Allowability of Consultant Costs Does Not Necessarily Depend Upon the Existence of "Work Product"

Earlier this month, the ASBCA (Armed Services Board of Contract Appeals) published its decision on a wide range of cost issues that were disallowed by a DCMA (Defense Contract Management Agency) administrative contracting officer (ACO). The contractor, Technology Systems, Inc. (TSI) challenged the ACO's decision, winning on some of the issues and losing on others. The decision is very informative in helping Government contractors understand and apply FAR cost principles and we will spend a few days discussing various aspects of the decision.

Today we start with the ASBCA position on what constitutes "adequate support" for professional and consultant service costs.

SMI was a consultant hired by TSI to provide it with both marketing and lobbying services. It had separate agreements with TSI for each and invoiced TSI separately for each. The contracting officer disallowed about $51,000 for the marketing services on the grounds that TSI did not provide enough documentation to permit an understanding of the work performed nor did it provide the "work products" and other itesm that the ACO believed were required in accordance with the provisions of FAR 31.205-33(f)(2) and (3).

FAR 31.205-33, Professional and consultant services costs provides that fees for services rendered are allowable only when supported by evidence of the nature and scope of the service provided and that evidence necessary to determine that work performed is proper and does not violate law or regulation shall include agreements, invoices, and work products.

That seems pretty clear, right? Not so fast. Here's what the Board ruled:

The government labors under the false impression that the FAR requires a consultant to create "work product" merely for the purposes of proving its costs. Though the FAR language in question is not as clear as we might like, it can be read - as we read it here - to impose no such requirement. Moreover, we have factually found the invoices submitted by TSI to be adequate to support a finding that TSI incurred the charged costs for SMI's marketing activities.

The government makes a superficially persuasive argument, that the FAR's statement that the evidence necessary to determine that the work is proper "shall include ... work products" and related documents, makes the provision of such documents mandatory. The problem with this interpretation of the FAR is that it does not account for the case in which such documents were never created by the consultant. Moreover, it does not account for the case where, as here, the invoices include the data that the FAR defines as work product, such as persons visited and subjects discussed. We further note, that DCAA's own audit manual reflecting the government's own interpretation of this FAR requirement, provides that "the auditor should not insist on a work product if other evidence provided is sufficient to determine the nature and scope of the actual work performed.

Thus, we conclude that FAR 31.205-33(f) may require the provision of a consultant's work product, if it exists, but is not so rigid as to require its creation when it would not otherwise be necessary for the consultant to perform its duties. To be sure, any lack of work product makes it more difficult for a contractor to prove that it incurred the costs for which it seeks compensation, and the lack of work product in an instance where the consulting work was of such a scale or scope that work product would be expected may properly subject the costs to question. As with most things, the proper amount of documentation and work product to be expected will largely depend on the scope of work performed, and we do not conclude that the FAR intended to impose "make work" upon consultants that would only lead to higher costs to the contractor which would then be imposed upon the taxpayer.

The burden of supporting professional and consultant service costs (as with any costs charged to Government contracts) is squarely on the contractor. However, if, as in this case, there is no formal work product, FAR allows for alternative evidence to support the nature and scope of the actual work performed.

The full ASBCA decision may be downloaded here.

Fraud Indicators Related to Professional and Consulting Services

We have discussed on these pages several times about the importance of compiling and maintaining documentation to support professional and consultant service costs. This is one of the FAR cost principles where auditors often find "low hanging fruit" because the principle requires three forms of documentation; an agreement, an invoice, and evidence of work performed. Although auditors have been told recently to lighten up a bit with respect to "evidence of work performed", consulting costs continue to be a "high risk" area for potential audit findings and cost recoveries.

Professional and consultant services are those services rendered by persons who are members of a particular profession or possess a special skill and who are not officers or employees of the contractor. Contractors hire consultants for a multitude of services (such as legal, economic, financial, or technical).

But did you know that the Department of Defense Office of Inspector General (OIG) considers it to be a high risk for contract fraud? It is one of the few cost principles that has its own listing of fraud indicators - conditions that if existing will require the contract auditor to dig deeper or expand its audit coverage and make referrals for investigation, if warranted. Contract auditors are, in turn, required to "consider" these fraud indicators when planning their audit procedures.

According to the OIG, contractors may be hiding payments for illegal activities by charging them as consultant fees and maintaining no or only minimal supporting documentation. The contractor's possible objective in not maintaining adequate support is to encourage the auditor to question the cost rather than spend the time identifying the true nature of the payments.

These seven fraud indicators include the following:

1. No formal signed agreements or contracts; however, large sums paid for "services rendered" based on invoices with few specifics.
2. Formal agreements or contracts exist but are vague as to the services to be rendered, and no other documented support, such as detailed invoices, trip reports, or studies, exists to justify the expenses.
3. Services paid for were used to improperly obtain, distribute, or use information or data protected by law or regulation.
4. Services paid for were intended to improperly influence the content of a solicitation, the evaluation of a proposal or quotation, the selection of sources for contract award or the negotiation of a contract, modification or claim. It does not matter whether the award is from the Government, a prime contractor, or any tier subcontractor.
5. Services paid for were obtained or performed in some way that violated a statute or ergulation prohibiting improper business practices or conflict of interest.
6. Services paid for violated a Federal, state, or local statute or regulation.
7. Services paid were recorded in unusual accounts or cost objectives.

Consulting Costs - What to Expect from an Audit

For the past couple of days, we have been discussing professional services and consulting costs, the risks associated with those costs from the Government's standpoint, factors that the contracting officer must consider when evaluating the propriety of such costs, and questions the contract auditors try to answer as they audit the costs. Today we want to tie up a few loose ends on this subject as we complete the series.

If you missed the first two parts of this series, you can read them here and here.

What are "sensitive" consultants?

DCAA (Defense Contract Audit Agency) has compiled a listing of sensitive consultants based on overall agency audit experience. The ranking, shown in decreasing order of sensitivity include:

• lobbyists
• sales/marketing
• management services (excluding CPA firms)
• legal
• technical/engineering
• accounting, CPA firms, actuaries, and insurance

You can be certain, that if you claim any costs for these categories of professional service and consulting costs, the auditor and contracting officer will be asking a lot of questions.

How does the auditor develop the universe of consultants?

Contractors do not typically collect all professional service and consulting costs into one account. Such costs can be scattered among many accounts such as legal, accounting, marketing, outside services, and may also be charged direct to contracts under subcontractor or again, outside services. It would not be easy for the audit to compile an accurate listing. So, usually, the auditor will ask the contractor to provide a listing. Then after the listing has been provided, the auditor will likely ask for copies of the 1099 filings as a way of cross-checking contractors' representations.

What other audit evidence might an auditor request besides the agreement, invoice, and evidence of work performed?

Auditors have been know to request copies of consultant travel and trip reports. With these reports, auditors can determine whether there is sufficient information to establish a link to activity that benefits the business or Government contracts. Contractors might have a problem if, for example, a trip report identifies travel to a location that has nothing to do with the contract to which the costs were charged.

If after the auditor is satisfied as to the adequacy of the supporting data, is there anything else to be concerned about?

Yes - reasonableness. The auditor will endeavor to assess whether the fees charged are reasonable. Although "reasonableness" is often subjective, there are means for bench-marking fee schedules. For example, most of the major accounting firms have their rates published on the GSA Schedule. Those are the rates that the accounting firms will charge the Government for any services provided. Auditors have been know to compare the rates charged to them with the rates the same firms charge the Government. If those comparisons are not somewhere in the same ballpark, the auditor might challenge them.

Professional service and consulting costs continue to be a high risk area for contracting officers and contract auditors. Contractors need to ensure that they have adequate systems and internal controls in place to prevent any hint of impropriety.

Consulting Costs - Overview of Audit Guidance

There is a lot more that goes into determining whether consulting costs are allowable under Government contracts than just the "big three" documentation requirements (i.e. consulting agreement, invoice, and evidence of work performed). Yesterday, we listed the eight factors that the Government must consider in deciding allowability (FAR 31.205-33(c)) and today, as we indicated, we will look at how the Government structures its reviews in order to effectively "consider" those factors.

First of all, the contract auditor must have knowledge of the contractor's procurement and subcontracting procedures, including methods of ensuring competition. An important competent of the procurement system is understanding the contractor's procedures used to identify the need for consultants in the first place. After that, its important to fully understand the selection process and finally, the manner in accounting for the costs.

So, how does a contract auditor go about "understanding" and evaluating a contractor's system of internal controls for consultant costs? DCAA (Defense Contract Audit Agency) has gone to the trouble of compiling a list of questions that should be answered as part of a risk assessment. Depending upon how these questions are answered will dictate how much additional work is necessary to audit consultant costs.

(a) Are consultant's hours controlled in the same manner as the contractor's professional labor?

(b) Are time cards required?

(c) Does the purchasing department maintain specifications for purchased services?

(d) Is the organization receiving the service independent of that purchasing the service?

(e) Does the contractor have a written policy explaining prohibited activities by purchasing agents?

(f) Do procedures require complete history files for purchased services?

(g) Do buyers document the purchase order files to explain price variances?

(h) Are purchase orders specific and complete as to work scope, specifications, performance dates, and clauses of any type required by the contract?

(i) Does the contractor have an established policy regarding the types of information and provisions to be included in agreements with outside legal firms?

(j) Do procedures require competitive acquisitions of consultant services?

(k) Does the contractor have a designated reviewer(s) of bills submitted by outside legal counsel and procedures to be followed when the designated reviewer believes the outside legal bills contain duplicative of excessive charges?

(l) Does the contractor use consultants to engage in unallowable lobbying activity? If so, does the contractor identify and exclude such costs from billings, claims and proposals applicable to Government contracts?

Contractors, could you pass these tests?

There has been a lot of abuse over the years of this particular cost category. The Government is very sensitive when it comes to professional and consultant service costs charged to its contracts and contractors that make extensive use of consultants, must also ensure that it has sufficient policies and procedures in place to ensure the propriety of such costs.

Continue on to Part 3.

Consulting Costs - On Beyond Documentation Requirements

Long time readers of this blog will have a pretty good understanding of the specific documentation requirements for professional and consultant service costs found in FAR 31.205-33(f): consulting agreement (i.e. details of the agreement), invoices or billings, and work product. Although DCAA (Defense Contract Audit Agency) recently admonished its auditors to loosen up on strict interpretations by considering other forms of evidence that would satisfy the requirement, (see Consultant Costs - Revisited), this cost category still attracts lots of attention. In the word of one contract auditor, it represents "low hanging fruit" meaning that its an easy target for questioning costs.

When audited, smaller contractors will get by with providing the consulting agreement, invoice, and work product. However, there is a lot more to the cost principle than just the amount of documentation required. The standard includes a listing of factors that the contracting officer must consider in determining whether the cost is allowable in the first place. It is only after these factors have been considered, do the documentation requirements come in to play.

Professional and consultant service costs are not automatically allowable if well documented. They must be reasonable in relation to the services rendered and they cannot be contingent upon recovery of the costs from the Government. In determining the allowability of costs in a particular case, no single factor or any special combination of factors is necessarily determinative. However, the contracting officer shall consider the following factors, among others:

1. The nature and scope of the service, considering the contractor's capability in the particular area.
2. The necessity of contracting for the service, considering the contractor's capability in the particular area.
3. The past pattern of acquiring such services and their costs, particularly in the years prior to the award of Government contracts.
4. The impact of Government contracts on the contractor's business.
5. Whether the proportion of Government work to the contractor's total business is such as to influence the contractor in favor of incurring the cost, particularly when the services rendered are not of a continuing nature and have little relationship to work under Government contracts.
6. Whether the service can be performed more economically by employment rather than by contracting.
7. The qualifications of the individual or concern rendering the service and the customary fee charged, especially on non-Government contracts.
8. Adequacy of the contractual agreement for the service (e.g. description of the service, estimate of time required, rate of compensation, termination provisions).

Now you might be thinking that you've never heard of a contracting officer going to that level of detail in assessing the propriety of claimed professional and consultant service costs. And you might be correct. But DCAA, as the contracting officer's representative will, in cases were professional and consultant service costs are significant. DCAA takes a more systematic approach in assessing these factors with elements of purchasing system criteria thrown in. Tomorrow we will take a look at DCAA's approach methodology.

Continue on to Part 2.

"Purchased Labor" is Not "Consulting Costs"

Yesterday we highlighted new guidance to DCAA auditors that essentially told them to be reasonable and use common sense when evaluating whether professional and consultant services costs are adequately supported (if you missed that blog posting, you can read it here).

There is a related issue in that sometimes, auditors (and contracting officials) use the documentation criteria required in FAR 31.205-33 to evaluate costs that do not meet the definition of "professional and consulting services".

The definition of professional and consultant services, as defined in FAR 31.205-33 means those services rendered by persons who are members of a particular profession or possess a special skill. Examples include those services acquired by contractors (or subcontractors) in order to enhance their legal, economic, financial, or technical positions. Professional and consultant services are generally acquired to obtain information, advice, opinions, alternatives, conclusions, recommendations, training, or direct assistance, such as studies, analyses, evaluations, liaison with Government officials, or other forms of representation.

If the costs being evaluated do not meet this definition, we just quoted out of FAR, they are not "professional and consultant" costs and should not be evaluated using the criteria of FAR 31.205-33.

Here are some examples of costs that are not professional and consulting costs (according to DCAA's newly issued guidance):

1. Temporary accounting services to perform bookkeeping activities.
2. Program management activities for a contract (the individual works directly with contractor employees and contractor management to track and monitor progress on contract performance
3. Outside writers to augment their in-house staff in preparing technical publications.

Each of the foregoing examples represent purchased services or purchased labor. Allowability should be governed by the reasonableness criteria found in FAR 31.201-3, not by the consultant and professional services criteria.

Consultant Costs - Revisited

We have frequently written concerning consultant costs on these pages (see for example this posting from last August). Historically, auditors have loved consulting costs because the language written into FAR 31.205-33 make it easy for them to question costs. That FAR cost principle is one of the few where allowability is predicated upon specific documentation requirements; an agreement, invoices, and work product. Failure to provide any one or more of those, renders the costs unallowable - at least that's the way it typically works. Until, that is, the contracting officer has to make a decision on the contract auditors recommendations. Contracting officers are usually a lot more lenient than auditors as to what level of documentation will satisfy the requirements.

DCAA issued new guidance last month which effectively tells auditors to lighten up a bit. Instead of insisting upon a strict interpretation of "work product" being some formal report that evidences work performed, DCAA is now acknowledging that there are many ways for contractors to satisfy FAR 31.205-33 documentation requirements. DCAA states:

The type of evidence satisfying the documentation requirements will vary significantly based on the type of consulting effort and from contractor to contractor. Therefore, it is important for the audit team to understand that the evidence required from the contractor is essentially the following:

• An agreement that explains what the consultant will be doing for the contractor;
• A copy of the bill for the actual services rendered, including sufficient evidence as to the time expended and nature of the services provided to determine what was done in exchange for the payment requested, and that the terms of the agreement were met. This documentation does not need to be included on the actual invoice and can be supported by other evidence provided by the contractor;
• Explanation of what the consultant accomplished for the fees paid – this could be information on the invoice, a drawing, a power point presentation, or some other evidence of the service provided.
 

DCAA will even accept retroactively prepared evidence:

The contractor may provide evidence created when the contractor incurred the cost as well as evidence from a later period. Audit teams should consider evidence from a later period provided by the contractor, taking care to assess the quality of the evidence (generally, evidence prepared after the fact is less persuasive) and will likely need to obtain additional corroborative evidence. As an example of evidence from a later period, the contractor may facilitate a meeting between the consultant and the audit team to obtain documentation (oral/written) from the consultant regarding what effort they performed (i.e., third party confirmation). The audit team should consider the evidence provided by the consultant, along with other evidence obtained, to determine if the total evidence gathered is sufficient to satisfy the documentation requirements. 

  And consider this statement from the same guidance:

The purpose of the work product requirement is for the contractor to be able to demonstrate what work the consultant actually performed (in contrast to what work is planned to be performed). Although a work product usually satisfies this requirement, other evidence also may suffice. Therefore, if the audit team has sufficient evidence demonstrating the nature and scope of the consultant work actually performed, the contractor has met the FAR 31.205-33(f)(3) requirements even if the actual work product (e.g., an attorney’s advice to the contractor) is not provided. The audit team should not insist on a work product if other evidence provided is sufficient to determine the nature and scope of the actual work performed by the consultant.  

This new guidance should ease the burden of justifying the allowability of consulting costs - it tells auditors to quit being so strident in their interpretations and use some judgment and common sense.