved and detailed than those for non-major contractors. If you missed Parts 1 and 2, click here and here, respectively.

Billings can be reconciled to cost accounting records for both current and cumulative amounts. This requirement should be obvious but surprisingly, many contractors (and subcontractors) have been known to base their billings on something other than incurred costs. Also, some accounting software applications (such as QuickBooks) allow changes to prior periods with little or no documentation to explain the debits and credits. When that happens, cumulative costs will no longer reconcile with cumulative billings.

Subcontractor invoices are included only if payments are made in accordance with subcontract terms and conditions. The idea here is that contractors must develop and maintain procedures to ensure that subcontractor and vendor costs are only included in billings if payments to the subcontractor or vendor will be made in accordance with the terms and conditions of the subcontract or invoice and ordinarily within 30 days of the contractor's payment request to the Government. Auditors will often request Accounts Payable aging schedules to help with this analysis. Also, while the actual contract provision  uses the term "ordinarily within 30 days", the Government tends to overlook the significance of the word "ordinarily" and hold out 30 days as firm.

Billings are consistent with contract terms. Sometimes contractors (and subcontractors) forget to consider the terms of the contract when preparing billings. It is imperative that contractors develop and maintain a robust contract briefing system. Amounts billed cannot exceed any contract, work order, funding ceiling, or any other contract ceiling amount. For example, almost every cost-reimbursement contract contains the provision at FAR 52.222-2, Payment for Overtime Premium. This provision limits the amount of overtime a contractor may charge to the contract. Usually, the amount is zero. Other provisions often overlooked include:

1. Restrictions on billing frequency
2. Special withholding provisions
3. Contractual unallowable costs

Contractors that don't read their contracts are at risk for billing system deficiencies.

Click here for the concluding part in this brief series on billing system attributes.

Billing System Adequacy - Part 2

The billing system is often considered part of the accounting system. After all, any billing based on incurred costs is derived from the accounting records. The Government usually disaggregates the two systems when reviewing large contractors but reviews them as one system for smaller contractors and for preaward accounting system surveys.

Yesterday, we began a discussion on billing system attributes that the Government considers necessary in order for a billing system to be considered adequate. In Part 1, we discussed the requirements for monitoring actual costs against contract ceilings and for ensuring annual incurred cost submissions are timely submitted. If you missed Part 1 of this series, click here. Today we're going to pick off a few more system attributes.

Billings are submitted using "approved" billing rates and the "approved" billing rates are reasonable. Most contractors know and understand that if the contract auditor will be provisionally approving cost reimbursement vouchers, he will also expect that the contractor submit provisional billing rates for review and approval and once approved, will consistently use the approved rates until circumstances require that they be adjusted (either up or down). One key aspect of this requirement is the need for contractors to monitor their billing rates against the year-to-date rates and their expected or anticipate final year-end rates and adjust them if differences become too great. Sometimes, contractors just assume that once they have approved billing rates, they are free to use those rates for the entire year, regardless of what happens. Failing to monitor rates and/or ignoring significant differences will likely be considered a billing system deficiency.

Billings are reconcilable to accounting records. This should really go without saying but we've seen numerous examples where contractor are preparing billings based on something other then their accounting records. For example, one common deficiency is where billings are based on negotiated labor rates rather than actual labor charged to the contract.

For cost-reimbursable costs, billings are submitted only for paid costs. In cost-type contracts, there is an expectation that the contractor pays employee salaries and pays vendor invoices prior to requesting reimbursement from the Government. There are some exceptions to this. The applicable contract clause, FAR 52.216-7(b)(1) provides the following:

For the purpose of reimbursing allowable costs, the term "costs" include only those recorded costs that, at the time of the request for reimbursement, the Contractor has paid by cash, check, or other form of actual payment for items or services purchased directly for the contract. When the Contractor is not delinquent in paying costs of contract performance in the ordinary course of business, costs incurred, but not necessarily paid for supplies and services purchased directly for the contract and associated financing payments to subcontractors, provided payments determined due will be made in accordance with the terms and conditions of a subcontract or invoice, and ordinarily within 30 days of the submission of the Contractor's payment request to the Government.

We have seen situations where auditors will closely scrutinize vendor payment information to determine whether a contractor has been delinquent in paying for supplies and services. Contractors may be requested to provide an Accounts Payable aging schedule in connection with this audit step.

Next week we will continue our discussion on billing system attributes. Go read Part 3.

Billing System Adequacy

Its been awhile since we specifically addressed billing systems and the criteria that the Government uses to determine whether a particular billing system is adequate for the determining the proper reimbursement amounts for cost-type contracts. We've discussed it in connection with requirements for accounting systems. Recently DCAA (Defense Contract Audit Agency) revised its audit procedures for determining accounting system adequacy and has enhanced the audit requirements specific to billing systems.

By way of background, DFARS (DoD FAR Supplement) 242-7503 requires the contracting officer to include the clause at DFARS 252.242-7006, Accounting System Administration, in solicitations and contracts for cost reimbursement, incentive type, time-and-materials, labor-hour contract or a fixed-price contract with progress payments made on the basis of costs incurred by the contractor or on a percentage or stage of completion. Contracting Officers are required to determine if contractors with the accounting system clause comply with the DFARS accounting system criteria. Contracting officers use this determination to assess whether a contractor is a responsible prospective contractor, as required by FAR Part 9. The contracting officer will base this determination, in part, on advice from DCAA.

The first thing an auditor is directed to assess is whether the contractor monitors contract expenditures against contract limitations on price. This is a requirement of the various limitation of costs clauses at FAR 52.216-5, -6, -7, etc.

Limitation of costs applies to fully funded cost reimbursement contracts. The clause requires a contractor to notify the Government when it expects in the next 60 days to have spent 75 percent of the estimated cost, or expect expenses to be greater or substantially less than previously estimated. The clause allows variations in the number of days, between 30 and 90 days and variations in the percentage between 75 and 85 percent.

This is a process that is fairly simple to set up but surprisingly, many contractors fail to do so. Some high-end government-centric accounting software programs have integrated this capability but even with QuickBooks and Excel, its easy to implement. Contractors just have to make a practice of doing it. Now if you are a very small contractor with one or two contracts, you probably know - you intuitively know how your expenditure burn rate is stacking up against contract ceilings. That's not good enough for the auditors - they want to see a written policy and adherence to that policy.

The next thing the auditor will assess when reviewing a contractor's billing system is to determine whether the contractor is up to date in submitting its annual incurred cost proposals. This is important because the indirect rates used for billing purposes must be adjusted to reflect the final rates from the incurred cost submission. If the final rates are lower than the provisional billing rates, the Government is harmed. If final rates are higher than billing rates, the contractor is harmed. You might think that the Government wouldn't care too much if the contractor were harmed but those rates do impact the limitation of cost monitoring requirements discussed above. The Government really wants to know its true exposure under cost type contracts.

Tomorrow, we will continue our discussion on the criteria that make up an adequate billing system for Government contracts.

Go on to Part 2.

Accelerating Payments to Small Business Subcontractors - Final Rule

Here's some good news for small business subcontractors. The FAR committees have issued their final rule regarding the acceleration of payments from prime contractors to small business subcontractors. Its been almost a year since the proposed rule was published - about time, no? This new rule applies to all contracts, even those for commercial items.

The new clause requires that prime contractors, upon receipt of accelerated payments from the Government, to make accelerated payments to small business subcontractors, to the maximum extent practicable, after receipt of a proper invoice and all proper documentation from small business subcontractors. This new provision does not provide any new rights under the Prompt Payment Act (still 30 days).

If you parse this clause, you can see that there is a lot of "wiggle room" for prime contractors. They might receive their expedited payments but forget to pass that along to their subs. Consider these:

1. Maximum extent practicable - what does this really mean? What if the prime contractor doesn't have sufficient resources to process expedited subcontractor payments? What if the accounts payable system requires extensive modification?
2. After receipt of "all proper documentation" - Any business, if that is their bent, can find ways to prolong the period in which they make payments.

With this in mind, the question arises as who will enforce the new rule. There is nothing in it that provides a Government party to address the prime's failure to accelerate payments to small business subcontractors. There is no penalty, there is not "audit" to ensure compliance, nor are there any performance standards to which prime contractors will be held.

There is some remedy available under FAR 32.112, Subcontractor assertions of nonpayment. That clause provides two remedies: i) the contracting officer will "encourage" the prime to pay its bills and ii) the Government may withhold payments from the prime. Well, that's weak and ineffectual and never happens. Or, the Government could discontinue accelerated payments to the prime contractor. That remedy doesn't help anyone.

So, suffice to say that small business subcontractors suffer at the mercy of their primes.

Accounts Payable Aging Schedules

An accounts payable aging schedule is used for listing the amounts that you owe your vendors and suppliers. Generally, it breaks down accounts payable by what is current, and what is 30, 60, and 90+ days overdue. Obviously, no company wants to be overdue in their payments to vendors. For Government contractors with contracts that are reimbursed based on cost or progress payments, the Government doesn't want the company to be overdue in its payments to vendors either. Yesterday, we discussed the consequences of asking for reimbursement from the Government before paying the expenses for which reimbursement was requested.

Auditors will, from time to time, perform testing to ensure that contractors are making timely payments against their invoices. They have a number of procedures they can perform. One procedure they might perform is to verify that there are no delinquent vendor invoices. An auditor might request accounts payable aging schedules to determine the extent of overdue invoices. The auditor might request several month-end schedules and might also request a current (interim) aging schedule. While aging schedules are inconclusive when it comes to determining whether contractors are complying with the requirement to bill only for expenses that they have already paid or expenses that have been accrued and will be paid in the normal course of business, the schedules can, if showing overdue invoices, lead the auditor to ask more questions.

Auditors have been instructed to be careful when reviewing accounts payable aging schedules. First, the auditor needs to test the reliability of the aging report. In other words, contractors could enter bogus due dates into their accounting systems far into the future and the invoice would not show up as late. In addition, DCAA says that Generally Accepted Accounting Principles (GAAP) allow for the write-off of liabilities. Now this one leaves us puzzled. We cannot think of any situation where GAAP would allow the write-off of accounts payable. If you can think of a situation, please comment to this posting. There could be returns of some items but returns would be reflected on aging schedules.

Contractors should exercise care in entering vendor/supplier invoice due dates into their accounting system. It's important for effective cash management (paying bills on-time but not too early) and for supporting requests for reimbursement.

Pay Your Invoices When Due - Or Else....

DCAA recently issued an audit alert telling its auditors that if a contractor doesn't pay its bills within "... the ordinary course of business (ordinarily within 30 days of the request for payment to the Government)" that auditors should question the amounts and to " ... consider whether this is a fraud risk indicator."

The full text of the 'alert' can be read here.

According to FAR 52.216-7(b)(1), Allowable Cost and Payment, the term "costs" for purposes of reimbursement, includes two things. First, "costs" include recorded costs that, at the time of the request for reimbursement (e.g. a public vouchers and progress payments), the Contractor has paid the bill by cash, check, or other form of actual payment. Secondly, when the contractor is not delinquent in paying its bills in the ordinary course of business, "costs" include those that are incurred but not necessarily paid for supplies and services purchased directly for the contract. In this second case, the payments will be made in accordance with the terms and conditions of a subcontract or invoice, and ordinarily within 30 days of the contractor's payment request to the Government.

Now, DCAA is instructing its auditors to go out and design some audit tests to determine whether contractors are in compliance with FAR 52.216-7(b)(1). And, if the auditors find non-compliance, they are to suspend the costs using the DCAA Form 1 and must consider the likelihood that fraud has occurred. If there is a suspicion, the auditor must refer it up the chain using the DCAA Form 2000.

So here's the problem. Auditors like to focus on the "ordinarily within 30 days" criteria and ignore the first criteria; "payments made in accordance with the terms and conditions of the subcontract or invoice." We have seen quite a number of subcontracts for example that have payment terms of 30 days after the prime contractor has been reimbursed by the Government. Obviously, that's going to stretch out much longer than 30 days after receipt of the subcontractor invoice - we've seen subcontractor payments mad 90 days and longer. Also, not all vendor invoices have terms like "Net 30". Terms are often negotiable and some contractors have negotiated very favorable terms with their vendors.

We recommend that contractors perform a risk assessment to ascertain their level of compliance with this contract provision. Its better to know your vulnerabilities and fix them then to have them discovered by a contract auditor.

Accelerating Payments to Small Business Subcontractors - Policy Extended

About a year ago, we reported on OMB's initiative to accelerate payments to small business subcontractors. The initial program was set to expire this month (July 11th). OMB just announced at extension of the policy for another year. Essentially, this directive encouraged expedited payments to prime contractors so that those contractors, in turn, could expedite payments to its subcontractors, especially its small business subcontractors.

According to the OMB (Office of Management and Budget) "... this initiative is part of the Administration's ongoing commitment to supporting small business growth and prosperity, as an engine to drive economic activity and job creation". Under the policy all Executive Branch agencies (including the Department of Defense) should, to the full extent permitted by law, temporarily accelerate payments to all prime contractors - with a goal of paying them within 15 days of receipt of "proper invoices" in order to allow them to provide prompt payments to small business subcontractors.

Some agencies have incorporated clauses in their prime contracts that require contractors to accelerate payments to their small business subcontractors when they receive accelerated payments from the government. However, small business subcontractors we've talked to have not yet seen any accelerated payments as a result of this policy. For them, its business as usual.

From a Government oversight perspective, this is one of those provisions that would be nearly impossible to monitor. Contract administrators are not staffed to go out looking for compliance. DCMA is not going to send someone out to ensure a contractor, who has benefited from accelerated payments, is, in turn, accelerating payments to its subcontractors.

From a contractor's perspective, this policy would require significant changes to its business systems. It would need to set up some kind of exception system to identify contracts subject to accelerated payments and then, if it received an accelerated payment from the Government, it could, it turn, accelerate payments to small business subcontractors. The transient nature of this policy (one year but now extended for one more year) makes it unlikely that contractors could justify the cost required to modify existing systems.

As part of this policy, OMB is asking agencies to provide bi-annual reports on their progress in making accelerated payments "...including steps the agency has undertaken to ensure that small business subcontractors are paid in a prompt manner. Good luck getting meaningful data on that.