But lessons to be learned for contrtactors….
But lessons to be learned for contrtactors….
A DCAA auditor recently contacted a client with a concern about their incurred cost submission for 2014, The auditor asked the following (contract information redacted):
1) In comparing on Schedule I to Schedule H, Schedule I, cell G30 ($38,287) and Schedule H, cell P36 ($34,579) are both values for FYE 2014 Costs, Subcontract XXXXXXXXXX. What accounts for the difference between these two numbers?”
If you could not guess, this was the T&M section of the Schedule I. This section of the Schedule I records the government’s costs while the section referred to in the Schedule H records the contractor’s costs. Under any reasonable circumstances they should not tie. A careful reading of DCAA’s own adequacy checklist confirms this (link to Schedule K not H).
Answering this type of question is a conversation I try to have over the telephone or in person. I avoid putting our response in writing due to the fear of focusing the adequacy discussion on the government and not the contractor.
I telephoned the auditor and she immediately agreed with my response but insisted that I reply in writing to provide a record of the response. This is when I guessed that the question originated with her supervisor and not herself. Apparently, a supervisor who survived the DCAA Internal 2008 Adequacy Crisis and is now a supervisor.
I can take this one of two ways:
The following is from the New ICE Manual .
“The following Schedules and information are not required for submittal of an adequate proposal; however, the information will be required to complete the audit. ICE contains Supplemental Schedules A-1, A-2, A-3, A-4, B, C, and O that can be utilized by the contractor to provide information as noted below:
SUPPLEMENTAL MODEL INCURRED COST PROPOSAL INFORMATION
These schedules may be used for comparison of prior year actual costs; however comparative analysis of budgetary data will also be required by the auditor.
Return on Investment (ROI) always proved a concept of limited value and extreme abstraction in government. How does one measure the ROI associated with a paratrooper sitting on the ground at the green ramp waiting to deploy in harm’s way? How is the ROI measured on a nuclear missile resting in its silo?
Several years ago, DCAA adopted ROI as one of its main arguments to defend (or excuse) the quantity and quality of their work to taxpayers. ROI was an alternative to other measurements such as audit productivity, down to 1.06 audits per year per auditor from 1.5 in 2012. Additionally, form your own opinion about the fact that DCAA wins only half of the fights that get past the auditors and are made by someone outside DCAA.
Let us not forget that one of DCAA’s critical missions, and long neglected by their own admission, is to prevent or reduce costs associated with cost findings by auditing by approving or disapproving contractor’s business systems. I argue that developing and subsequent auditing of a compliant accounting system is a major return on investment for both the contractor and government. I will point out that DCAA recently developed and launched new tools that make major strides in this area with preliminary checklist forms and new audit programs that I believe will greatly enhance DCAA’s future efforts in this area.
I question how DCAA measures ROI as they include forward pricing ‘savings’ in the calculation. This is a classic example of counting your chickens before the eggs hatch. If a contractor proposes $100,000 in fringe benefit costs and DCAA only approves $80,000, DCAA counts the $20,000 toward ROI. Unfortunately, when the year ends the contractor may discover the fringe costs proved $110,000 and bill the government for the $30,000 in difference. To further complicate the issue, the incurred cost submission may propose a different number and the subsequent audit even a fourth number.
The irony of all of this is the development of the ROI model contributed to DCAA’s current crisis, the continued replacement of DCAA as incurred cost proposal auditors by outside accounting firms. ROI is now a dangerous temptation in evaluating ‘independent” accounting firms’ “success” in auditing incurred cost proposals.
In recent testimony before Congress, Industry complained that DCAA acted more like a collection agency than auditors. Imagine our response if this becomes formalized as commercial contractors are awarded contracts on their promises regarding return on investment.
 There is no indication that DCAA follows the potential saving through the entire chain. First, they do not report how they calculated the ‘savings’ and given the incurred cost proposal backlog of years, one would wonder about the practicality of going beyond the simplest and first number.
The scratched out areas were discussed in previous articles. Today, I am going to look at the last two areas, “Accrued costs crossing the fiscal year” and “Bonuses”. Again, I am not a lawyer and this is not legal advice. I am an accountant and there may be some accounting advice.
Twice in the ruling the government raises an objection to the allowability of TCI’s costs because TCI accrued them in one year and expensed them in a subsequent year. At least I hope that is the government’s objection as the only reasonable alternative opens up a can of worms that the government would appear blind to.
Here are the two objections:
The ACO also disallowed some of the bonuses because they were paid in March 2008, in the fiscal year after FY 2007, which is the subject of this ICP.
According to the COFD, this prohibition prevented TSI from submitting its legal costs contemporaneously with their being incurred, 15 but the reason that TSI gave the DCAA for submitting the costs in the FY 2007 ICP, instead of in 2006 (when it supposedly became aware of the fact that it was cleared of wrongdoing), was that it “forgot” (R4, tab 16 at 260). Mr. Fletcher (with whom DCAA was dealing and would have been the person who DCAA claimed stated that he “forgot” to include the legal fees in FY 2006) denies ever making such a statement to DCAA (tr. 2/212).
For its part, the government does not dispute the fact that the legal fees for the investigation, as subjected to the 20% discount, would otherwise be allowable (see gov’t br. at 62, 64 ), but argues that the fees were expensed to the wrong year (id. at 62-63).
In the first case, the Board ignored the timing argument and disallowed the bonuses for reasons we will discuss later. In the second case, the Board directly rejected the timing argument in reference to the legal fees and allowed the majority of the fees.
Over the years, I encountered this timing argument from only a couple of DCAA auditors. Auditors raised the argument rarely and we addressed it pretty quickly by responding that GAAP required the accruals. The question displays a limited understanding of accrued accounting which is forgivable in a young auditor working through the differences between cost and expense. It is a bit more difficult to understand when the limited understanding rises all the way up DCAA and into an appeal before the Appeals Board. It is disheartening to look at the Appeals Board teaching DCAA GAAP 101.
Let us start with a simple absolute rule: if a cost is properly accrued and recorded, this is only reconsidered if the original entry is invalidated. An example of invalidation would be a subsequent decision not to pay the accrued expense. I would also note that GAAP enjoys extensive procedures for addressing such a subsequent event.
Legal fees present some unique challenges in government contractor accounting. Legal fees are, in my humble opinion, one of the only reasons for suspense accounts, as I go into detail about in this previous article. As I recommend in this article, legal costs where the allowability is unknown at yearend should be capitalized (after being accounted for tax and financial statement purposes) and expensed out as either claimed or unclaimed when their character is recognized. This would be a GAAP compliant policy in keeping with government contracting requirements.
In order for the government’s argument to make sense — that the contractor “forget” (see above) and the contractor expensed them in the wrong year, there are only three reasonable possibilities: 1) the costs were not on the general ledger or 2) the expenses were not recorded properly in the first place (capitalized instead of expensed), or 3) the expenses were capitalized but not expensed properly (the wrong year).
Obviously, the first issue is the can of worms I mentioned earlier and, if true, we would be experiencing a completely different discussion.
The second possibility is one that major publicly traded corporations are often accused of – unnecessary capitalization to control earnings. Not something a tax paying small business if often accused of, and again the argument here would not be timing but why the expense was capitalized.
As noted above, GAAP enjoys extensive rules to address mistakes surrounding the third possibility and DCAA does not appear to raise these, especially in light of both times DCAA raises timing in this case (bonus and legal fees).
No, DCAA seems to object to the fact that the contractor wishes to charge the government in 2007 but not pay it until 2008.
Hm, isn’t that concept enshrined in the FAR at FAR 52.216-7? The one where a few DCAA auditors chastise contractors for not paying accrued expenses fast enough?
Come on DCAA, the real question is if the contractor reversed the accruals in 2008 before paying them or just expensed them again.
Bonuses or Incentive pay, present unique challenges for contractors. The issue is complicated by the specific and narrow regulations found within the FAR.
The Appeals Board quotes FAR 31-205.6(f) in its entirety but also utilized FAR 31-205.6(a)(6) when they refer to profits:
“This determination is buttressed by evidence that Mr. Fletcher considered the bonus pool to effectively come from company profits and the fact its distribution ca at the whim of TSI’s “in” group, justifying “close scrutiny,” Nolan Brothers, 437 F.2d at 1834, which it simply cannot withstand.”.
Every time a DCAA auditor brings up the ‘distribution of profits’ I respond, or am tempted to respond, that the statute defines the 401(k) as a ‘profit sharing’ plan and that is allowable.
I believe it is proper for DCAA, and in this case the Appeals Board, to use the IRS distribution of profits as a method for assessing unclaimed bonuses, I just wish they understood it better. The IRS standard is directed toward ‘C’ corporations that pay out all of the profits at year end as a bonus to avoid the double taxation inherit in ‘C’ corporations. But the rules work as a good method of determining what is a profit and what is earned compensation.
What every small business contractor wants is the right to award employees, at management’s complete discretion, for a job well done. I imagine the employees would like the same.
The regulations take all the fun out. In order to pass muster a bonus plan must be so well written that it is “an agreement to make such payment”. TCI failed this standard even after they thought they received DCAA acceptance.
So what is a poor small business contractor to do? Why the same thing the huge federal government does: avoid the words “bonus” or “incentive pay”.
Remember the GSA bonus scandals a few years ago? When the federal government handed out millions of dollars to employees despite poor performance? Look for the words “bonus” or “incentive pay” in GSA policies. The word “bonus” is there alongside another program not as extensively defined: “award”.
Contractors are free to develop well written and measurable bonus plans that meet the regulatory requirements. Contractors should also reserve the right to award employees for single or periodic exceptional performance (as does the federal government).
Of course awards are subject to audit and question by DCAA, but under the reasonable and prudent standard plus a possible excessive compensation argument.
DCAA Director Bales testified yesterday before the House Armed Services Subcommittee On Oversight and Investigations. Here is a link to her written testimony: http://docs.house.gov/meetings/AS/AS06/20170406/105777/HHRG-115-AS06-Wstate-BalesA-20170406.pdf
What is not clear is if DCAA is actually caught up. In the era of parsing words within the beltway, she states that there still is a backlog and the hiring freeze makes it impossible for them to catch up.
Best line from the industry testimony so far:
David Berteau, Professional Services Council
“As one of our member companies characterized it, DCAA should focus on being an auditing agency, not a collection agency”
The scratched out areas were discussed in previous articles. Today, I am going to talk about developing findings and documenting consultants’ work products. Again, I am not a lawyer and this is not legal advice.
The fact that I consider this topic worthy of discussion illustrates the reality that the failure of auditors to properly develop findings is an ongoing issue in too many DCAA audits. Way too often, the first time a contractor hears about a proposed finding is when it is proposed.
During a recent DCAA auditor, the auditor thought she could benefit from the research she did on me and my views by announcing her agreement with what she thought was one of my strong assertions:
“Well, we all know that the Contract Audit Manual. is not regulatory and only guidance”.
My response had a visible impact on her: “The CAM is guidance for contractors, but it is your standing orders. I would expect a DCAA auditor to follow those orders.”
Let us see what those standing orders in the CAM say about developing findings:
4-303.1(b) The auditor should discuss preliminary audit findings (e.g., potential system deficiencies, potential FAR/CAS noncompliances, etc.) with the contractor to ensure conclusions are based on a complete understanding of all pertinent facts. These types of discussions do not impair auditor independence and are generally necessary to obtain sufficient evidence to support audit conclusions.
6-708(b). During the course of the audit, significant audit findings should be brought to the attention of, and discussed with, the contractor, and when appropriate with the cognizant principal ACO and CAC, as soon as possible to expedite the resolution process (See 6-902e). The discussions are to ensure that the auditor’s conclusions are based on a proper understanding of the facts and to ascertain whether the contractor/ACO/CAC has any additional information which would support or modify the audit findings. This will enable resolution of the findings to take place prior to the completion of the audit. If agreement on an issue cannot be reached, the contractor should be requested to prepare a rebuttal for inclusion in the audit report. The process outlined above will result in an efficient audit that will conserve both audit and contractor personnel resources.
6-709(b). During the course of the audit, significant audit findings should be brought to the attention of, and discussed with, the contractor, and, where appropriate, with the principal cognizant ACO and CAC, as soon as possible so as to expedite the resolution process (see 6-902e). The discussions are to ensure that the auditor’s conclusions are based on a proper understanding of the facts and to ascertain whether the contractor/ACO/CAC have any additional information which would support or modify the audit findings
I simply cannot stress how many times simple misunderstandings were cleared up because the DCAA field operator brought it to our attention before taking it to their supervisor, and after that writing it up as a proposed finding. Heading off trouble at the earliest stages is an essential aspect of successful DCAA relationships.
One famous example was a DCAA auditor putting together this extensive spreadsheet that “proved” the contractor was calculating social security taxes incorrectly and that highly compensated employees were not paying their fair share of social security tax. He was still pretty embarrassed, but at least he had not written it up and sent it to his supervisor.
No one likes egg on their face and contractors should avoid watching DCAA auditors make fools of themselves. Sometimes this results a stubborn refusal on the part of some DCAA auditors to admit an error, such as my aggregating “Backspace Key Crisis”
In the TSI case, it appears time and time again that both DCAA (at least the second auditor) and DCMA bent over backwards in the attempt to allow the contractor to dispute the findings. Despite this, it appears DCAA and DCMA stuck to their guns only to find the appeals board disagreeing with the auditors on over half of their findings.
It is a pure joy to hear the appeals board admonish DCAA with the exact arguments I made time and time again. I will let the judges speak for themselves:
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 (see R4, tab 16 at 258, 260; gov’t br. at 54-55, 64-66). 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.
We begin by examining that language of the FAR that the government holds out as requiring the generation and provision of “work product” to entitle recovery of costs for professional and consultant services. FAR 31.205-33, Professional and consultant service costs, provides in relevant part that:
(f) Fees for services rendered are allowable only when supported by evidence of the nature and scope of the service provided. work performed is proper and does not violate law or regulation shall include
(1) Details of all agreements (e.g., work requirements, rate of compensation, and nature and amount of other expenses, if any) with the individuals or organizations providing the services and details of actual services performed;
(2) Invoices or billings submitted by consultants, including sufficient detail as to the time expended and nature of the actual services provided; and
(3) Consultants’ work products and related documents, such as trip reports indicating persons visited and subjects discussed, minutes of meetings, and collateral memoranda and reports.
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 (gov’t hr. at 54). 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, “[t]he 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.” DCAA Manual, at 58-2 – 58-3. Moreover, amongst the “Frequently Asked Questions” in the relevant portions of the audit manual are responses indicating that other additional evidence may be considered to determine whether the services were, indeed, provided and allowable. Id. at 58-7.
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 25 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.
Turning to the facts before us, we have found that the consulting agreements and the invoices provided, combined with the testimony given at the hearing, persuade us that the costs included in TSI’s FY 2007 ICP for SMI’s marketing services were, in fact, for that purpose and are allowable. This portion of the appeal is sustained.