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.

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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.

 

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Accounting System, Cost And Accounting, DCAA Relations, Incurred Cost Proposals

Just What is a Subcontractor?

At a recent conference an audience member asserted that the FAR (Federal Acquisition Regulations) did not define subcontractors and she felt free to put the costs wherever she wished on an incurred cost proposal, specifically under Other Direct Costs. I assumed she meant consultants providing direct services on a job or contract, but I did not argue with her and we agreed to disagree.

Subsequent to this, I gave up documenting FAR definitions of subcontracting after the fifth one. All of these included the term “services”.  I will quote, cite, and discuss some of the specific definitions in a bit, but first I want to broaden the issues to the needs of government contractors, especially small business government contractors.

Not only does the FAR define subcontractors, it is an area of intense regulation and receives serious attention from DCAA to include an ever evolving “Schedule J” on DCAA’s model incurred cost electronically (ICE). It is in a contractor’s interest to avoid this greater scrutiny while complying with existing statutes, case law, and regulations (notice I did not say guidance, as in DCAA’s Contract Audit Manual or Information for Contractors).

I will also note that some contractor approaches can lead to unnecessary complications and even visits from the IRS wanting more money.

Traditionally, direct costs are recorded in five broad accounts: Direct Labor, Direct Travel, Materials, Other Direct Costs, and Subcontractors. Over the years. I observed contractors recording what the FAR and I define as subcontractor costs, in all five accounts to include Materials and Direct Travel. There is actually an accounting tax argument for recording subcontractor travel costs under direct travel (see my presentation: Meals & Entertainment Rules – Or How to Avoid Inviting Government Auditors to Your Lunch . I prefer to track subcontractor Meals and Entertainment (M&E) as part of the Subcontractor account, but I acknowledge the argument.

Despite what many DCAA auditors might argue, there is no requirement to use these five main direct cost account groups, but I am going to assume their use because of my vain hope as a taxpayer, that we can reduce costs by reasonable acceptable conventions. Adopting these five major accounts for tracking direct costs is such a convention. Further, these are the five the government cares about.

Subcontractor Definitions

Now to some of the definitions:

FAR 3.502-1

“Subcontract” means a contract or contractual action entered into by a prime contractor or subcontractor for the purpose of obtaining supplies, materials, equipment, or services of any kind under a prime contract.

“Subcontractor” (1) means any person, other than the prime contractor, who offers to furnish or furnishes any supplies, materials, equipment, or services of any kind under a prime contract or a subcontract entered into in connection with such prime contract; and (2) includes any person who offers to furnish or furnishes general supplies to the prime contractor or a higher tier subcontractor.

FAR 4.1.1701

“First-tier subcontract” means a subcontract awarded directly by the contractor for the purpose of acquiring supplies or services (including construction) for performance of a prime contract. It does not include the contractor’s supplier agreements with vendors, such as long-term arrangements for materials or supplies that benefit multiple contracts and/or the costs of which are normally applied to a contractor’s general and administrative expenses or indirect costs.

FAR 52.244-2

“Subcontract” means any contract, as defined in FAR Subpart 2.1, entered into by a subcontractor to furnish supplies or services for performance of the prime contractor a subcontract. It includes, but is not limited to, purchase orders, and changes and modifications to purchase orders.

Subpart 22.801

“Subcontract” means any agreement or arrangement between a contractor and any person (in which the parties do not stand in the relationship of an employer and an employee)—(1) For the purchase, sale, or use of personal property or nonpersonal services that, in whole or in part, are necessary to the performance of any one or more contracts; or (2) Under which any portion of the contractor’s obligation under any one or more contracts is performed, undertaken, or assumed.

“Subcontractor” means any person who holds, or has held, a subcontract subject to E.O. 11246. The term “first-tier subcontractor” means a subcontractor holding a subcontract with a prime contractor.

Discussion

So much for the FAR not defining subcontractors and the definition not covering ‘services’ provided by consultants and other professionals. Having said this, it is critical to remember that FAR definitions typically apply to the section where they are found. For example, the last definition is found in the Equal Employment Opportunity section which is why it further defines subcontract as non employment.

This is where the FAR experts, Contracting Officers, DCAA auditors, and other government employees can spend too much time parsing the FAR in an attempt to twist it into what they mean. A few years ago, a DOE pricing specialist in a vain attempt to prove that the contract was enforceable before the FAR, ended up accidentally accusing the contractor of criminal fraud. Context is critical to pulling out FAR clauses.

But sometimes, the only regulatory guidance is stranded in strange places. The ONLY guidance on how to withdraw an incurred cost proposal properly is found under “Indirect Cost Rates” (FAR 42.7) but under the section about waving penalties (42.709-5)

Now, having said that, the first three definitions appear numerous times in the FAR and could be argued to create a general definition. Let us look at some of the general conclusions we can draw from these definitions:

  • Subcontracts, for government contracting purposes, only apply to direct costs. Many DCAA auditors attempt to apply subcontractor regulations and procedures to costs charged as indirect. Notice one definition specifically addresses this. Professional and consultant costs are covered under FAR 31.205-33. This FAR section seems to assume such charges are indirect; but is not specific about consultants as a direct charge, and not burdening them with the additional definition as a subcontractor.
  • There does not have to be a contract, note the term ‘contractual action’ in the first definition and the inclusion of purchase orders in other definitions.
  • Your weekly trip to Walmart for office supplies does not make Walmart a subcontractor. Any contractual action, to include the right of return, does not create a subcontractor relationship. Again, I am not a lawyer, but I do believe this is a bit of a grey area. A recent example of this was the IRS attempt to force business to issue 1099s to everyone. Fortunately, Congress corrected the situation. Vendors such as Walmart are not subcontractors, but a plumber that provides services on multiple contracts is a subcontractor even if one of the definitions would appear to make this an exception.

As a final look at the regulations, let us look at the requirements reference subcontractors for the contractor’s incurred cost proposal found at FAR 216-7(d) :

(J) Subcontract information. Listing of subcontracts awarded to companies for which the contractor is the prime or upper-tier contractor (include prime and subcontract numbers; subcontract value and award type; amount claimed during the fiscal year; and the subcontractor name, address, and point of contract information).

Complicating Your Life

Now if we are all depressed about the definition of a subcontractor and recovering from our dashed hopes of trying to avoid the extensive subcontractor requirements, let us look at a couple of other common actions small business contractors take with subcontractor costs that can actually complicate their lives.

  • Treating subcontractors as Direct Labor – This is fairly common. For example: Jane, your 1099 ‘employee’ works alongside the regular employees and is invited to all of the parties. Your customer may even require her to fill out a timesheet just like the regular employees. This treatment does presents a couple of challenges.
    1. First, since you treat Jane as an employee and charge her time to Direct Labor; the IRS will decide she is an employee and will send you a bill for her payroll taxes, interest, and penalties. There is now even a section on Jane’s tax return to tell the IRS about this.
    2. Second, as if the first issue was not enough, it makes a bit of a challenge to reconcile your payroll to your labor costs, as required by regulation and on the Schedule L of the DCAA model ICE. If you segregate the 1099 costs in their own account under Direct Labor, you identified them as nonemployee and we are back to the subcontractor identification.
    3. Third, there is the issue of rates and comparative rates in competitive bidding. If you are including 1099 labor in your fringe and G&A base, an appeal could argue that your rates are artificially low and even deceptive. Additionally, we all know how many contracting officers hate paying G&A on subcontracts and will award only a special ‘handling’ or ‘management’ rate for the subcontractor part. I am sure they would be happy to discover what they consider subcontractor costs in Direct Labor.
    4. Fourth, many contracts require contractors to notify the contracting officer about any subcontracts and if a significant portion of your Direct Labor could be seen as actually subcontractors, this could present a problem to include allowability of the costs.
  • Another common approach is to classify all ‘consultants’ as Other Direct Costs. This decision would raise the same issues raised above as to rates and notification. Also, the common sense definition of Other Direct Costs are costs that cannot be easily categorized as Labor, Travel, Materials, or Subcontractors. DCAA might conclude that consultants would fail this categorization as Other Direct Costs.
  • Spreading the Joy – I mentioned the tax argument for segregating the subcontractor M&E costs and some of those engineers might express a desire to separate out the material costs from the subcontractor’s invoice.

These temptations are easily addressed by adding subaccounts to the subcontractor account for travel and materials, if you wish.

Conclusion

Ah, the joy of government contracting. Again, there are excellent reasons why contractors attempt to reduce the government (DCAA) involvement in subcontractor management. Both the regulation and guidance are extensive, to include a requirement to flow down clauses on employee texting while driving. Unfortunately, this is the nature of the beast and any attempts to reduce the government’s involvement in the contractor’s employment of subcontractor needs to be carefully planned and compliant with statute and regulation.

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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.

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DCAA Relations, Department of Defense News, Incurred Cost Proposals

A World Without DCAA – Now a Reality

Consequences — Rates and Rate Structure

The recently passed Department of Defense funding bill prohibits DCAA from working outside the Department of Defense until the Defense Secretary certifies DCAA’s backlog is under eighteen months

This does not come as a surprise and in many ways DCAA checked out in 2009. I wrote an extensive article on this in 2012 titled “A World Without DCAA”.

Although detail after detail remains uncertain (cognizance for example), it is not too early to start discussing some of the consequences of this legislation. Let begin with concerns about contractor rates and rate structure.

A couple of years ago, the Army could not get DCAA out to audit a client’s accounting system in anticipation of an award regarding critical research. In coordination with DCMA, the Army sent out its own auditor. This Army auditor recommended approval of the contractor’s accounting system and DCMA signed off on the report.

The one argument between the Army auditor and I arose out of cost allocation methodology or bases and pools. The contractor worked on two cost type contracts. The first, already in place, with the Air Force, involved mainly services. The second, the proposed Army contract, involved significant material purchases.

The Army objected to the allocation of administrative (G&A) over all other costs (Total Cost Input or TCI) as this allocation method would assign more administrative costs to the Army contract.

I persuaded the Army auditor that the guidance required the government to establish that the allocation method was inequitable to the government not the contract. As much as I loved the Army, as a former paratrooper, I could not change the allocation method for each contract.

This type of argument is familiar to everyone working in government contracting accounting. Time and time again, local contracting officers will attempt to impose cost allocation and rates on individual contracts. Refusal to pay G&A costs on direct travel is a classic example. Wanting a separate pool/rate of materials and/or subcontractors is another example. One Air Force contracting office tried to tell me with a straight face that he had never approved a G&A rate above ten percent.

This is one area where DCAA provided a service to the small contractor as DCAA would swoop in and make pronouncements, right or wrong on the contractor’s rates and rate structure. It also underlines the critical importance of an excellent cost accounting system to provide the data necessary to understand what the choices cost.

Who will make these decisions now? You can bet that arguing about it is going to cost both the contractor and the government.

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