Annual Audit Planning Meetings with Contractors

At contractor locations with a significant amount of planned audit activity, the Defense Contract Audit Agency (DCAA) conducts what they term, "Annual Audit Planning and Requirements Planning Meetings" with contractor representatives and contracting officers.

These meetings are typically held during the first quarter of the Government fiscal year (i.e. October -December time frame). At these meetings, the auditors present the various types of audits they plan to conduct in the current year. Applicable audit guidance also instructs them to solicit contractor and contracting officer input into the planned audit schedule.

Regardless of the meetings' ostensible purpose to solicit input from contractors and contracting officers, by the time the meeting rolls around, the audit plan for the year is very much fixed.. We know of no situation where the audit plan was changed as a result of input from either the contractor or the contracting officer.

Even though contractors have no real input into the annual audit plan, these meetings are informative for learning what the auditor(s) plan to do during the year. It is especially important to know which internal control systems will be audited, which CAS standards will be reviewed for compliance, and which contracts have been selected for defective pricing audits (compliance with TINA, or the Truth in Negotiating Act). Knowing this information will help contractors prepare for the audit and compile information and data that is likely to be required/requested.

Many times, contractors sit passively through these meetings, taking a few notes, and nodding once in awhile.   We think it is much better to use this time to engage the auditor. Once the audits begin, auditors are not likely to be very conversant. Now is the time to ask them why they chose to schedule a particular internal control audit, how they view the existing system, what were the results of audit the last time they audited and whether there are any risk indicators currently. When the discussion turns to defective pricing, be sure to ask them your PASS rating and the objective and subjective elements that made up the rating. Challenge the auditors to explain why particular CAS standards are applicable or not applicable.

Sometimes the auditors want to "call it in" rather than face to face. We don't believe that annual planning meetings make efficient conference calls - its too difficult to have meaningful communications. Have the auditors come out and make their presentations.

Feeling the Pinch Yet?

The Office of Federal Procurement Policy (OFPP), part of the Office of Management and Budget (OMB) announced yesterday that contract spending in fiscal year 2012 fell by $20 billion compared to fiscal year 2011.

According to OFPP, seven of the $20 billion came from reductions in management support services such as information technology systems, development, program management and engineering. Savings were also achieved by agencies pooling their purchases to get the same goods and services at lower prices.

The administration is proud of its accomplishments and last Wednesday, announced a new series of initiatives to continue the trend. The focus of the new initiatives is to drive even better coordination of contracting to achieve more savings in buying computers, IT software, janitorial and sanitation supplies, office furniture, building maintenance and operations services, and other professional technical services.

As almost an afterthought, the new initiatives add "To the maximum extent practicable, all strategic sourcing opportunities shall seek to increase participation by small businesses".

Access to Internal Audit Reports

Yesterday, we informed you that the Senate unanimously (98-0) passed the fiscal year 2013 National Defense Authorization Act that included caps on employee compensation. That same bill included a provision that will require defense contractors to provide not only their internal audit reports but also the supporting working papers to Government auditors.

Specifically, Section 843 will ensure that the Defense Contract Audit Agency has sufficient access to contractor internal audit reports and supporting materials in order to

1. evaluate and test the efficacy of contractor internal controls and the reliability of associated contractor business systems, and
2. assess the amount of risk and level of testing required in connection with specific audits to be conducted by the Agency.

Contractors who fail to provide access, risk having one or more of their business systems determined to be inadequate (or disapproved) and would result in billing withholds.

Last August, we wrote a three-part series on internal audits and their value in reducing the amount of audit testing by DCAA (hint: not much). You can read those postings here: Part I, Part II, and Part III. But, the GAO thinks it is important and DCAA cited the general lack of access as one of the issues causing inefficiencies in its audits.

The Senate bill must be reconciled with the House version. It is unknown whether this provision will survive the conference committee.

Compensation Caps

Yesterday evening, the Senate unanimously approved the Fiscal Year 2013 National Defense Authorization Act (NDAA) that includes a provision capping compensation of any contractor employee at $230,000 per year. It will become effective on January 1, 2013 and applies to all contracts including those entered into before, on, or after that date. The House version of the NDAA does not contain the provision. The question now is whether the Conference Committee will leave it in or take it out? Stay tuned.

Continuation of Essential Contractor Services

With all the discussion about sequestration and fiscal cliffs, contractors with DoD contracts might want to check their contracts for the existence of DFARS clause 252.37-7023. DoD Contracting Officers are required to use this clause in solicitations and contracts having essential contractor services. The clause requires the appropriate functional commander or equivalent to specifically identify which functions of a contract are mission essential services. A contractor who provides Government-determined essential contractor services shall have a written plan to ensure the continuation of these services in crisis situations.

“Essential contractor service” means a service provided by a firm or individual under contract to DoD to support mission essential functions, such as support of vital systems, including ships owned, leased, or operated in support of military missions or roles at sea, and associated support activities, including installation, garrison, and base support services. Services are essential if the effectiveness of defense systems or operations may be seriously impaired by the interruption of these services during periods of crisis caused by the changing threat environment, hurricanes, tornados, earthquakes, blizzards, floods, or pandemic influenza, etc.

“Mission-essential functions” means those organizational activities that must be performed under all circumstances to achieve DoD component missions or responsibilities, the failure of which would significantly affect DoD's ability to provide vital services or exercise authority, direction, and control.

When the clause for continuing performance of essential services is incorporated into a contract, the cost of preparing the plan and costs to keep the plan in place, such as potential retainer fees with other service providers and costs related to contracting officer directed training activities associated with testing the effectiveness of the plan, would be valid contract costs subject to the allowability, reason­ableness, and allocability provisions of FAR 31.201 and the cost principles at FAR 31.205.

Since most plans for continuation of essential services will be specific to the contract and contractor, auditors are being instructed to carefully examine the validity of these costs on a case-by-case basis. Most contractors normally allocate the costs of planning for continuing operation of the overall organization as an indirect cost. However, contractors should generally charge planning costs for contractually required continuation of essential contractor services as direct costs. While CAS 402, Consistency in Allocating Costs Incurred for the Same Purpose, requires that each type of cost is allocated only once and on only one basis to any contract, the illustrations at CAS 402-60(b) support that planning for the continuing operations of the overall organization are not incurred for the same purpose in like circumstances as the planning for continuing essential contractor services as required by the contract.


Plan Execution Costs. The contractor is required to segregate and separately identify all costs incurred in continuing performance of essential services in a crisis situation. A contractor has 90 days (longer if approved by the contracting officer) to notify the con­tracting officer of an increase or decrease in costs after he or she has directed continued performance. The parties shall negotiate an equitable adjustment to the contract price as soon as practicable after receipt of the contractor’s proposal. As DFARS 252.237-7023 provides for an equitable adjustment, costs to execute the plan should not be included in price proposals. Auditors are being instructed to question any plan execution costs included in price proposals.

IG Faults DoD Decision to Raise Audit Thresholds

A little more than two years ago (September 2010), the Department of Defense raised the threshold for price proposals requiring audit to $10 million for fixed priced contracts and $100 million for cost-type contracts. Last month, the DoD Inspector General's Office (DoD-IG) issued a scathing report on that decision stating that the Department had not performed a business case analysis to support it.

That decision, according to the DoD-IG will cost taxpayers $249 million per year in lost return on investment from DCAA contract audits.

The audits under the DCAA threshold were given to DCMA (Defense Contract Management Agency) but according to the DoD-IG, DCMA is not prepared to perform contract cost analaysis in place of DCAA and that DCMA cannot reliably report performance. Furthermore, the Department of Defense has no idea whether DCMA has even a remote chance of replicating the $249 million that DCAA could have achieved had the audit thresholds remained at their pre-September 2010 levels. Finally, the DoD-IG found that the Department did not demonstrate why they chose to direct taxpayer resources to DCMA to perform a job that it was not prepared to perform when DCAA had existing infrastructure in place to get the job done.

Perhaps the Department of Defense did not perform a business case analysis for shifting work from DCAA to DCMA but the fact is, DCAA was not getting the job done and their failure was significantly delaying the awards of contracts. The decision was borne more out of frustration than anything else.

The DoD-IG made a number of recommendations including a return to the old audit thresholds. You can read the entire report here.