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

GAO Turns Left at Albuquerque and I Did Not Even Get the Chance to Wave….

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The Ignorance regarding how DCAA works is not limited to contractors, but is prevalent (no surprise) among government acquisition staff. The ignorance found among the GAO appeals division is a bit surprising and disconcerting.

There have been several decisions recently supporting the acquisition staff’s positions requiring a DCAA approved accounting system. Bidders who are not “DCAA Approved” face disqualification or penalization in the bidding process. Look at my recent article on this issue.

In the famous words of Bugs Bunny “I knew I should have taken that left turn at Albuquerque”, the GAO has taken a strange turn moving government contracting out of the Twilight Zone and into Toonland.

Now, A contractor is not only required to bid with only an approved DCAA accounting system, but must have a positive assertion of the DCAA approval. The contractor asserting such and even providing the DCAA audit report number is now deemed inadequate.

DISCUSSION

Leader essentially argues that the solicitation required only that offerors have received verification from DCAA that their accounting systems had been audited and determined adequate, but did not require the submission of any documentation from DCAA itself.[3]  Protest at 5-6; Comments at 3-4.  In this regard, Leader contends that its elimination from the competition was unreasonable because Leader met the RFP’s requirement by providing its own unambiguous statement that its accounting system had been audited and approved by DCAA, along with the 2008 DCAA audit report number and additional information.  Id.  In Leader’s view, this information was sufficient for the agency itself to independently confirm with DCAA the verification and audit of its accounting system.  Id.

In response, the agency acknowledges that a DCAA audit report would have been an acceptable source of verification; however, it explains that the solicitation expressly required offerors to furnish verification from DCAA with its proposal.  AR, MOL at 8; AR, see also Supp. MOL at 3-6.  In this regard, the agency also explains that the solicitation did not permit offerors to essentially self-verify the adequacy of their accounting systems.  Rather, by requiring offerors to provide verification from DCAA, the agency would obtain independent verification that offerors’ accounting systems had been audited and determined adequate.  Id.

When a dispute arises as to the actual meaning of solicitation language, our Office will resolve the matter by reading the solicitation as a whole and in a manner that gives effect to all provisions of the solicitation.  See Level 3 Commc’ns LLC, B-412854 et al., June 21, 2016, 2016 CPD ¶ 171 at 7; KAES Enters., LLC, B-411225 et al., June 18, 2015, 2015 CPD ¶ 186 at 5.  A solicitation is not ambiguous unless it is susceptible to two or more reasonable interpretations. WingGate Travel, Inc., B-412921, July 1, 2016, 2016 CPD ¶ 179 at 7.  If the solicitation language is unambiguous, our inquiry ceases.  Id.

On this record, we find that the agency’s interpretation of the solicitation, when read as a whole, is reasonable, whereas the protester’s interpretation is not reasonable.  Here, the solicitation stated that an offeror “must have verification from [DCAA]. . . of an accounting system that has been audited and determined adequate” in order to be eligible for award.  Id. at L-17 (emphasis added).  The solicitation also advised that the agency would “evaluate evidence that the [o]fferor . . . [has] an adequate accounting system . . . as required under Section L.3.1.h.”  Id. at M-3 (emphasis added).  Finally, the solicitation cautioned that failure to “furnish verification of an adequate cost accounting system” would result in a rating of unacceptable and render the proposal ineligible for award.  Id. (emphasis added).  As explained by the agency, contrary to Leader’s contentions, the solicitation did not contemplate that an offeror could simply provide a declarative statement in lieu of the submission of evidence from DCAA verifying the adequacy of the offeror’s accounting system.  See AR, Supp. MOL at 5.  On this record, we find that the agency followed the clear and unambiguous terms of the solicitation and reasonably found Leader’s proposal unacceptable because it did not provide verification from DCAA that its accounting system had been audited and deemed adequate.[4]

Leader also argues that its proposal should nonetheless have been accepted because it satisfied the agency’s actual and reasonable needs, its acceptance would not result in unfair prejudice to other offerors or provide Leader with a competitive advantage, and it contained sufficient information for the agency to obtain additional verification or confirmation with DCAA.  See Protest at 6; Comments at 7-8.  We disagree. 

Clearly stated RFP requirements are considered material to the needs of the government, and a proposal that fails to conform to such material terms is unacceptable and may not form the basis for award.  AttainX, Inc.; FreeAlliance.com, LLC, B-413104.5, B-413104.6, Nov. 10, 2016, 2016 CPD ¶ 330 at 5; TYBRIN Corp., B-298364.6, B-298364.7, Mar. 13, 2007, 2007 CPD ¶ 51 at 5; National Shower Express, Inc.; Rickaby Fire Support, B-293970, B-293970.2, July 15, 2004, 2004 CPD ¶ 140 at 4-5.  As explained by the agency, here, the requirement to provide verification from DCAA was a material requirement, the waiver of which would result in an inconsistent and unfair evaluation, thereby prejudicing other offerors.  See AR, MOL at 6-7; AR, Supp. MOL at 7.  Accordingly, we have no basis to sustain the protest. 

Well, golly gee, what is next? Are we awaiting a disqualification because the DCAA audit is not fresh (over two years old)?

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The Good and the Bad — All in the Same Audit

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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 developing findings and documenting consultants’ work products. Again, I am not a lawyer and this is not legal advice.

 

Developing Findings

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.

Documenting Consultants Work Product.

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.

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One Little Email and We Might be Talking a Different Case

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The Armed Services Board of Contract Appeal is down again for the second time in the last several months. I will not let this attack on democracy (although I am sure the government has an excellent reason for the prolonged denial of access to this information) stop our discussion of the TSI case.

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’s right to change their mind in subsequent audits. Again, I am not a lawyer and this is not legal advice.

 

DCAA’s Right to Change Their Mind

The disagreement between the ASBCA judges and too much of the 61-page opinion addresses the question of DCAA’s changing its mind from audit to audit and from auditor to auditor. To sum up, the two judges in the majority believe DCAA has a broad right to do so, while the minority judge does not.

I am not going to quote their respective arguments, which coincidently coincides with their website unavailability, because I believe this is a horrible case to address the issue.

If DCAA audits, or chooses not to audit, a subcontractor’s invoices in 2012 and sees nothing wrong; this does not prevent them from looking at the subcontractor’s new invoices in 2013 and deciding there is something wrong. All of the extensive legal arguments between the judges aside, the ability to look at costs fresh from year to year is simply common sense to me. This is not absolute but generally true.

One obvious area where DCAA must change its opinion is when there a change in law, regulation, or GAAP.

Does this infer that I believe DCAA is allowed to change their mind at any time and without any constraint? NO, IT DOES NOT. I just believe, despite the pages and pages dedicated to the issue, that this was not the case to explore DCAA’s mind changing abilities.

Let us look at some areas where I believe DCAA’s ability to change its mind is limited.

Reasonableness

Underlying this, as is often the case with DCAA, is the fundamental issues surrounding burden of proof. DCAA auditors can propose findings based on two conclusions: first; the finding is based on a violation of statute, regulation, or GAAP[1]; second; the finding is based on DCAA’s assertion that the cost is unreasonable or imprudent.

If a subsequent DCAA auditor objects to a cost that a previous DCAA auditor allowed because the previous auditor missed an applicable regulation, then the new DCAA auditor is not only within rights to question, but is ethically obligated to proceed with the finding development. However; if the proposed finding is based on reasonableness (or unreasonableness), I believe the contractor enjoys a strong argument that the actions of the previous auditor establish the cost was reasonable and that the personal differences in auditors cannot form the basis for a finding.

Implicit in this is the assumption that both auditors actually sampled and audited the cost. If the first auditor did not actually sample and audit the cost, there is no assumption made.

Sometimes I believe the only person some DCAA auditors lacks respect for more than a contractor is another DCAA auditor. It does not surprise me that this second guessing occurs frequently, but I have now provided a basis for evaluation and objection.

For a closer look at burden of proof issues, look at these previous articles.

Documentation

Another common area where we witness disputes between prior and present DCAA auditors is regarding documentation. The first auditor accepts the documentation while the subsequent auditor does not. Again, there is the assumption the first auditor actually sampled and reviewed the documentation. Again, if there is a SRG issue, especially a change in one of them, I believe the subsequent auditor has the right to raise the issue.

In most cases, the difference arises out of a different interpretation of the SRG. A good example is how some auditors read the requirement for consultant documentation. We will discuss this thoroughly in a future article on this case, but I will just point out that the judges noted that the subsequent DCAA’s auditor’s interpretation of the regulation on consultant documentation was wrong.

Where the documentation is basically identical, the issue gets a bit trickier. As the recent Lockheed Martin case asserted (I would link it if the website was up), inadequate documentation is not a reasonable and prudent argument. Because of this the burden of proof that the documentation is inadequate rests with the government auditor. Now the auditor has to demonstrate the documentation is inadequate despite the previous auditor’s acceptance. I think that is a challenge, but not an impossible one.

Policy and Procedure

Where DCAA should respect prior audit opinions is in the area of a contractor’s policies and procedures, and accounting structure.

DCAA recommended approval of an accounting system is a positive assertion on their part that the contractor’s accounting system is adequate for government contracting purposes. This is done by the auditor signing the SF 1408.

Some consultants sign the SF1408 and argue that this is the contractor’s privilege. I absolutely believe this is contrary to the regulation and it also takes away the DCAA signature accepting your accounting system and the positive assurance I am talking about.

I would argue that if it is covered by the SF 1408, the contractor and the government is provided assurance by DCAA that the system, to include policies and procedures is adequate.

For example, section 2(c) of the SF 1408 addresses allocation method.:

“A logical and consistent method for the allocation of indirect costs to intermediate and final cost objectives. (A contract is final cost objective.).”

There is a critical grammar mistake on the government’s part (is it “A contract is a final cost objective” or “A contract is the final cost objective”?).

Grammar question aside, an approved SF 1408 is an approval of the contractor’s allocation method (Total Cost Input, Value Added, or otherwise). DCAA should not subsequently object to the contractor’s allocation method unless there is a change (SRG or internal).

The SF 1408 is not comprehensive even if your policies and procedures are. Unfortunately, this does not mean that, as part of the process, when you send DCAA your hundred-page accounting policies and procedures you can assume they are all approved. I would only assume the ones covered by the SF 1408 are.

The best example of this are bonuses, which are not addressed in the SF 1408.

TSI believed they addressed the issue with DCAA. Their bonus plan was new to the year that was the subject of the audit findings and the appeals case. Before the submission they started a discussion on the bonus plan with DCAA :

“Mr. Fletcher testified that he met with DCAA auditor Marie Pepin for approximately two hours on 28 February 2008 to discuss the ICP for FY 2007 that would be submitted later in 2008, and raised the executive bonus plan with her during this discussion (tr. 2/121-22). According to Mr. Fletcher, Ms. Pepin said words to the effect of “this looks good to me,” and then they moved on to other subjects (tr. 2/123). We find, as a matter of fact, that this discussion was relatively short and superficial in nature and did not constitute any representation that the government gave final approval to the bonus plan as proposed or executed.”

I wonder if the court would have thought differently if TSI had employed my recommended procedures and followed up the meeting with an email documenting the agreement and attaching the plan?

If TSI had sent that email, we might have had a good case for deciding when and how DCAA can change its mind, even if DCAA ignored the email.

[1] I am going to refer to proposed findings based on statute, regulation or GAAP as “SRG” for the rest of this article.

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Very, Vary, Variance

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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.

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A Shot Across the Bow?

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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.

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

Really? Meals and Entertainment Expenses

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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?

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

Part Two – Early Childhood or “How DCAA, Contractor, and Consultant Can Ruin an Audit”: Souring the Milk

When the contractor bid on the Air Force contract they had no written policies and procedures, utilized a popular accounting software package, and operated with an alphabetized chart of accounts (not really, but that is what their outside tax CPA claimed). There was an extensive inventory system that ran through cost of goods sold directly (no capitalized inventory).

Back in 2011, a DCAA audit of an accounting system focused, in theory, on two parts: the mechanics of the contractor’s accounting department (usually audited by field work) and the contractor’s policies and procedures (usually provided to DCAA ahead of the fieldwork). Often, DCAA looked at the proposed rates as part of the accounting system audit, effectively combing two audits into one.

Sometimes DCAA gave the impression that the policies and procedures were more of a checkbox than anything else. Often DCAA confirmed policies and procedures during the fieldwork. You would walk through an area such as invoicing, and DCAA would ask if this was reflected in your policies and procedures. You answered yes and moved on to the next subject.

Thus, it was possible to buy a set of policies and procedures, stamp your name on them, and send them to DCAA without realizing that the purchased policies and procedures did not relate to your business and operations at all and sometimes, just sometimes, get away with this.

When our contractor heard that DCAA was on the way, they hired a consulting firm and the consultant recommend they purchase the canned policies and procedures from still another consultant (still not me, (these cost over five times what mine cost)).

Contractor purchased said policies and procedures, but their name on them, and sent them into DCAA. Of course the purchased set of policies and procedures were geared toward a construction company, not a company developing scientific instruments.

The next recommendation the consultant made was based on the conclusion that the contractor’s accounting software set up was adequate. That it was possible to identify direct and indirect costs, claimed and unclaimed costs, plus government and commercial costs. All of the areas identified in the SF 1408 could be demonstrated and defended. The consultant decided on three indirect pools, Fringe, Overhead, and G&A. The consultant’s analysis indicated that the contractor spent $19.43 in indirect costs for every $13.05 in direct costs. The consultant prepared an incurred cost submission, using DCAA’s current ICE model, reflecting these conclusions.

Policies and procedures in place, accounting system compliant with the SF 1408, incurred cost proposals prepared and sent, and rates determined. The contractor felt ready for a DCAA audit.

DCAA came out in the late spring of 2011 and reached several immediate conclusions they promptly passed on to the contractor:

  • The Policies and Procedures provided by the contractor (purchased on recommendation of the consultant) not only had very little to do with the business operations of the contractor but those few areas, such as timekeeping, were not implemented or followed. For example, the policies called for supervisor approval on all timesheets while in practice all of the timesheets went straight to the bookkeeper for entry and processing.
  • The rates and rate structure found in the contractor’s incurred cost submission could not be replicated or tied to the contractor’s actual books of records. Direct and Indirect costs were confused and merged in several accounts. For example, the incurred cost submission reported a little over $90,000 in direct labor while the contractor’s trial balance reported the amount at about $23,000. The contractor and the consultant could not defend either number and there was some evidence the amount was closer to $600,000. Such problems were found throughout the incurred cost submission and the trial balance. This was not an incurred cost submission audit (thank you, thank you, thank you) but DCAA had properly used the concurrent document to try and figure the simple issue of direct and indirect within the contractor’s books.

As DCAA’s questions seem to multiple and answers seemed to generate only further questions. In response to DCAA comments, the contractor began to make rapid changes during the audit that only made things worse. Specifically, all of the costs that DCAA questioned as unallowable were moved to an unallowable G&A account. I do not know if the consultant was aware of the changes.

DCAA poor reaction to the contractor’s preparation and subsequent results raised alarm with the contractor. The contractor felt that the situation was spiraling out of control. Before the contractor received the statement of proposed findings, they terminated their relationship with the current consultant and engaged me as a replacement.

I literally walked into the middle of a bad DCAA audit without any clear idea about what was going on. I was concerned about the relationship with the former consultant but did not make any immediate decisions about either the quality of the previous consultant’s work or the contractor. I focused more on what I figured, wrongly, was DCAA issues.

I will admit that I have a tendency to blame DCAA in such circumstances, especially during this timeframe. On occasion I had seen DCAA and contractors feed off each other as both tried to figure out just what was going on. I listened to the contractor’s legitimate concerns about DCAA’s claims on rental cars as a classical example of audit confusion.  I just figured the consultant had gotten stuck in the middle and I offered a chance for a reset.

As I looked at it, it became clear that DCAA had done a pretty good job. The proposed findings were actually developed and discussed fully with the contractor before any commitment to writing and there were several proposed findings, nine to be exact. There was some confusion in the proposed findings. For example, one finding confused G&A Base and G&A Pool. Two other findings appeared contradictory until one realized the books were contradictory.

All in all, DCAA proposed nine findings:

  • Inadequate Internal Controls Over Timekeeping
  • Inadequate Segregation of Duties Over Timekeeping
  • Fragmentation of the G&A Base Used To Allocate G&A Costs
  • Failure To Properly Segregate and Accumulate Direct and Indirect Costs
  • Failure To Calculate and Monitor Indirect Rates
  • Improper Recording of Direct Material Costs
  • Noncompliance With FAR 52.232-22(c) Limitation of Funds
  • Use of an Arbitrary Rate to Bill the Government for Indirect Costs
  • Inclusion of Unallowable G&A Costs in the G&A Base

All of the findings were constructed and supported out of references to the Federal Acquisition Regulations (FAR), something the successor auditor failed to do. The last finding was a little confusing, I am sure the auditor meant “Pool” and not “Base”.

Number six, “Improper Recording of Direct Material Costs”, arose out of the contractor utilizing a complicated inventory system but then expensing everything through Cost of Goods Sold. The auditor raised FAR 31.201-2 (a) (3) and pointed to the GAAP Matching principle as the basis for the proposed finding.

Number four, “Failure To Properly Segregate and Accumulate Direct and Indirect Costs”, arose out of the fact that the contractor had hundreds of thousands of dollars in costs (over half a million in labor alone) marked in the job system as commercial contract work but booked to indirect accounts in the general ledger such as “G&A Labor”.

The third proposed finding, “Fragmentation of the G&A Base Used To Allocate G&A Costs”, arose out of the circumstances I described above where DCAA raised the issue early in the audit, the contractor made a change, and DCAA gigged the contractor on the change.

It started when the auditor asserted that the FAR required (and I later confirmed this assertion) that all rental cars had to be compact to be allowable. The contractor found this so unbelievable that the CFO decided to move all rental cars to unallowable G&A. This of course raised another issue and DCAA proposed a finding based on the change. It took me a while to work this through with the CFO. Yes, the auditor was wrong about the rental car position but the issue was now direct versus indirect. It is not just the direct cost of the rental car that is alleged to be unallowable but also the associated G&A costs. That is why the change the contractor made did not work. Since the auditor was careful to support all of the proposed findings with strong regulatory support, it was doubtful the auditor would actually propose a finding asserting that rental cars must be compact, but the auditor had no problem with objecting to the change and creating proposed finding number three.

The first two timekeeping proposed findings, “Inadequate Internal Controls Over Timekeeping” and “Inadequate Segregation of Duties Over Timekeeping” were pretty standard DCAA objections. One, anybody could charge anything. Two, the bookkeeper approved the timesheets.

Findings seven and nine (corrected), “Noncompliance With FAR 52.232-22(c) Limitation of Funds” and “Inclusion of Unallowable G&A Costs in the G&A Base” are pretty standard also. Nine related to using unclaimed costs to calculate the indirect rate for proposing billing rates. The reason why I believe the auditor confused the terms “base” and ‘pool’ is due to the simple fact that unallowable direct costs are required to be included in the G&A base but unallowable G&A costs must be excluded from the G&A pool.

The last two findings, five “Failure To Calculate and Monitor Indirect Rates” and eight “Use of an Arbitrary Rate to Bill the Government for Indirect Costs” relate to the easy conclusion reached by DCAA that the contractor did not employ an accounting system that allowed for consistent, supported, and even clear calculation of rates and management of the associated pools/bases.

How was the consultant involved? Much of this had the consultant’s thumbprints on it. Proposed findings five, eight, and nine arose out of the consultant’s own work and conclusions. The first two findings plus number seven are government contractor compliance 101 and should have been addressed before the audit. As to number four, which the contractor included in the incurred cost proposal with fractional modifications, I noticed problems when I first glanced at the contractor’s general ledger.  I wondered, along with DCAA, about an 18 to 1 ratio of G&A labor to direct labor. I did not even need to ask the contractor, I simply ran a job ledger and saw hundreds of thousands of dollars marked with active jobs but booked to G&A labor. DCAA apparently saw the same data.

You might argue about the matching (proposed finding six), but given the extent and support surrounding the other findings, it would be drowned in all of the valid DCAA arguments.

I can only report what I found and my subsequent experience with the contractor. I continued to work with the contractor years after the events described. They were dedicated, even to the point where they considered compliance their patriotic duty. They understood, committed to, and adopted my recommendations, even though new issues with DCAA arose over the next several years. The last recommendation of mine they finally adopted was to leave government contracting. They were losing money with cost sharing contracts (no fee) and if the government wanted their technology the government could buy it like everyone else.

Next – “Potty Training”

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