Cost And Accounting, DCAA Relations, Department of Defense News, Incurred Cost Proposals

DCMA Criticized for not Following DCAA Recommendations on Incurred Cost Proposal Audits.

One again proving that the contractor should defend costs BEFORE DCAA makes its findings official.

 

http://www.dodig.mil/pubs/report_summary.cfm?id=7287&utm_source=DoD+IG+Email+Update+-+Reports+and+Testimonies&utm_campaign=e02c5e6e40-DoD_IG_Reports&utm_medium=email&utm_term=0_3a17f8681e-e02c5e6e40-277174597

Visit us at www.dcaacompliance.com

Advertisements
Standard
Accounting System, Cost And Accounting, Incurred Cost Proposals, Running Your Business

Very, Vary, Variance

Let us take a break from the Technology Services, Inc (TSI) case and talk about a continuing flaw in most small government contractor’s accounting system: tracking variances, specifically those associated with cost type contracts and the associated indirect costs.

Simply put, the variance is the amount the government owes you because your rates ran higher than your billing rates or the amount you owe the government because your rates ran lower than the billing rates.

DCAA’s Information for Contractors discusses the subject in Enclosure 5.

  1. Provisional Billing Rates.
  2. FAR 42.704 provides the CO (or cognizant Federal agency official) or auditor responsible for establishing the final indirect cost rates also shall be responsible for determining the billing rates. The Government allows interim payments, if authorized by the contract, during contract performance by progress payments for fixed-price contracts, or by public voucher for cost-type contracts. Reimbursement of indirect costs for these payments is generally made through billing rates that are established to approximately equal the expected final indirect cost rates for the contractor’s fiscal period, as adjusted for any unallowable costs. These billing rates are used for interim reimbursement purposes until settlement is reached on final rates after the end of the contractor’s fiscal year. Billing rates may be prospectively or retroactively revised by mutual agreement, at either the Government’s or contractor’s request, to prevent substantial overpayment or underpayment. Once the final rates are established, an adjustment is made for any variance between the billing and final rates.
  3. Upon receipt of the certified final indirect cost rate proposal, FAR 42.704(e) provides that the Government and the contractor may mutually agree to revise billing rates to reflect the certified proposed indirect cost rates. The proposed indirect rates will be adjusted to reflect historically disallowed amounts from prior audits until the proposal has been audited and settled. The historical decrement will be determined by either the CO or the auditor responsible for determining final indirect cost rates. If billed costs exceed claimed costs, the contractor must appropriately adjust the next voucher or remit or otherwise credit the Government for the difference.

This government publication points to one of the critical knowledge areas for small business government contractors. If you keep your books and accordingly run your business like the IRS wants their information, your will probably go out of business. If you do the same with regards to DCAA, you will almost certainly go out of business.

The IRS wants to collect information in a manner that makes it easier to assess your tax liability and collect the taxes. They simply have no interest in how your business is doing, your success or failure is not within their job description. DCAA enjoys a theoretical interest in a contractor’s success as it assumes that the contractor’s work is necessary to the government, but their institutional focus has been on the contractor’s expenses in terms of allocability and allowability. Profitability, to DCAA, is, at best, out of their scope of work. At worst, contractor profits can be a focus of suspicion for DCAA.

And variances have a direct impact on profitability and the ability of the contractor to succeed and prosper. Here are a couple examples from my work over the years:

A couple of decades ago, a contractor I worked with secured a $10,000,000 contract with the government and managed to talk them into a $5,000,000 advance payment on the contract. Almost unheard of, even back in those days.

Unfortunately, the owner died tragically just after receiving the advance payment. The company made the IRS happy and paid the taxes on the $5,000,000 and recorded the “revenue” on the books. Properly, the company should have booked the advance payment as Deferred Revenue, a liability, and the money should only have hit revenue as it was earned. This is an excellent example of how you fill out your tax return often should have no influence on how you manage your business.

I am sure you can guess, the contractor spent a lot of the money before they even began serious work on the contract and struggled for a couple of years to do the work without any new money for the work.

In another example going the other way, a client of mine brought me in to work some audit issues on a $27,000,000 contract. As I looked everything over, I asked about any variances and they assured me there were no variances. I looked at the billing for the five years and could not see any variance billing, and asked to take a look at one year to check. After some resistance, they agreed and I found they underbilled the government about $75,000 in the sample year. That justified taking a look at all five years and the amount grew to approximately $900,000 never billed to the government.

The latter one annoyed me a bit as this contractor paid me to help create their policies and procedures. These policies and procedures called on the contractor to track the variance on a monthly basis. Obviously this did not happen.

Other contractors I worked with over the years discovered during the preparation of their Incurred Cost Proposal that they owed the government tens of thousands of dollars they did not anticipate. Another former client never had a variance, his books somehow tied exactly to the billing rate year after year. It is a bit more innocent than it sounds. He actually thought he was contractually obligated to spend to that amount exactly.

And of course I have to mention the major accounting firm that called an emergency conference call because they did not understand why the rates on the incurred cost proposals differed from the billing rates.

Tracking variances is cost accounting 101. No one should be surprised by a variance. Contractors should track the variance on each contract each month. You calculate the variance (actual vs. billed) for the month and post the difference to the balance sheet. If you the variance is up one month and down the next, this method will show the contract-to-date total each month. Putting the variance on the books of record and reporting it on the balance sheet formalizes the process, making it a routine item to discuss at those monthly finance meetings.

After writing the first draft of this article this morning I reviewed standard report from one the popular government contracting system and discovered, to my great annoyance, that the variance was reported as an increase of profits!!!!  How do you explain this to your boss when you have to pay the money back? Maybe it is a setup issue, sigh….

There is some disagreement about where on the balance sheet to post the variance. I prefer to post the balances to an accounts receivable account (“CPFF Variance”) and the offset is to “CPFF Variance Revenue”. Some contractors use an inventory method, posting the variance to an inventory Work in Progress account on the balance sheet and posting the other side to a Cost of Goods Sold account.

Either way, you know where you are each month and there are no surprises.

What do you do if you are caught by surprise? Depending on your circumstances, there are some legitimate methods for addressing variances starting with a thorough analysis of allocability, allowability, and costs.

Both Books graphic

Visit us on www.dcaacompliance.com

Standard
Cost And Accounting, DCAA Relations, Incurred Cost Proposals

A Shot Across the Bow?

Back to the recent Armed Services Board of Contract Appeals (ASBCA) Technology Systems, Inc. (TSI) (ASBCA 59577 and the nine areas I believe are worth discussing:

  1. Supporting Material Overhead rate
  2. DCAA auditor independence
  3. DCAA’s right to change their mind in subsequent audits
  4. Tax vs. Book on depreciation issues
  5. Bonuses
  6. Accrued Costs crossing fiscal year
  7. Unapproved subcontractors
  8. An excellent example of DCAA properly developing findings.
  9. Documenting consultants work product

The scratched out areas were discussed in previous articles. Today, I am going to talk about DCAA auditor independence. Again, I am not a lawyer and this is not legal advice.

DCAA Auditor Independence

CPA ethics drove me insane for years before I took the exam and the subsequent ethics exam. I often compare the profession’s complicated ethics rule to the Pharisees described in the New Testament. But beyond the esoteric ethic issues surrounding the audit of the town’s only bank by the town’s only CPA who is a customer of the bank, I want to focus on a couple of simple clear issues regarding DCAA auditor independence.

First, there is the general issue of questioning DCAA’s very ability to be independent. DCAA works for the government, often they work directly for the contractor’s “customer” DCMA. DCAA actually advertises their job as not finding the truth but finding “unallowable” tax dollars.  From a common sense point, not a great argument for independence. As a comparison, I do not see the IRS’s primary focus on recovering tax dollars. The focus there seems a little more skewed toward finding the facts (truth).

While I may question DCAA’s institutional ability to be independent, I acknowledge they are granted this assumption of independence by statute. While DCAA in fact, may not be independent, such independence is assumed in order for the government to protect tax payers.

Some of the alternative’s may be worse. I have argued that the government hiring of outside CPA firms to conduct incurred cost proposal audits as destroying even the institutional illusion of independence. The outside CPA firms are contractors looking to keep the contract while, for good or bad, DCAA auditors enjoy some job security and thus a bit more independence. I even referred to the CPA firm contractors as “contractors” in management responses. Outside CPA firms are even more strongly motivated than DCAA to find “unallowable” costs on behalf of their actual customer.

Again, while moaning about the possible illusionary independence of DCAA, I accept it as an institution. This brings us to the second level of auditor independence: those cases where individual auditors, offices, branches, or even the institution abandon the illusionary independence and act in an unethical manner. There are those rare occasions when an auditor is “on a witch hunt” for the contractor, or at least the contractor comes to believe this.

The issue is discussed in several paragraphs of the TSI opinion on both the actual opinion and the dissenting opinion. The following paragraph gets to the heart of the matter:

TSI advances two somewhat related factual allegations that are relevant to its course of conduct legal theory, which we will discuss shortly: first, that the DCAA auditor who performed the initial work on the FY 2007 ICP audit was, for some unstated reason, biased against TSI; and second, that the DCAA had been much easier on it in past audits (app. br. at 3-5; app. reply br. at 10-11). In testimony presented by TSI, Mr. Fletcher, its CFO, characterized the first DCAA auditor, Ms. Waller, as having been “on a witch hunt” (tr. 2/165). Moreover, as discussed above, there was ample evidence of friction between Ms. Waller and TSI and early indications from TSI that it did not believe that it would get a “fair” audit from Ms. Waller. Nevertheless, the evidence also demonstrates that the preliminary work performed by Ms. Waller was not the end of the story, given the change in questioned costs demonstrated most clearly by Tables 1, 2, and 3 above. Moreover, the ACO credibly testified that her decisions regarding which costs to question were made independently (tr. 1/251 ), which is consistent with the back-and-forth which she attempted with TSI prior to issuing her COFD. We need not delve into these circumstances any further due to the fact that TSI, itself, has “concede[ d]” that its claim that the COFD should be set aside due to lack of auditor independence “cannot be sustained” (app. br. at 3).

 

Off the top of my head, I do not recall an incident where I concluded that a DCAA auditor’s personal bias interfered with an audit, but there were many occasions where the contractor thought so and I understood how they came to this belief. To be frank, I believe contractors take personally an auditor’s professional incompetence and see this incompetence as a witch hunt. Professional competence is not simply technical but also encompasses behavior with the audit subject, and not all DCAA auditors show a mastery of this area and some of them experience a strong reaction when a contractor questions their actions or requests.

All of this simply reminds us that DCAA auditors are human beings working, in my opinion, in a less than ideal envrioment. They are asked to function as independent auditors in a instution that places enormous value on finding contractor errors. I do believe the vast majority of them rise above this pressure.

Another example of where it appears personal is when we remember that DCAA auditors are thrust out on audits with a great deal of authority and not always the experience, knowledge, or support, to exercise that power in the best way possible. DCAA is working hard to address this issue, but the last crisis took a serious toll on the agency’s institutional knowledge. I remember a young DCAA auditor threatening me with a fraud referral because he concluded that a working trial balance was an instrument to defraud the government. Many such auditors are now supervisors.

There are many findings of auditor incompetence, even serious allegations of DCAA malpractice, but I believe it is rarely, if ever, personal.

What is interesting about the TSI case is that all three of the judges were willing to look at evidence of bias. That is a warning shot across the bow of the ship DCAA.

Both Books graphic

visit us at www.dcaacompliance.com

 

Standard
DCAA Compliance Logo
Accounting System, Cost And Accounting, DCAA Relations, Incurred Cost Proposals, Running Your Business

Material Overhead Rate — Off and On

Back to the recent Armed Services Board of Contract Appeals (ASBCA) Technology Systems, Inc. (TSI) (ASBCA 59577 and the nine areas I believe are worth discussing:

  1. Supporting Material Overhead rate
  2. DCAA Auditor independence
  3. DCAA’s right to change their mind in subsequent audits
  4. Tax vs. Book on depreciation issues
  5. Bonuses
  6. Accrued Costs crossing fiscal year
  7. Unapproved subcontractors
  8. An excellent example of DCAA properly developing findings.
  9. Documenting consultants work product

I talked about unapproved contractors in the last article and today I am going to look at item one: Supporting Material Overhead rate. Again, I am not a lawyer and this is not legal advice.

The material overhead rate did not actually end up as part of this case only because the second DCAA auditor did not pursue it. TSI proposed a material overhead rate of 1.05% that the first DCAA auditor recommended be 100% disallowed while the second auditor accepted the rate. TSI alleged that the first auditor “had it in” for them and we will discuss the minimal discussion on DCAA auditor independence later.

Almost all of this article is speculative on my part and should not be taken to represent what actually occurred, but when I got the page where the initial DCAA auditor rejected all of the material overhead rate I thought “Crap, that has been a long time coming”. When I saw that DCAA backed off in the second stab at the audit, I breathed a sigh of relief and thought, “Not this time”.

Two Sides of the Circle or Contractors with Multiple Government Bosses

It is important to remember that government contractors circle around two extremes of government compliance. On one side, there is the programs staff and their associated contracting officers. These are the guys who issue the RFP, decide you are the guy they want, and issue the contract in coordination with DCMA.

On the other side of the circle is DCAA which looks at the contractor’s costs and business systems then recommends actions to DCMA based on their audit work.

A government contractor needs to make both sides as happy as possible, and I would argue that Material Overhead Rates is one of the bizarre evolutions within government contracting that arose to make this hope of making both sides (programs and compliance) happy a reality. The concept exists in established cost accounting practice but is not as universal as many RFPs would imply.

Just Where Do We Put that Pesky G&A?

The FAR, CAS, and DCAA are strong on contractors allocating general and administrative (G&A) costs utilizing a method labeled Total Cost Input (TCI). TCI allocates G&A costs over all other costs (direct (to include materials and subcontractors), overhead, fringe and so on). CAS actually states “A total cost input base is generally acceptable as an appropriate measure of total activity of a business unit”.

Thus TCI is automatically accepted as a valid way of allocating G&A by everyone. Everyone except the government people on the other side of the circle (programs and their branch contracting officers). It often seems a majority of them think burdening travel, materials, subcontractors, and materials with a G&A rate is an outrageous and immoral act. Addressing this indignation over the years, it is clear to me that many of the associated program people (including buyers) look at this allocation as a mark-up not an allocation of actual allowable indirect costs.

I will give you two recent examples. One was a final four major accounting firm auditing a client’s incurred cost proposal on a DOE contract. The supervisor auditor entered my office at the client site (I was there supporting the audit) and spent a lot of time arguing that allocating G&A on a subcontract was unethical (his words) since the subcontract contained its own G&A and this meant the government was being charged twice.

Obviously he did not enjoy a great deal of experience with value added taxes, and I responded by asserting that was the subcontractor’s G&A and not the prime’s (my client). The two could simply not be compared. A G&A rate is not arbitrary and represents an allocation of legitimate indirect expenses, expenses of both the subcontractor and the prime contractor. It is not a ‘profit’.

He then argued that the allocated G&A simply stood out of proportion to the base cost. It takes a great deal more G&A to administer direct labor than cut a check to a subcontractor. I actually thought this a much stronger argument, but he was still out of his league. I reminded him that the prime is responsible for the subcontractor and it is never as simple as cutting a check.

He still argued on and on about the injustice of the allocation. I finally made two additional points that finally closed the argument. First, all allocation methods are ultimately subjective and arbitrary. Second, please leave my office and come back with a statutory or regulatory basis that supported his argument.

The second example involved an Army contracting officer complaining that because their contract with the contractor was about half materials and the Air Force’s contract was all services, the Army was receiving an inequitable allocation of G&A. I responded by stating that the inequity could only be applied on a government wide level and not a branch level.

The thought behind these arguments and the countless other times I encounter them, is that a dollar spent on direct materials, subcontractors, and even travel, should not receive the same amount of G&A as direct labor. To approach from a different angle, given a G&A rate of 10% it is unfair to burden $500,000 of material costs with $50,000 of G&A.

One way I attempt to explain this to the program’s side is by trying to tie them into the whole picture:

“Okay, if a contractor has $75,000 in direct labor, $25,000 in subcontractor costs with $10,000 in allowable G&A, we have to allocate the $10,000.  The government is legally obligated to pay for the $10,000. Total Cost Input gives $7,500 to the labor costs and $2,500 to the subcontractor costs. How would you do it?”

Too often I get a response such as “I do not know, but that is too much on the subcontractor”.

The Program People Come Up with an Idea

This, I believe led to the development of “Material Overhead Rate”, “Subcontractor Handling Rate” and other similar line items on various RFPs approximately fifteen years ago. These line items are intended to relieve materials and subcontractors of G&A costs while acknowledge there are indirect costs associated with these direct cost elements.

Problem solved?

The number one question I get from contractors working on these RFPs is “What rate do we use?” or “How do we calculate this rate?” In other words, how do contractors separate out from G&A the part of G&A associated with subcontractors or materials. The base is defined, but how do you populate the pool? How do we justify a 3% Material Overhead Rate with a separate 10% G&A rate?

If you want a glimpse at the potential can or worms these rates may open look at questions 12 -21 on the “Contractor Forward Pricing Rate Proposal Adequacy Checklist” under DFARS 215.403-5.

Again, this is supposition on my part, but I wonder if the first DCAA auditor asked TSI for just such documentation, the justification for creation and operation of the Materials Overhead rate. I am guessing she decided it was inadequate. I am also guessing the second DCAA auditor understood the complexity of this issue and decided to focus valuable time elsewhere.

Material Overhead and Subcontracting Handling are legitimate cost accounting objectives The challenges in developing and maintaining the rate are reduced for larger contractors where the size and frequency of activity makes it easier to allocate and define such allocations.

Small business contractors face greater challenges developing, implementing, and defending these rates. If you can identify time spent on handling materials on a specific contract, is this Material Overhead or Direct Labor? The same is true of the time spent reviewing a subcontractor invoice. Even if you feel comfortable with the methodology you develop there is no guarantee DCAA will not question it this year or next year (which is another issue raised in this case that we will address later).

This is one of those rare occasions where I will not share some of my approaches for addressing this issue among small business contractors. I prefer to share these on a case by case basis with DCAA if required. They are ethical and defensible, but vary from contractor to contractor.

Some RFPs appear to acknowledge some of these complexities and replace Material Overhead Rate with Material Overhead Fee. Take them at their word and treat it as a fee, a request not to burden materials or subcontractors with G&A while compensating contractors for the acknowledged costs involved in administrating those costs (materials and subcontractors). Do not include it in your rate proposal.

That is until some bright DCAA auditor wonders if the fee should be included in the base….

Visit us at www.dcaacompliance.com

Standard
Accounting System, Cost And Accounting, DCAA Relations, Incurred Cost Proposals, Running Your Business

Really? Meals and Entertainment Expenses

While working on another project this morning, I recalled that twice in the last year; two separate DCAA auditors working thousands of miles apart, asked why the contractor had separate accounts for Meals and Entertainment in their Chart of Accounts.

Enough said?

Standard
Cost And Accounting, DCAA Relations, Department of Defense News, Incurred Cost Proposals

Wait a Moment

As pointed out by Ken Bricker, DCAA has announced that they are all caught up on incurred cost submission and will begin working on audits outside the Department of Defense. And the world turns……

http://www.dcaa.mil/mmr/16-PPD-008.pdf

Both Books graphic

Available on Amazon and www.dcaacompliance.com

 

Standard
Cost And Accounting, DCAA Relations, Incurred Cost Proposals

A World Without DCAA– Today

NASA awards contracts to 6 audit services companies

NASA has awarded contracts to six companies to provide agency wide contract auditing support services, previously performed by the Defense Contract Audit Agency, the company said.

The selected companies are: Castro & Company, Kearny and Company PC, CohnReznick LLP, KPMG LLP, Moss Adams LLP and Regis and Associates PC.
The contracts are fixed-price, indefinite delivery/indefinite quantity contracts that include a one-year base period and four one-year options, with a combined maximum potential value of USD100 million.

The NASA Shared Services Center (NSSC) at Stennis Space Center in Bay St. Louis, Mississippi, administers the contract. The NSSC performs select business activities for all NASA centers.

NASA awards contracts to 6 audit services companies

If you are looking for someone to support you while being audited by an auditor trying to audit like DCAA, drop us a line at mail@dcaacompliance.com.

Standard