Each year Cherry Bekaert addresses topics that effect the Defense Contract Audit Agency (“DCAA”) in our DCAA “Hot Buttons” webinar. A summary of the January 17, 2018, webinar is presented here. The webinar is replay is also available on our YouTube channel.
Section 803 of the 2018 National Defense Authorization Act (“NDAA”)
Section 803 of the 2018 NDAA contains several provisions reforming defense contract auditing. Perhaps the provision with the greatest impact on DCAA directs the Department of Defense (“DoD”) to begin using private auditors to perform incurred cost audits to reduce the current backlog. The provision intends to focus DCAA resources on forward-pricing audits, which are considered to yield a higher rate of return.
DoD must submit a plan for implementing this direction to Congress by October 1, 2018, and must issue contracts to at least two audit firms by April 1, 2019. In addition, no later than October 1, 2020, the Secretary of Defense shall comply with commercially accepted standards of risk and materiality in the performance of each incurred cost audit.
The Secretary of Defense must use private auditors to perform incurred cost audits to eliminate any backlog of incurred cost audits by October 1, 2020.
The Secretary shall ensure that any private auditor performing an incurred cost audit:
- Has no conflict of interest in performing such an audit; and
- Signs a nondisclosure agreement.
Private auditors must conduct audits in accordance with generally accepted government auditing standards (“GAGAS”) and must develop and maintain complete and accurate working papers for each audit, which will be the property of DoD.
DCAA Objections
In Congressional testimony in April, 2017, Anita Bales, Director of DCAA objected to the use of private auditors because:
- Contract auditing requires a special set of skills;
- DCAA can attain certain efficiencies in the audit of incurred costs;
- Only DCAA can efficiently audit subcontracts; and
- Contract audit process is inherently governmental in nature.
We will review each of these objections in turn.
Audit Expertise of the DCAA Workforce
DCAA considers contract auditing unique in that it requires a special set of skills requiring familiarity with cost accounting, Federal Acquisition Regulation (“FAR”) and Cost Accounting Standards (“CAS”). Where DCAA is deeply experienced with FAR and CAS, public accounting firms are not. Therefore, public firms face a learning curve with FAR and CAS, which could take significant time to overcome.
However, many public firms already perform contract audits for federal departments. These public firms have proven capable of properly interpreting and applying FAR and CAS.
Only DCAA Can Attain Efficiencies in the Audit of Incurred Costs
DCAA uses information gathered during various contract audits to assess the risk involved in the audit of the incurred cost submission. DCAA is, therefore, able to focus its audit effort on the riskiest submissions and the most significant areas of risk within submissions.
Based on its familiarity with contractors, DCAA has been able to audit a sample of the low-risk incurred cost submissions — reducing the number of submissions audited annually without significantly increasing risk to the government.
In contrast, public accounting firms do not have access to the information DCAA has, which hampers their ability to assess risk. Those firms also lack a large population of low-risk submissions from which to select a sample.
These are good points. However, if the Secretary were to provide access by public firms to previous submissions and DCAA audits of those submissions, public firms could conduct risk assessments similar to those conducted by DCAA. Also, DoD could distribute audits of low-risk submissions to public firms after DCAA has selected the sample.
Only DCAA Can Efficiently Audit Subcontracts
When performing audits at prime contractors, DCAA identifies high-risk subcontracts as part of its audit procedures. The DCAA office performing the audit of the prime contractor requests audits of the selected subcontracts (known as assist audits) from the DCAA offices responsible for each subcontractor. The DCAA office at the prime incorporates the subcontract audit results into the audit results of the prime contractor. DCAA considers this process to be very efficient.
This process does not always operate smoothly because the audits of some submissions, usually large prime contractors, often lag behind others. The consequence of this backlog regarding subcontract audits is that DCAA offices requiring audit of subcontracts performed by Boeing in 2014 will likely have to wait until 2019 to get the results, if even by then.
Public firms can assist in resolving this issue by helping to reduce the overall backlog and speeding up the availability of subcontract audits. In situations where different public accounting firms are auditing the prime and the subcontractor, procurement organizations would have to establish a process where the procurement organization would facilitate the audit process.
The Contract Audit Process is Inherently Governmental in Nature
FAR 7.503(c) (12) (vii) states that determining whether costs are reasonable, allocable and allowable is an inherently governmental function.
DCAA determines approximately 65 percent of all auditor-determined final indirect cost rates. The remaining 35 percent of DCAA’s incurred cost work isn’t inherently governmental because rates are negotiated by the contracting officer (“CO”). However, DCAA’s work still contains characteristics of inherently governmental work because DCAA audits submissions and makes recommendations to the CO.
FAR 7.503 describes policy that can be changed to include language regarding the audit of incurred cost submissions by public accounting firms. Determining whether costs are reasonable, allocable and allowable can be done by non-government auditors as well as government ones.
Other Section 803 Requirements
Peer Review by a Commercial Auditor
Effective October 1, 2022, DCAA may issue unqualified audit findings only if DCAA passes peer review by a commercial auditor. The peer review must be conducted in accordance with GAGAS peer review requirements.
Audit Results Must Be Issued No Later Than One Year After Receipt of a Qualified Submission
Within 60 days after receipt of an ICS, the contractor must be notified whether the submission is a qualified submission (i.e., acceptable for audit). In addition, audit findings must be issued for an incurred cost audit no later than one year after the date of receipt of a qualified ICS.
DCAA is focused on reviewing incurred cost submissions for adequacy soon after receipt. If DCAA finds that an ICS is not adequate, it returns the ICS to the contractor for edit. This move enables DCAA to push back audit of the submission.
DCAA often takes longer than a year to audit submissions and considers the timeframe of a year to produce audit results too short. DCAA contends that the current timeframe of 36 months for closing out of physically completed contracts found in FAR 4.804-1(a) is more appropriate.
With Certain Exceptions, Multi-Year Auditing Is Allowed Only for Incurred Cost Submissions Submitted More Than 12 Months Prior to Enactment of the 2018 NDAA
DCAA contends that multi-year audits reduce audit labor costs by 40% over separate single-year audits and benefit contractors because of reduced time required to support audits.
Other Sections of the 2018 NDAA
Section 811 of the 2018 NDAA revises the certified cost or pricing data threshold to $2 million for contracts awarded after June 30, 2018.
Section 818 requires revisions to the Defense Federal Acquisition Supplement (“DFARS”) that will provide for enhanced post-award debriefings for disappointed offerors in DOD procurements for awards exceeding $100 million.
- These enhanced debriefings will include the right to receive a redacted copy of the agency’s written source selection award determination and the right to ask follow-up questions within two (2) business days of receiving a post-award debriefing.
- The agency must provide written responses to any follow-up questions within five (5) business days, and the debriefing will not be concluded until the agency delivers its written responses.
- The day the Government delivers the written responses will begin the five-day period to file a protest at the Government Accountability Office.
- The NDAA also provides that small businesses or nontraditional contractors may request redacted source selection determinations for awards more than $10 million.
Armed Services Board of Contract Appeals (ASBCA) Decisions of Interest
Lockheed Martin Integrated Systems, Inc. — ASBCA Nos. 59508, 59509 (20 December 2016)
“In this case, we are presented with a claim based on a legal theory originated by an auditor. The government moved forward with a claim for over $ 100,000,000 that is based on a plainly invalid legal theory.” This is how the ASBCA described this case which case involved the allowability of subcontractor costs under two IDIQ contracts, one T&M and one that allowed T&M or cost reimbursement orders.
DCAA and the ACO alleged that LMIS breached FAR 42.202(e)(2) because it did not require subcontractors to establish final indirect cost rates. During the hearing, the government admitted FAR 42.202 was not incorporated into either contract. In this regard, the FAR does not apply to contractors, but only provides guidance to government procurement personnel.
Another issue was LMIS’ alleged failure to produce records showing that it could substantiate subcontractor costs. The Board observed that the audit clause (FAR 52.215-2) “requires contractors to retain records for three years after final payment or any shorter or longer period required by FAR Subpart 4.7 or another clause of the contract.” Moreover, the T&M Payments clause “does not require the contractor to maintain . . . substantiating records until DCAA is finished conducting incurred cost audits seven or so years after the costs were first billed and paid.”
Technology Systems, Inc. — ASBCA No. 59577 (12 January 2017)
This case addressed the common problem of DCAA not questioning costs for years, then questioning them. The contractor used two legal theories, retroactive disallowance and prior course of dealing, to argue that because DCAA had not questioned certain costs in the past, DCAA could not do that now.
The Doctrine of Retroactive Disallowance prevents the government from challenging costs incurred when:
- “the cost or accounting method in question previously had been accepted following final audit of historical costs;
- the contractor reasonably believed that the accounting method would continue to be approved; and
- it detrimentally relied on the prior acceptance.”
The Board held that the Doctrine of Retroactive Disallowance was a form of estoppel. The Supreme Court has held that before estoppel can apply against the government, the government must have engaged in misconduct toward the other party.
Therefore, because retroactive disallowance is a “special application of estoppel, “it is subject to the affirmative misconduct requirement. Here no misconduct was demonstrated, and thus DCAA could question costs it had not questioned before.
The Board also rejected TSI’s course of dealing argument. A course of dealing is a sequence of previous conduct between the parties to an agreement that is treated as establishing a mutual interpretation of the terms of a contract.
DCAA’s failure to question certain costs in prior audits, without more, does not “establish a common basis of understanding” of what should constitute adequate substantiation of (or support for) TSI’s incurred costs. This is the case because the failure to question certain costs could mean more than one thing and not necessarily mutual agreement on the interpretation of the cost principles.
In a footnote, the Board observed, “This is not to say that in no circumstances could an auditor’s course of conduct establish evidentiary standards for substantiation.”
Another issue concerned the statement in FAR 31.205-33 that the evidence supporting consultants’ work “shall include … work products.” The government argued that this statement in FAR 31.205-33 makes the provision of such documents mandatory. The Board held that the government labors under the false impression that the FAR requires a consultant to create “work product” merely to prove its costs.
The problem with this interpretation, however, is that it does not account for the case where invoices include the data that the FAR defines as work product, such as persons visited and subjects discussed. (Also, see Raytheon Company, ASBCA Nos. 57743, 57798, 58280 (17 April 2017))
DCAA Memorandums for Regional Directors (“MRDs”) – Missing in Action
MRDs contain guidance for DCAA personnel on a wide variety of audit issues in addition to those found in the DCAA Contract Audit Manual. DCAA usually issues numerous MRDs annually and posts them for public perusal on its website. However, DCAA has posted only four MRDs for 2017.
We know DCAA issues many more MRDs than they are releasing. Here is the current trend:
- 2017: 4
- 2016: 6
- 2015: 8
- 2014: 14
At this rate, DCAA will publish only two MRDs in 2018!
