Coping With ( Or, Hopefully Avoiding ) DCAA

1. Coping With (Or, Hopefully Avoiding)DCAA John Edward ("Ed") Murphy CPA CFE CGFM CPCM FINANCIAL MANAGEMENT INSTITUTE http://www.fmi.cc 2334 Oak Street Falls Church VA 22046 – 2326 Telephone: 703‑532‑9106/9107 FAX: 703‑532‑4295 E Mail: ed@fmi.cc

2. What prompts a Defense Contract Audit Agency (DCAA) audit and how to avoid a visit from DCAA • Contractor rights and obligations • What a contractor can expect during a "systems" review or audit, the consequence of "flunking," and how to pass with flying colors • What a contractor can expect during a DCAA audit and how to prepare for one • How to expedite any audit • Consequence of an adverse audit finding You Will Learn

3. “Flexibly priced” contract types that require you to report the actual cost incurred in order to:   Claim compensation for cost incurred (e.g. cost reimbursement contracts);   Demonstrate your entitlement to incentive fees (e.g., fixed price incentive contracts);   Redetermine contract compensation (e.g., fixed price redetermination contracts); or   Prove your compliance with the Truth In Negotiations Act (TINA), PL 87-653. Target Contracts for DCAA Interest

4. Audits of Proposed or Incurred Costs • Pre-award Survey of Prospective Contractor Financial Capability, (SF 1407) • Pre-award Survey of Prospective Contractor -Accounting System, (SF 1408) • Timekeeping and Labor Charging (Floor Checks) • Cost Accounting Standards • Estimating System • Purchasing System • Indirect Cost • Truth in Negotiation Act (PL 87-653) Enforcement Audits and Reviews by DCAA

5. Tonight’s attendance is a good start. • Don’t Wait Until DCAA Contacts You --- Learn About DCAA Now! • DCAA’s website (http://www.dcaa.mil/) with downloadable useful publications and electronic files. • Information for Contractors (DCAAP 7640.90) will tell you a lot about DCAA and what a contractor can expect during a DCAA visit. • DCAA auditor’s bible, Contract Audit Manual (phonetically referred to as the “CAM”). Review the sections of the CAM that correspond to the contents of Information for Contractors. Chapter 10 of the CAM showing examples of the different DCAA audit reports is particularly informative. • If a you know how DCAA works and what to expect from them, you can expedite the audit visit and avoid spending more time with them than necessary. Conversely, if you are not prepared, the audit time frame may be unnecessarily extended. Learn About DCAA

6. l • “Avoiding” DCAA ≠ “Bashing” DCAA • “Avoiding” DCAA ≠ Contempt or Disrespect • If you cannot avoid a visit from DCAA, then welcome DCAA as a respected representative of your valued customer, “Uncle Sam.” Avoiding DCAA

7. All submissions to your Contracting Officer should made in a manner that conveys the following messages- We know the FAR and what is expected of us.- An audit or review by DCAA is unnecessary; and probably a ‘waste of time.’ - If you insist on an audit or review, we will cooperate to expedite it.Accordingly all submissions should be - In sufficient detail and with explanations to preclude follow up. - Accompanied by assurances of compliance with the FAR --- particularly FAR 31. - Free of costs deemed unallowable per FAR 31, or contract terms. - In accordance with prescribed instructions. - Free of mathematical errors. - Cosmetically appealing. - On time Avoiding DCAA Guiding Principle

8. M&M’s annual Cost Allocations Plans for fiscal years ended 31 December 20X6 (actual), 20X7 (actual), 20X8 (actual), and 20X9 (budget) are summarized in the attached Excel electronic working paper. This plan has been or will be submitted pursuant to the Allowable Cost and Payments Clause (FAR 52.216-7). Major features of this electronic working paper shows — (continued on next slide) Avoiding DCAA Guiding Principle (continued) Assurances

9. A reconciliation of the cost allocation plan with the results of operations as presented in M&M’s audited (Clean Opinion from PriceWaterhouseCoopers) financial statements. • The constituent general ledger account balances for each Direct Costs Element. • The constituent general ledger account balances for each of the five final indirect costs pools. • The proper accounting for applicable credits pursuant to FAR 31.201‑5.   • The proper accounting for unallowable costs pursuant to FAR 31.201‑6. (M&M’s chart of accounts identifies costs expressly unallowable pursuant to FAR 31. M&M accounting practices adhere to FAR 31.201 6 (a), (b), Accounting for unallowable costs; and CAS 405. Unallowable costs are identified and excluded from any billing, claim, or proposal applicable to a Government contract. But, pursuant to FAR 31.203 (d), unallowable costs are included in any base used to allocate a subsequent indirect cost). Assurances

10. Allow access to your books, records, and facilities only when required. Know your rights. Read the "access to records" clauses in your contracts, and the Federal Acquisition Regulation (FAR) or the Defense FAR Supplement (DFARS). DCAA does not have unlimited authority to review your operations. Don't ask them to defend their right to access. Instead, question their right to access using arguments based on law, regulation, and contract provisions, not on emotion, ideology or inconvenience to your firm. Contractor Rights and Obligations

11. Virtually all DCAA audit requests are initiated as a result of a sound determination of DCAA rights. DCAA will not (except by an embarrassing mistake) ask to review a proposed price submitted in response to Sealed Bidding (a response to an Invitation for Bid). Nor will they ask to review costs proposed in response to a Request for Proposal (RFP) unless instructed to do so by the contracting officer. DCAA's rights to access to your accounting records are identified by regulations or contract. Contractor Rights and Obligations(continued)

12. If DCAA's access to records is based on a specific contract clause, you have very little foundation for denial. As a practical matter, don't waste time entertaining such foolish fantasies. Under a “flexibly priced” contract, they have a contractual right, for example, to review your accounting records to verify the actual cost incurred, so that you can get paid. Do all you can to facilitate this cost incurred audit, and get paid as soon as possible! Contractor Rights and Obligations(continued)

13. You may have some basis for denial when DCAA asks to review the data supporting the price proposed in response to a Request for Proposal (RFP). The best way to deny DCAA access to the data supporting your cost estimate is to avoid submitting Cost and Pricing Data. Instead prepare a claim for exception. While your exception request is being considered, do not release any cost and pricing data to DCAA (or any other government agent). Don't disclose any cost or pricing data unless and until the Contracting Officer denies your exception request. Contractor Rights and Obligations(continued)

14. Contracting officers initiate an audit or review --- not the auditors. Contracting officers --- not the auditors ---have the ultimate responsibility of determining if a contractor’s proposed or actual compensation is fair and reasonable. But in many instances contracting officers will rely on others government agents, particularly the contract auditors. About DCAA (continued)

15. If most of a your work is with the DOD, DHS, NASA and DOE there is a good probability that a contractor will encounter auditors from DCAA. If your workload is primarily with other civilian agencies, a contractor may still encounter DCAA. Almost all Federal agencies rely on DCAA under various interagency agreements. DCAA is the dominant Federal agency performing contract audit work for the entire government. If you never encounter DCAA or any other contract auditor, don’t feel slighted! And if you do encounter DCAA or any other contract auditor, treat them as a representative of a valued customer! About DCAA (continued)

16. Market-Based Prices rather than Cost-Based Prices • Propose and negotiate a "bottom line" selling prices, without disclosing any information on the composition of your prices (material cost, labor cost, indirect cost, and profit) Avoiding DCAA - Best Practice

17. A contractor’s general policy should be to propose and negotiate "bottom line" selling prices, without disclosing any information on the composition of our prices (material cost, labor cost, indirect cost, and profit). For the purpose of this policy statement, a bottom line selling price may be expressed as a unit price; an hourly billing rate; or a lump sum price for a project, program, or other endeavor. • The FAR encourages — indeed supports --- this general policy. The FAR forbids obtaining anything but the bottom line selling price in Acquisition of Commercial Items (Part 12), Simplified Acquisition (Part 13), Sealed Bidding (FAR 14). • Information other than a bottom line selling price is usually in the form of a cost and price breakdown and shows each element of cost and the proposed profit. Only in Acquisition by Negotiation (Part 15) does the FAR permit information other than a bottom line selling price. But even in Acquisition by Negotiation, the buying activity (a Federal activity or a prime contractor) is cautioned to avoid asking for more that a bottom line selling price. Furthermore the buying activity is proscribed in the method of requesting information other than a bottom line selling price. Establish a General Policy “Bottom Line" Selling Prices

18. Competitive offers • Catalog prices • Established market prices • Prices established by law or regulation Market-based Prices

19. Cost-Based Prices often trigger the inclusion of a (intrusive) Defective Pricing clause in contract Avoiding DCAA - Best Practices (continued)

20. Seller's Cost and price breakdown is presumably the seller's best estimate of what they feel it will cost to produce the goods and services called for in the solicitation, and the requested profit margin. • Seller is forced to disclose data which can be challenged by the buyer. Buyer can perform cost analysis to detect ineconomies, inefficiencies, and ineffectiveness inherent in seller's proposal. • Buyer can also perform cost realism analysis by analyzing such data as labor hours and labor mix, to determine if the seller's proposed effort is responsive to the buyer's solicitation. • Buyer challenges the seller's will cost position with its own should cost position. Buyer may also challenge seller's proposed profit. • Differences between buyer and seller positions are worked out through negotiation before contract award. • Fair and reasonable price determined through full disclosure, negotiation, and mutuality of agreement. Cost-based Prices

21. Materials costs 1/ $ 200,000 Materials handling overhead 3/ 5,000 Direct labor costs 2/ 500,000 Production overhead 3/ 1,000,000 Total production costs $1,705,000 General and administrative (G&A) expenses 3/ 295,000 Total costs $2,000,000 Profit 100,000 Selling price $2,100,000 __________________ 1/ Based on a "priced out" bill of materials. 2/ Based on a work breakdown structure (wbs) and estimated labor rates. 3/ Based on indirect cost allocation plan derived from the enterprise's financial statements and cost accounting system produced in conformity with generally accepted accounting procedures. METAPHYSICAL DEVICECOST AND PRICE BREAKDOWN

22. A careful reading of FAR 15.402, Pricing policy demonstrates that Uncle Sam's policy is to avoid making contractors submit Cost or Pricing Data; and that Cost or Pricing Data should be requested only when other means of determining a fair and reasonable price are unavailable. • FAR 15.403‑5 shows that Contracting Officer, as part of the solicitation, shall give the offeror an opportunity to avoid the submission of Cost or Pricing Data. Avoiding DCAA - Best Practices (continued)

23. “By submitting this proposal, we grant the Contracting Officer and authorized representative(s) the right to examine, at any time before award, those records, which include books, documents, accounting procedures and practices, and other data, regardless of type and form or whether such supporting information is specifically referenced or included in the proposal as the basis for pricing, that will permit an adequate evaluation of the proposed price.” Contracting officers usually use this as the basis for requesting contract audit support. Avoiding DCAA - Best Practices (continued)

24. Gather financial statements from the past three or four fiscal years. Summarize the information for these three or four years on a spread sheet, so that comparison between years is apparent. Provide a copy of this comparative trend report, together with several interpretive ratios. The most common ratios are the current ratio, "acid test" ratio, receivable turnover, inventory turnover, debt to equity, and earnings per share. Provide this information on an electronic spread sheet. Also assemble filings with regulatory agencies (e.g., SEC, SBA, etc.); cash forecasts, budgets, and other future projections; credit history and ratings; and any other documents you feel a government auditor would need to complete a pre-award survey. Pre-award Survey of Prospective Contractor Financial Capability, (SF 1407)

25. Summarize all the information assembled. Have two or more employees independently complete the Preaward Survey of Prospective Contractor Financial Capability, Standard Form 1407 acting like impartial government auditors. An employee unable to recommend "complete award" should be instructed to either get additional information or to prepare a narrative for a best case situation. This "devil's advocate" review should enable you to prepare a convincing case (or at least your best case) for a review. If you feel comfortable about your financial capability, there's a good chance the government auditor will feel comfortable. Preaward Survey of Prospective Contractor Financial Capability, (SF 1407) (continued)

26. Big Myth --- DCAA must approve our accounting system before we are eligible to receive a “flexibly priced” contract. • True contracting officers will often commission a survey of a contractor’s accounting system using the standards articulated in SF 1408), a survey often performed by an audit activity such as DCAA. • FAR 16.301 3 (a) provides that a cost reimbursement contract may be used only when, “The contractor's accounting system is adequate for determining costs applicable to the contract.” But this is a determination is the responsibility of the contracting officer. • Contracting officer can and do make this determination of accounting system adequacy, BUT … Pre-award Survey of Prospective Contractor – Accounting System, (SF 1408)

27. You will have to convince the contracting officer --- and yourself --- that your accounting system meets the FAR 16.301 3 (a) standards.

28. Do your own assessment using the SF 1408 standards. Knowing what a government representative (e.g., a DCAA auditor is looking for will enable you to: • Improve your current system; • Identify and correct any deficiencies in your current system; • Assert, in a response to any solicitation for a cost reimbursement or other flexibly priced contract that your accounting system meets the requirement of FAR 16.301 3 (a); and •  Be confidently prepared for any pre-award review of your cost accounting system. Murphy’s Recommendation

29. 1. Except as stated in Section I Narrative, is the accounting system in accord with generally accepted accounting principles as applicable in the circumstances? 2. Accounting System Provides For: Proper segregation of direct costs from indirect costs. Identification and accumulation of direct costs by contract. A logical and consistent method for the allocation of indirect costs to intermediate and final cost objectives. Accumulation of costs under general ledger control. A timekeeping system that identifies employees’ labor by intermediate or final cost objectives. SF 1408 Standards

30. 2. Accounting System Provides For (continuted): A labor distribution system that charges direct and indirect labor to the appropriate cost objectives. Interim (at least monthly) determination of costs charged to a contract through routine posting to books of account. Exclusion from costs charged to Government contracts of amounts that are not allowable pursuant to FAR Part 31, Contract Cost Principles and Procedures, or other contract provisions. Identification of costs by contract line item and units (as if each unit or line item were a separate contract) if required by the proposed contract. Segregation of preproduction costs from production costs. SF 1408 Standards (continued)

31. 3. Accounting System Provides Financial Information: • a. Required by contract clauses concerning limitation of cost (FAR 52.232.20 and 21 or limitations on payments (FAR 52.216‑16). • b. Required to support requests for progress payments. • 4. Is the Accounting System designed, and are the records maintained in such a manner that adequate reliable data are developed for use in pricing follow‑on acquisitions? • Is the Accounting System currently in full operation? • If not, describe in Section I Narrative which portions are (1) in operation, (2) set up. but not yet in operation, (3) anticipated, or nonexistent. SF 1408 Standards (continued)

32. 2. Accounting System Provides For: d. Accumulation of costs under general ledger control. M&M's job order cost accounting system, is NOT and extra territorial “cuff records” system. On the contrary M&M’s is fully integrated into the general ledger accounting system which produces the fundamental accounting reports (See 1.). SF 1408 Standards With Convincing Response

33. Accounting System Provides For: • A timekeeping system that identifies employees’ labor by intermediate or final cost objectives. • A labor distribution system that charges direct and indirect labor to the appropriate cost objectives. • M&M’s timekeeping and labor distribution is accomplished through Time Collection web-based software. • Using a numeric coding system, employees must contemporaneously — at least daily — record the time worked on different work assignments. The numeric coding system identifies the labor hours with a job (final cost objective) or with a multiple cost objective (indirect cost subject to allocation or division). SF 1408 Standards With Convincing Response (continued)

34. Accounting System Provides For: • A timekeeping system that identifies employees’ labor by intermediate or final cost objectives. • A labor distribution system that charges direct and indirect labor to the appropriate cost objectives. • ANSWERS CONTINUED… • Each employee reports their time online. The electronic timesheet proceeds electronically through two levels of supervisory approval. • Untimely, corrected, retrospectively prepared, or other not-contemporaneously prepared timesheets require two levels of supervisory review. SF 1408 Standards With Convincing Response (continued)

35. An unacceptable system is not in your best interests. • An unacceptable cost accounting system may not preclude you from getting government business. • But it will severely restrict the type of contracts and financing options open to you. • The government auditor will tell you and the procurement official if your system is acceptable or not. • Do all you can to correct any deficiencies. Consequence of an Unacceptable Cost Accounting System

36. Auditors do not disallow costs. • Only the contracting officer can disallow costs. • But the audit report may identify some proposed or incurred costs as “questioned,” "unsupported," or “unresolved.” Audits of Proposed or Incurred Costs

37. Questioned costs are costs proposed or incurred which, in the auditor’s opinion, are unallowable, unreasonable, or not properly allocable to Government contract. • Questioned costs are de facto recommendations by the auditor to the contracting officer to disallow these costs. Audits of Proposed or Incurred Costs (continued)

38. Unresolved costs are cost proposed that the auditor is unable to render an opinion as to their reasonableness, allowability, or allocability. • Unlike unsupported costs, however, the contractor has presumable prepared the proper support. • Unresolved costs require additional audit work usually being performed simultaneously by another audit team at another location (e.g., a sub-contractor's facility). • Costs identified as "unresolved" signal the contracting officer to expect more factual data (usually in the form of an assist audit report) before accepting the contractor’s proposed or incurred costs. Audits of Proposed or Incurred Costs(continued)

39. Unsupported costs are costs proposed or incurred that the auditor is unable to render an opinion as to their reasonableness, allowability, or allocability. • Costs identified as "unsupported“ signal the contracting officer to demand more factual data before accepting the contractors proposed or incurred costs, or to even disallow these costs in the event that the contractor fails to provide better support. Audits of Proposed or Incurred Costs(continued)

40. Be prepared. DCAA seldom makes unannounced visits. • Allow access to your books, records, and facilities only when required. • Demonstrate the integrity and reliability of your accounting and internal control systems • Treat each audit or review by DCAA as a separate engagement. • Host meetings. • Control and monitor access. • Provide appropriate workspace near accounting and estimating personnel. Instruct employees to limit socializing. • Provide copies of past reviews that could reduce the current audit effort. • Respond quickly. • Prepare a special file showing all significant non‑routine transactions recorded during the fiscal year.   • Prepare a special file to explaining recurring special issues.   • Be businesslike, but courteous and respectful.   • Debrief the auditors. During the Audit or Review

41. QUESTIONS?