Senator McCaskill to Hold New Hearing on DCAA

Sen. McCaskill's Subcommittee on Contracting Oversight (The Senate Committee on Homeland Security and Governmental Affairs) will be holding a hearing tomorrow on "Improving Federal Contract Auditing". According to the committee's website,

The hearing will examine how federal agencies use contract audits to detect and prevent waste, fraud, and abuse in government contracts. In particular, the hearing will review the findings of the Subcommittee’s ongoing investigation of the type and number of contract audits at federal agencies. The hearing will also examine the role played by the Defense Contract Audit Agency (DCAA) in performing contract audits for agencies other than the Defense Department.

As you might recall, this is the Senator who in a previous hearing called the deficiencies disclosed in DCAA audits "capital crimes" and tweeted "the top of my head is about to pop off". It wouldn't surprise us if there will be more quotable moments at this hearing.

If you would like to watch the hearing live, follow this link. Its starts at 2:30 PM (East Coast Time).

On a somewhat related note, contractors are now complaining that DCAA has gotten too strict. If you missed the recent Washington Post article, follow this link. The gist of the article is that DCAA is increasing its levels of transaction testing and contractors are spending more time and effort to be responsive to those queries.

Auditor Jargon Part 6 - Material and Immaterial

The terms "material" and "immaterial" are part of the accounting lexicon. Accountants and auditors use these terms with hardly a passing thought but in a way that is readily understood among themselves. The terms represent well established concepts used to assess the significance of whatever cost is being examined at a particular moment. Materiality enters into risk assessments, in deciding whether to pursue a "finding", or whether to report an internal control deficiency. If something is determined to be immaterial, its not going to be pursued, quantified, or reported upon.

To illustrate, suppose you buy a $10 waste basket that will last 10 years. The accounting matching principle requires that you record the asset and depreciate it over those 10 years at $1 per year. The materiality principle allows you to expense the entire $10 in the year it is purchased. No one is going to get excited about $1 per year. Likewise, an auditor reviewing costs charged to Government contracts will focus on large dollar items because low cost resistors, capacitors, machine screws, or lubricating oil isn't going to significantly affect costs charged to the Government.

In financial reporting (e.g. a company's audited financial statements) the auditor issues an opinion on the financial statements as a whole. The opinion does not state that the financial statements are accurate down to the nickle. The opinion states that the financial statements present fairly in all material respects the financial position of the company. Determining what is material or immaterial therefore requires the exercise of professional judgment.

While the Financial Accounting Standards Board (FASB) and the Cost Accounting Standards Board (CASB) have refrained from giving quantitative guidelines for determining materiality, a few common standards have developed in the accounting industry and public accounting practice. One of those is the five percent rule; an error or misstatement equal to 5 percent of pretax net income or gross profit, or amount proposed.

While avoiding definitive guidelines, the Government, through the CAS Board, has issued some guidelines for assessing materiality (see CAS 9903.305)

In determining whether amounts of cost are material or immaterial, the following criteria shall be considered where appropriate; no one criterion is necessarily determinative:

• The absolute dollar amount involved. The larger the dollar amount, the more likely that it will be material.
• The amount of contract cost compared with the amount under consideration. The larger the proportion of the amount under consideration to contract cost, the more likely it is to be material.
• The relationship between a cost item and a cost objective. Direct cost items, especially if the amounts are themselves part of a base for allocation of indirect costs, will normally have more impact than the same amount of indirect costs.
• The impact on Government funding. Change3s in accounting treatment will have more impact if they influence the distribution of costs between Government and non-Government cost objectives than if all cost objectives have Government financial support.
• The cumulative impact of individually immaterial items. It is appropriate to consider whether such impacts:
• Tend to offset one another, or
• Tend to be in the same direction and hence to accumulate into a material amount.
•  The cost of administrative processing of the price adjustment modification shall be considered. If the cost to process exceeds the amount to be recovered, it is less likely the amount will be material.

CAS 409 - Depreciation of Tangible Capital Assets

CAS 409 - Depreciation of Tangible Capital Assets. CAS 409 is the second half of the capitalization/depreciation standards. Yesterday we discussed CAS 404, Capitalization of Tangible Assets and today we discuss how those capital assets should be depreciated. This Standard came about in order to "enhance objectivity and consistency" in allocating depreciation costs to Government contracts. For companies with a significant number of capital assets, this standard will require extensive record-keeping.

The first thing the standard requires is that contractors estimate residual values for all assets (or groups of assets). Residual value is deducted from capitalized value to determine the depreciable cost base. The Standard generally prohibits contractors from depreciating assets below their residual value unless residual values are immaterial. .

The next thing contractors need to determine is how long the assets are going to last - the estimated service life. The estimated service life of the tangible capital asset, over which the depreciated cost is assigned, must reasonably approximate the actual period of usefulness to its current owner, considering such factors as obsolescence and required quality and quantity of output. Here's where it gets tedious. The standard requires contractors to maintain adequate records which identify the age of the asset or asset group at retirement or withdrawal from active use. These records should contain such information as asset acquisition/disposition dates, date asset was withdrawn from active service, and any other factors that directly influence asset lives.

If supporting records are not available on the date the contractor must first complywith the standard, the estimated service lives should be those used for financial accounting. However, the required supporting records must be developed by the end of the second fiscal year after that date and used as a basis for estimated service lives on assets subsequently acquired. When a new asset is acquired for which the contractor has no available data or prior experience, the estimated service life must be based on projection of the expected useful life using IRS Revenue Procedure Guidelines.

After determining residual values and useful lives, contractors must then determine the depreciation methodology. Contractors may select any appropriate method of depreciation which reflects the pattern of consumption of services over the life of the asset. For example, an accelerated method is appropriate where the expected consumption of services is greatest in the early years of the asset life. The method used for financial accounting is usually appropriate for contract costing unless it does not reasonably reflect expected consumption.  The method used for income tax purposes is almost never appropriate for contract costing purposes because it does not approximate the consumption of services over the life of the asset.

Depreciation costs are generally allocated as indirect costs to the cost objectives for which the assets provide service. They may be charged directly to cost objectives at average rates only if the charges are based on usage and the costs of all like assets used for similar purposes are also charged directly. Depreciation costs for assets included in service centers, where significant, must be charged to the service center.

CAS 404 - Capitalization of Tangible Assets

CAS 404 - Capitalization of Tangible Assets. Cost Accounting Standard 404 establishes criteria for determining the acquisition costs of tangible assets which are to be capitalized. It does not cover depreciation or disposition of fixed assets. Depreciation and disposition is covered under CAS 409 which we will look at tomorrow.

This standard requires contractors to capitalize the acquisition cost of tangible assets in accordance with a written policy that is reasonable and consistently applied. There is an emphasis here and an expectation that the policy will be in writing. The written policy must include the following:

1. A minimum service life criterion which shall not exceed two years but which may be a shorter period. This is logical. Companies "expense" rather than "capitalize" short-lived assets.
2. A minimum acquisition cost criterion which shall not exceed $5 thousand but may be a smaller amount. The acquisition cost criterion is something that contractors should carefully consider and probably discuss with their IPAs (Independent Public Accountant). A $5 thousand capitalization threshold could significantly distort the financial statements of small businesses. Based on our experience, a $1 thousand capitalization threshold seems to be very common among small businesses.
3. Identification of the asset accountability units to the maximum extent practical. An "asset accountability unit" is defined elsewhere in CAS 404 as a tangible capital asset which is a component of plant and equipment that is capitalized when acquired or whose replacement is capitalized when the unit is removed, transferred, sold, abandoned, demolished, or otherwise disposed of. Typically this applies when there are buildings or complex manufacturing equipment.
4. Establishment of minimum dollar amounts for the capitalization of original complements of low cost equipment and for betterments and improvements.  "Original complement of low cost equipment means a group of items acquired for the initial outfitting of a tangible capital asset or an operational unit, or a new addition to either. The items in the group individually cost less than the minimum amount established by the contractor but in the aggregate, represent a material investment.

CAS 404 also requires that "acquisition costs" include not only the purchase price but all costs necessary to prepare the asset for use. This includes the cost of placing the asset in location and bringing the asset to a condition necessary for normal or expected use such as shipping, initial inspection and testing, installation, and similar expenses.

Thirdly, CAS 404 requires that costs incurred subsequent to the acquisition of a tangible capital asset which result in extending the life or increasing the productivity of that asset (e.g. betterments and improvements) shall be capitalized. Costs incurred for repairs and maintenance to a tangible capital asset which either restore the asset to, or maintain it at its normal or expected service life or production capacity shall be treated as costs of the current period. This is perhaps the most contentious aspect of the Standard because it requires the exercise of judgment. When does an expenditure extend the life or increase the productivity of the asset and when does the expenditure merely represent a repair cost?

CAS 404 is not highly technical but there have been a number of contractor noncompliances over the years. The ones that we have seen involve inadequate written policies and procedures (i.e. the written policies and procedures did not cover the minimum requirements) and a disagreement over the definition of "repair and maintenance" (it was too broad and included elements of "betterments and improvements").

2011 Standard Mileage Rates

Last month, the Internal Revenue Service issued the 2011 optional standard mileage rates used to calculate the deductible costs of operating an automobile for business.

Beginning on Jan. 1, 2011, the standard mileage rates for the use of a car (also vans, pickups or panel trucks) will be 51 cents per mile for business miles driven. This is a reduction from the 2010 rate of 50 cents per mile but still well under the 2009 rate of 55 cents per mile. The mileage rate for 2011 reflect generally higher transportation costs compared to a year ago. It is based on an annual study of the fixed and variable costs of operating an automobile.
 
If gasoline prices keep rising as they have in the past month or so, we may see a mid-year adjustment to this rate like we saw in 2008 where the rate was 50.5 cents per mile for the first half of the year and 58.5 cents per mile for the second half.

FAPIIS Information Set to Go Public

Last April, the Government launched its contractor responsibility database called FAPIIS (Federal Awardee Performance and Integrity System). The purpose of this database is to enhance the government's ability to evaluate the business ethics and quality of prospective contractors competing for Federal contracts. Access has been limited to Government acquisition personnel for use in making responsibility determinations prior to award of a contract. 

The FAPIIS data base tracks five years worth of contractor misconduct and performance data. It includes criminal, civil, and administrative proceedings (input by contractors and prospective contractors through the CCR system), past performance evaluations, records of suspensions and debarments, administrative agreements issued in lieu of suspension or debarment, nonresponsibility determinations, terminations for default, defective pricing determinations, and instances where a contractor's behavior "might" have put its employees in harm's way. Also, cases where procurement officials denied or reduced contractor's award fees because of reckless or negligent behavior must now be disclosed. For contracts above the simplified acquisition threshold (currently $150 thousand), contracting officers must check the FAPIIS data base and document (in writing) its responsibility determination.

On January 24, 2011, the FAR Councils published an interim rule that will make all information in the FAPIIS database, except for past performance data, publicly available on April 15, 2011. The actual wording states that all information posted by contractors, offerors, and the Government after April 15, 2011 will be made publicly available which presumably means that data already in the database will not be made available to the public. There is a 60 day public comment period however since this new regulation is required by statute (section 3010 of the Supplemental Appropriations Act of 2010), don't count on significant revisions.

As expected, Government watchdog groups are enthusiastic about the increased transparency available through this new regulation while contractors and industry groups are not. A PSC (Professional Services Council) representative stated that "Making this data public opens the door to all kinds of misperceptions, misunderstandings and even mischief.” The Government is aware of these concerns and is emphasizing the importance of ensuring the integrity of the data base, cautioning procurement officials to redact company proprietary data, avoid information related to pending litigation, and give "thought and consideration" to the information they enter.

If you would like more information on FAPIIS, watch this short Federal Acquisition Institute trailer.