Contributor: John Ford, Senior Consultant
On June 27, 2024, the United States Department of Defense (DoD) published a proposed rule (Case 2021-D0006) in the Federal Register that would amend the six Defense Federal Acquisition Regulation Supplement (DFARS) business systems clauses. DoD has requested that any comments on the proposed rule must be received by August 26, 2024.
The proposed rule implements section 806 of the National Defense Authorization Act for Fiscal Year 2021 (FY 2021 NDAA), which amends section 893 of the FY 2011 NDAA. Section 893 required the Secretary of Defense to develop a program for the improvement of contractor business systems to ensure that such systems provide timely, reliable information for the management of DoD programs by both the contractor and the Department.
Defining Significant Deficiency in Contractor Business Systems
This program was to provide guidance for the disapproval of any contractor business system that had a significant deficiency. For this purpose, significant deficiency was defined as “a shortcoming in the system that materially affects the ability of officials in the Department of Defense, and the contractor, to rely upon information produced by the system that is needed for management purposes.” However, when the various business systems clauses defined significant deficiency, they each omitted “and the contractor” from the definition.
Despite the definition of significant deficiency in law and the business systems clauses, on April 24, 2012, the Defense Contract Audit Agency (DCAA) issued MRD 12-PAS-012(R) to provide guidance on how to evaluate contractor accounting systems based on the DFARS criteria. In the MRD, DCAA stated that a significant deficiency would generally represent a material weakness in internal control as defined in the auditing standards. In this regard, a material weakness represents a deficiency, or combination of deficiencies, in internal control over compliance such that there is a reasonable possibility that a material noncompliance with a compliance requirement (e.g., applicable government contract laws and regulations) will not be prevented, or detected and corrected, on a timely basis.
The DCAA largely ignored the standards imposed by the law and DFARS and substituted its own definition for a contractor business system with a material weakness instead of a significant deficiency. This is important because the DCAA is responsible for evaluating three of the six DFARS business systems, although the Defense Contract Management Agency (DCMA) is responsible for making the final determination as to whether any of the six systems are acceptable.
Differing Interpretations of Language Changes
Section 806 of the FY 2021 NDAA amended Section 893 to delete the term “significant deficiency” and replace it with “material weakness.” It also defined material weakness as “a deficiency, or combination of deficiencies, in the internal control over information in contractor business systems, such that there is a reasonable possibility that a material misstatement of such information will not be prevented, or detected and corrected, on a timely basis. A reasonable possibility exists when the likelihood of an event occurring is probable or more than remote but less than likely.”
Thus, section 806 essentially adopts the auditing standards in this regard. The proposed DFARS changes adopt the exact language found in section 806. However, there is no guidance on how that language is to be interpreted. For example, no guidance is provided around what would be considered “material” in regard to a misstatement of information. Because DCAA evaluates three of the systems and DCMA evaluates three, there can be a difference in the way the agencies interpret this term. This can lead to disputes between the agencies regarding evaluations conducted by the DCAA.
Another issue is how the systems operate in practice. In the MRD referenced above, the DCAA stated that the government does not need to have suffered any actual loss in the form of increased prices negotiated or amounts paid on contracts for an accounting system to be unacceptable.
Therefore, one or more of those systems may be determined to be unacceptable if an auditor believes there is a reasonable possibility of material misstatement (i.e., it is probable that a “material misstatement” will occur, although such misstatement never has occurred). Even if a contractor’s systems have operated for years in a particular way with no harm to the government, an auditor could still deem it unacceptable.
Finally, guidance needs to be provided concerning the difference between “probable” and “likely.” Merriam-Webster’s Dictionary lists these words as synonyms of each other. Although these terms are taken directly from section 806, the DoD needs to provide some clarity as to how they are to be interpreted in this context.
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