DCAA Relations, Department of Defense News, Incurred Cost Proposals

Bales Testifies Before House, Industry refers to DCAA as a “Collection Agency”

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

My Highlights:

  1. The Risk Assessment program for incurred cost proposal audits will continue.
  2. Outside CPA firms doing audits of incurred cost proposals are a bad idea because they are not qualified and lack governmental authority.
  3. She opposes proposed legislation requiring GS-14 managers to be CPAs because CPA skills do not translate to government contracting work (Yes, we are going to have fun with that one).
  4. She opposes proposed legislation requiring incurred costs proposal audits to be completed within one year of adequate submission because this would eliminate the efficiency of doing multiyear audits.

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”


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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….

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Cost And Accounting, DCAA Relations

17-2 Costs Related to Extraordinary Reviews of Unsettled Overhead Costs

One of the probably unforeseen outcomes of DCAA’s decision to spin off Chapter Seven of the Contract Audit Manual (CAM) into a new document SELECTED AREA OF COST GUIDEBOOK: FAR 31.205 COST PRINCIPLES is that it reminds us of some of the more interesting sections of the Contract Audit Manual.

And notice the clever way they seem to present their own thoughts as regulatory by linking their thoughts “Guidebook” to the actual rules “FAR 31.205 Cost Principles”.

Section 17 is lifted up from the CAM and only true regulatory or statutory reliance is the “reasonable and prudent” standard. In other words, DCAA applies the reasonable and prudent standard when they cannot find a law, legal decision, or regulation that supports their decision and decide that the contractor’s actions were not those typical to another contractor in a similar position. This assertion is made by DCAA Auditors whom, the vast majority, have never made a business decision. They have never sweated a payroll, created a set of books, invoiced, or other reasonable and prudent activities.

This aside, the section asserts DCAA’s right to question as unallowable contractor costs associated with reviewing indirect costs.

To your amazement, I have a few problems with this positon:

  • The adjective “Extraordinary” is in itself, extraordinary and subjective. It calls on DCAA auditors to determine if the review of indirect costs are routine or “extraordinary”.


Of course DCAA tries to help an auditor with this:


This extraordinary effort is often the result of the contractor’s earlier negligence in establishing, maintaining, and/or implementing an adequate system of internal control.

 When the circumstances cited above are encountered and the contractor is incurring or is expected to incur significant costs, the auditor should notify the contractor that the costs associated with such extraordinary reviews of unsettled overhead costs are considered to be unreasonable and will be questioned under FAR 31.201-3, Determining reasonableness. The reasons to be cited are:

  1.  1. The costs are not of a type generally recognized as ordinary and necessary for the conduct of the contractor’s business or the performance of a contract. The costs are duplicative of costs incurred for the same purpose in prior periods. The Government has already reimbursed the contractor for the costs of preparing billings and claims for reimbursement. The fact that this task was not adequately accomplished does not entitle the contractor to additional reimbursement.
  2. The costs are the result of the contractor’s failure to follow the requirements of generally accepted sound business practices and contract terms.
  3. The costs result from actions taken which were not those of a prudent businessman in the circumstances, considering his responsibilities to the owners of the business, his employees, his customers, the Government, and the public at large.

A lot more words they employ here call for professional judgement: negligence, significant, failure, and my favorite: duplicative.

Let us remember that DCAA Auditors are awarded professional judgment by an act of Congress. According to their own report to Congress, only about half of their professional judgements are supported and that is with the majority of contractors not contesting DCAA proposed decisions.

These words are loaded terms without definition. The “guidebook” provides no guidance to define the line between ordinary and extraordinary or any other loaded terms. The DFARS 252.242.-7006 provides some guidance on defining significant but this is not referenced in the guidebook.

2. And speaking of the DFAR regulation, how does this section match up with the requirement for Management Review and/or Internal Audit. When do these required activities become “extraordinary”?

3. Duplicative? Did DCAA forget that good internal controls are often duplicative by nature? When does double checking payroll cross from ordinary to extraordinary? When did taking advantage of the time spent preparing your incurred cost submission to check your costs become unreasonable and not prudent? Maybe DCAA is just trying to create work and success for themselves by discouraging contractors from double checking their work?

I am sorry, but I just have to wonder about this. Many people would argue that double entry is duplicative. Accounting is built on cross checking and rechecking, at least good accounting is.

DCAA, when you spend tax dollars to create something new, such as this guidebook, please create something new.


DCAA Relations, Running Your Business

It is all About Control

One note to my post yesterday “Some of the Strange Things Contractors Say“(https://dcaacompliance.wordpress.com/2016/08/22/some-of-the-strange-things-contractors-say/):

You want to control your business, your bid & proposal efforts, and all interactions with the government. The two cases I quoted yesterday demonstrate the problems that arise when Contractors lose control of the process to the Government.

In the first case the Air Force, with the subsequent support of the appeals board, recalculated the contractor’s fringe rate resulting (in the contractor’s belief) in the lost of the contract award.

The second case presents the opposite problem. Here, the Protester successfully argued that the government failed to evaluate the winning proposal’s rates, the government simply accepted the proposed rates. The Protester demonstrated pretty easily that these rates were inaccurate.

In both cases, the contractor surrendered control of the process to the government and even their competitor by not bidding supportable rates.

All easily prevented by an accurate complete cost accounting system.

Cost And Accounting, DCAA Relations, Running Your Business

Some of the Strange Things Contractors Say

We Are Doing Fine Without ALL OF THIS. We bid the Rates that Will Win the Contract and Still Make a Profit

I, for one, believe in the common sense I discover time and time again among small business contractors. Actually, without their common sense, my work would prove extremely difficult. They know when they are in trouble and they know when they are not.

Of course, in my humble opinion, backing up this common sense with data makes the small business decisions even more effective.

In almost every single contractor without DCAA activity I work with, the rates they bid are different on every proposal. Sometimes the use of different rates arises out of a perceived change in rates, but many times it is the pressure to feel competitive.

In a world without DCAA, the lack of accurate rate information is beginning to haunt contractors. Two recent GAO appeals (one involving an Air Force contract) illustrate the problem:

Because an agency must base its evaluation upon information contained within the offeror’s proposal, and because we will not consider Quantech’s untimely assertions that it could have substantiated its rates had it been permitted to revise its cost narrative, we have no basis to question the agency’s conclusion that Quantech’s revised indirect rates were unsubstantiated and thus unrealistic. In any event, we find that the Air Force’s adjustments to Quantech’s indirect rates were reasonable. Here, the CPET analyzed an offeror’s proposed indirect rates and cost narrative to determine whether the rates reflected the offeror’s unique business model with regard to allowable and allocable indirect costs, and compared the indirect rates to the offeror’s fiscal year 2015 provisional billing rates established by the Defense Contract Audit Agency (DCAA). While the agency concluded that Quantech’s initial rates were realistic based upon information in its cost narrative, the agency determined that the protester’s proposal provided “no rationale” to substantiate the dramatic reduction in its fringe benefit rate ([DELETED] percent to [DELETED] percent). AR, Tab 7, CPET Report, at 8. On this record, we find that the agency’s adjustments were reasonable, and the agency acted within its discretion in deciding to use Quantech’s initial rate, rather than the unsupported final proposed fringe benefit rate.[20] See CSI, Inc.; Visual Awareness Techs. and Consulting, Inc., B‑407332.5, et al., Jan. 12, 2015, 2015 CPD ¶ 35; Science Applications Int’l Corp., Inc.,supra.

The protest is denied.[1]


And this one

Here, we find that the agency’s acceptance of the unsupported G&A rates for eight of the awardees was unreasonable and inconsistent with the solicitation requirements. The RFP required that the proposed G&A rates would be evaluated using a cost analysis “based upon verification of the offerors’ cost submissions for their G&A rates and confirming that the submissions are in accordance with the contract cost principles and procedures described in FAR Part 31.”RFP, Tab 3 at 33.The protester, whose proposal complied with the solicitation requirements and whose G&A rate was supported by its certified financial statements, was prejudiced by the agency’s actions as follows: one offeror did not comply with the requirement to submit certified financial statements or a DCAA report; two offerors’ rates could not be verified by the information submitted; and five offerors proposed significantly lower rates than those identified in the certified financial statements they submitted with their proposals.AR, exh. 6, SSDD at 79-84. As a result, these offerors were viewed as offering a lower “price” to the government since the agency was using G&A rates as a proxy for price or cost. There is nothing in the solicitation that informs offerors that the agency would accept a G&A rate that was not supported by certified financial statements or DCAA reports and verified through a cost analysis of the required cost submissions. Accordingly, we sustain this basis for protest.[2]

Since contracting officers can no longer rely on DCAA to verify proposed contractor rates the burden now shifts to the contractor to defend those rates. A good defense arises out of a good cost accounting system.

A good cost accounting system also allows the contractor to defend any proposed changes to the rates. This is common due to the exponential growth experienced by successful small contractors.

I call this the “plumbing argument”. The plumbing costs in building a 2,000 square foot home as compared 5,000 square foot home are not as dramatically different as one would think as the plumbing layout is fairly centralized. Thus, plumbing costs more in a 2,000 square foot home than a 5,000 square foot home per square foot while the total cost of plumbing in the large home is a bit more.

This is also true of G&A costs. You are only going to need one Controller if you employ 100 people or 1,000 people, but she will cost more per employee for the smaller company.

But none of this does you any good if you do not know the costs and cannot do the math.

[1] Matter of:   Quantech Services, Inc. File:  B-408227.8; B-408227.9 Date:  December 2, 2015  http://www.gao.gov/products/D12374# =e-report

[2] Matter of: West Coast General Corporation File: B-411916.2 Date: December 14, 2015  http://www.gao.gov/products/D12409#mt=e-report


EXCERPT from  Surviving a DCAA Audit: The Accounting System: For Small Government Contractors Working With the DCAA and Other Government Agencies available on Amazon.


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

Overhead Part One


Do you really need this pool?

One common headache small business contractors create for themselves is adopting too many pools. Some of this confusion arises out of the fact that contractors

Surviving a DCAA Audit

Surviving a DCAA Audit

and DCAA often look at overhead differently. Many contractors see overhead as anything that is not direct (with the possible exception of Fringe Benefits) while DCAA looks at overhead as a specific type of indirect pool normally associated with different locations or company divisions.

Keep it simple, many contractors operate with a single indirect pool and many others with two pools – Fringe Benefits (over labor) and G&A (TCI).

Excerpt from Surviving a DCAA Audit


Many small business contractors definition of overhead grew out of their previous work with larger contractors with more complicated cost structures. Their past employers worked with multiple overhead pools based on location, labor types, or other concepts. The majority of the small business owners tend to look at overhead as all inclusive – all indirect costs.

And they are not wrong. This is the traditional definition of overhead created over the centuries as cost accounting developed. Traditionally, overhead was a cost that could not be directly charged to the job or customer. QuickBooks’® design incorporates some of this traditional cost thinking.

Over time, cost accountants started separating out Selling and Administrative costs (later Selling and/or General & Administrative costs) as an evolution of variable and fixed cost accounting. A final natural separation was the indirect costs associated with labor called Fringe Benefits or Labor Burden.

It is also important to remember that cost accounting evolved in a world of manual accounting aided by mechanical accounting machines and adding machines. I worked with one client several years ago who utilized the improvements in technology to allocate the actual fringe benefit costs to each employee.  I pointed out that the cost benefits were not clear and that the principals might not wish their individual fringe benefits subject to easy government review. I informed her about a DCAA auditor attempting to disallow relocation expenses as unreasonable based on his standards as a government employee. Today, I would also point out the evolution of the Supplemental Schedule B on DCAA’s model ICE.

We see that a contractor’s view of overhead evolved over time out of the idea of direct costs plus overhead. In this same way that many small business contractors come out of direct positions and now need to understand and manage overhead costs.

DCAA, the FAR, and the Cost Accounting Standards (CAS) came late to the party and take a more holistic view of the issue. They began with a world of direct, overhead, and administrative costs.

Actually, one can argue that DCAA’s journey into cost accounting arose in out of the opposite path of the typical small business contractor. DCAA’s thinking evolved out of a need to check and audit indirect costs primarily and direct costs secondary. DCAA is indirect first and direct second. Small business contractors are direct first and indirect second.

And where the wires typically cross between DCAA and the small business contractor is in the middle: at Overhead. Both approach it from different angles and miscommunication is common.

This is one area where DCAA enjoys a better academic understanding of overhead and where the contractor’s lack of precision often leads to mistakes and confusion.

Let’s us end this section with one critical definition from DCAA’s viewpoint that small business contractor’s often trip over:

Overhead, if it exists, is an intermediate allocation. To simplify, overhead stands between direct costs and general administrative costs. If Overhead is not an intermediate allocation, DCAA will argue there is no overhead, only G&A (general and administrative).

From a historical point, DCAA is wrong. Historically, overhead can serve as a final allocation, but most DCAA auditors are not trained and do not see it this way. Most important, from a practical modern view of government cost accounting compliance, DCAA’s position is supportable and preferred.

Small business contractors need to start separating overhead and G&A in their thinking. Not simply because DCAA prefers it that way but because, as their business grows, it will help them control their cost structure and their costs. Understanding overhead as an intermediate allocation is critical to managing overhead pools, costs and profits.

I deal with clients all the time who create complicated overhead structures that they never seem to be able to articulate their thinking on. They create various overhead pools that allocate over labor, total cost input, direct labor hours, machine hours, square footage: often without the ability to articulate why they need all of these pools and allocation methods. I personally believe the ability to articulate why you allocate costs in a certain manner is critical to both understanding and managing your costs.

DCAA Relations, Incurred Cost Proposals

Model Schedule I: Part 2 or: “With all respect, Sir, I can only follow your orders, not read your mind”


I remember enduring a room inspection as an enlisted man in the 82nd Airborne with a new company commander. The 1st Sergeant usually tried to make my room the first for inspection, trusting me to delay the CO long enough to prepare the other rooms for any of his individual idiosyncrasies. This particular company commander, who ended up as the best of the four or five I served under, was chewing me out for laying out my inspection items in a manner required by his predecessor. Finally, I turned to him and said:

“With all respect, Sir, I can only follow your orders, not read your mind”.

He laughed, agreed, and moved on. Of course the 1st Sergeant had time to warn the rest of the barracks and make the necessary adjustments. Once again, “Ave” (one of my many nicknames in service) took a bullet for the team.


I am reminded of this story almost every time I open an email from a DCAA auditor; although I can count on one hand the number of DCAA auditors who saw the other side of the issue.

The Model Schedule I is an excellent example of where contractors are often forced to read individual DCAA auditor’s minds and deal with their idiosyncrasies. The problem with the model exists primarily on two levels: design and implementation.


In the attempt to read the DCAA’s collective mind, the primary design of the Model I, as stated by the regulation, is a reconciliation of claimed and billed costs by contract.

DCAA appears to limit this universe of contracts and subcontracts to those contracts that include government participation. A simple definition of government participation are those contracts or subcontracts with variable indirect rates (adjustable indirect rates subject finalization and thus “government participation”).

Cost type contracts are the primary member of this universe and Time and Material (T&M) contracts where there is a variable rate (provisional G&A rate for example). For reasons poorly defined, the majority of DCAA auditors will expect all T&M contracts to be reported on the Schedule I regardless of government participation.

Let’s go ahead and focus on the cost type contracts for the moment to address the fundamental design flaw in the Model Schedule I


We agree that the Schedule I is intended to capture and reconcile COSTS, but whose costs: the government’s or the contractors? The difference is something we accountants refer to as the “Entity Concept”. The government’s costs (entity “government”) and the contractor’s costs (entity “contractor”) are not necessarily the same. DCAA’s failure to understand this primary accounting principle leads to problem after problem when working with their Model Schedule I.

First Example—Fee. Fee is a cost to the government but not a cost to the contractor. Where does fee go on the Model Schedule I? Obviously it is included with the contractor’s billed amount but then this makes reconciliation to the Schedule H (contractor’s costs) problematic. Some DCAA auditors address this by asking the contractor to add a column to the billed section for fee. Some demand the contractor remove the fee from the billed amount. Most ignore it.

Second Example – Sales Tax. A couple of states, Hawaii and New Mexico for example, tax many government contracts under sales tax or gross revenue tax.  Contractors are allowed to bill these amounts on cost type contracts. GAAP does not allow these payments to be treated as a contractor expense. The amount billed to the government goes to a liability account and is relieved when paid. According to GAAP, and we all know contractors are required to follow GAAP, the sales tax never hits the contractor’s income statement as an expense or revenue.

Thus, sales tax is an expense to the government entity but not the contractor entity. Some auditors take the same path as on fee and add a column to the Model Schedule I’s billing section for the tax amounts. Others go further and demand the contractor add a column to the Schedule H.


The other fundamental flaw in the

basic design principle of the Model Schedule I is timing. In all the innocence that can only be found with inexperience, when DCAA created the Model Schedule I assuming that billing would match costs in any particular year. This is an especially interesting assumption given that many contractors are allowed to bill as often as every eight days. In reality, the amount billed for the year rarely matches the costs for the year (fee and sales tax aside).



Given these significant design issues, it will not surprise anyone that the implementation created new issues. I will hit this on the next post.