Access to Records

An article in the latest Journal of Accountancy caught our attention. It seems that IRS has "rolled-out" a program to request the QuickBooks or Peachtree file from small business taxpapyers under examination. IRS revenue agents (i.e. auditors) are requesting the complete accounting software files from businesses under audit.

The AICPA (American Institute of Certified Public Accountants) has registered concern over the practice. In many cases, the software file contains data involving more than the year under examination, and the file may contain other data that could be considered private, confidential, and beyond the scope of the pertinent information for the audit. An accounting software file may contain taxpayer's client or customer list. In the case of an attorney or someone in the medical profession, it may contain information clearly considered confidential under the law.

The IRS is not deterred. In a written response to the AICPA, they stated that "it is important an exact copy of the original electronic data file be provided to the examiner and not an altered version. Only an exact copy of the original file includes the unaltered meta data which allows examiners to properly consider the integrity and veracity of the electronic files through use of such means as reports generated by the software program that may help to identify deleted or altered entries. For example, the original data file may provide the date a transaction was originally created, dates of subsequent changes, what changes were made, and the user name of the person who entered or changed that transaction. This type of information is directly relevant to the evaluation of the taxpayer's internal controls."

The IRS suggested that small businesses create a backup file immediately at the close of the audit year. In the even of an audit, the backup process will lessen the amount of data provided to the IRS, The IRS also suggested that prior year information be "condensed" so that it does not provide details. This response does not address the AICPA's concerns about the "proprietary" nature of data included in the the native data files.

This brings up the question concerning the contracting officer's (or the contracting officer's representative, DCAA) right to access the complete accounting system data file. In short, they do not have a right to the files. The data rights granted to the Government under the terms of the contract are limited to information relevant to determining the reasonableness, allocability, and allowability of costs charged to Government contracts. Accounting system files contain much more than that, revenues, profits, customer information, etc). Under no circumstances should a contractor be compelled to turn over its accounting system data files to a contract auditor. If an auditor needs a listing of transactions charged to a particular account, contractors can export to the data to Excel and provide it electronically. Exporting data from the accounting system in Excel format however is not the same as providing the complete data file.

There is also a practical aspect to such a request. The contracting community, and specifically the contract audit organizations) have not deployed accounting software for the purpose of "reading" contractor data files. They have not installed QuickBooks, Peachtree, or any other accounting software. Thus, there would be no way for them to "read" the files once they had them. It is likely then that if you encounter any such request, you are dealing with a rogue element within the organization.

You can read the AICPA letter and the IRS response here and here, respectively.

Interest Penalty for Late Payment

A Governmental Agency that has acquired property or services through contracting from a business concern and has failed to pay for the complete delivery of property or service by the required payment date must pay the business an interest penalty. The Government misses due dates from time to time. When it does, contractors are entitled to interest. Sometimes, the Government paying office calculates the interest and adds it to the amount remitted. But, not always. Contractors need to implement cash management polices and procedures to ensure timely receipt of monies owed it by the Government.

There are several statutes that require the Government to pay this interest penalty; 31 USC 3902(a), the Contracts Disputes Act of 1978, Public Law 95-563, and the Prompt Payment Act of 1982 are some of those.

The interest rate is established by the Secretary of the Treasury and changes every six months. The rate in effect now through the end of the years is 2.5 percent. (July 1 - December 31, 2011).

The interest period is calculated for the period beginning on the day after the required payment date and ending on the date on which payment is made.

Sometimes contractors submit vouchers or payment requests that are rejected by the auditor, contracting officer, or paying office for various reasons. This could be because of mathematical inaccuracies, incorrect billing rates, amounts in excess of contract funding limitations, etc. The contractor must correct the deficiency and resubmit the payment request. For interest penalty calculations, the "clock" begins when an adequate payment request (not the initial request) has been received by the Government paying office.

Interest on Defective Pricing Now Compounded Daily

DoD, GSA, and NASA issued a final rule amending the Federal Acquisition Regulation (FAR) to require compound interest calculations be applied to Government overpayments as a result of defective cost or pricing data.

On September 14, 2009, the U.S. Court of Appeals for the Federal Circuit (CAFC) issued a decision regarding the method of interest calculation on Cost Accounting Standards (CAS) cost impacts (see GATES v. Raytheon Co., 584 F.3d 1062 (Fed. Cir. 2009)). The interest on CAS cost impacts is set by reference in the enabling statute to 26 U.S.C. 6621. The CAFC ruled that the citation led to calculation of the interest using daily compounding.

The Truth in Negotiation Act (TINA) also references 26 U.S.C. 6621 for interest calculation. (See 41 U.S.C. 3507 and 10 U.S.C. 2306a) and so FAR needed to be modified so as to require compounding of interest on Government overpayments as a result of defective cost or pricing data.

This new rule replaces the term ``simple interest'' as the requirement for calculating interest for Truth in Negotiations Act cost impacts with the phrase ``Interest compounded daily as required by 26 U.S.C. 6622.'' Thus, compound interest calculations will be applied to Government overpayments as a result of defective cost or pricing data.

This could have a significant impact on contractors with TINA violations. Often, these issues take years to resolve and if the Government ultimately prevails, the difference between simple and compounded interest could be significant.

Annual Incurred Cost Submissions - Adequacy

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

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

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

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

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

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

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

New Rules Now in Effect for Payment of Fee

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

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

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

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

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

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

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

Getting Your Fixed Fee Paid

There are hundreds of small contractors that have been waiting years for DCAA to audit their annual incurred cost proposals. Right now, DCAA is hopelessly behind in performing these reviews and the Government is contemplating "outsourcing" these audits as a way of catching up. Because incurred cost audits have not been completed, contractors are unable to close out their contracts and collect fee withholds. In some cases, fee withholds are significant to a small company's cash flows.

There is some relief available under existing contract clauses and contractors should be aware of limitations on how much fee can be withheld. For example, FAR 52.216-8, Fixed Fee, states: 

(a) The Government shall pay the Contractor for performing this contract the fixed fee specified in the Schedule.

(b) Payment of the fixed fee shall be made as specified in the Schedule; provided that after payment of 85 percent of the fixed fee, the Contracting Officer may withhold further payment of fee until a reserve is set aside in an amount that the Contracting Officer considers necessary to protect the Government’s interest. This reserve shall not exceed 15 percent of the total fixed fee or $100,000, whichever is less. The Contracting Officer shall release 75 percent of all fee withholds under this contract after receipt of the 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 first thing to note is that the contracting officer "may" withhold fee. The clause does not require that fee be withheld even though many contracting officers and government auditors believe (or assume) it does. If a contracting officer determines that fee must be withheld in order to protect the government's interests, it must modify the contract accordingly. We've written about this in the past. Assuming that fee has been withheld, the contracting officer must release 75% of the withheld amount after the contractor has submitted a certified final indirect rate proposal covering the year of physical completion of the contract.

Finally, the contracting officer may release up to 90 percent of the fee based on past performance.

If you are up to date on your incurred cost submissions but still have contracts with 15 percent of the fixed fee withheld, you should contact your contracting officer to get most of the contract fee released.