DCAA’s New Direction March 10, 2010 Presentation By: James W. Thomas PricewaterhouseCoopers LLP

1. DCAA’s New DirectionMarch 10, 2010Presentation By:James W. ThomasPricewaterhouseCoopers LLP PwC

2. Topics for Discussion • DCAA Audit Issues • GAO September 2009 Report • DoD Policy Update • DFARS Proposed Rule on Contractor Systems • Cost Disputes • Future State of Compliance Controls Slide 2

3. DCAA Audit Issues • Audit Quality • GAO investigation • DoD IG Peer Review Expiration • GAGAS exception effective August 27, 2009 • GAO audit report – September 23, 2009 • Change in DCAA leadership • DCAA Guidance and Direction • Independence issues • Pressure on contractor system assessments • Expectations on contractor responsiveness • Access to records and people • “Disclosure” audits • DCAA / DCMA authority issues Slide 3

4. GAO Findings on DCAA Audit Quality • DCAA’s management established policies, procedures and training that emphasized a large quantity of audits over audit quality • Quality problems at DCAA offices nationwide, including: • Compromise of auditor independence • Insufficient audit testing • Inadequate planning and supervision • Lack of fraud risk detection procedures • Inadequate auditor understanding of controls • Reporting problems

5. Legislative and Other Actions Recommended by GAO • Leadership and Stability • Senate confirmation of a presidentially appointed DCAA Director • Mandate permitting DCAA Director to hold a renewable term appointment between 5 to 7 years • Conflict of interest provisions for DCAA Director and other key personnel • Access to Independent Legal Counsel • DCAA Director not always apprised of legal decisions by DoD Counsel that impact DCAA operations • Increased Authority and Independence • Provide same level of access to records and personnel available to IG • Reporting and oversight of audit results • DCAA currently has no external reporting requirement • Legislation could expressly allow DCAA to provide audit results to other agencies, which would improve its visibility and effectiveness Slide 5

6. Commission on Wartime Contracting Report on Contractor Business Systems- September 21, 2009

7. Resolving Contract Audit Disputes • New DoD policy issued on December 4, 2009 applies when, in setting a pre-negotiation objective, there is a significant disagreement between DCMA and DCAA • Policy threshold - when the contracting officer plans to sustain less than 75% of the total recommended questioned costs by DCAA for proposals valued at $10M or more • When significant disagreements occur: • The CO shall discuss and document the disagreement prior to negotiations • If unresolved, DCAA’s management may request DoD Component’s management review • If unresolved, DCAA Director may contact Shay Assad, Director of Defense Procurement & Acquisition Policy • Final stage of disagreement may be elevated to Under Secretaries for Defense, Acquisition, Technology, Logistics, and Comptroller

8. DoD Panel on Contracting Integrity 2010 Areas for Review and Development Prime contract surveillance and pricing of subcontracts DoD policy regarding the definition of adequate price competition Training to related to the current structure of contracting integrity Use of level-of-effort contracts, including firm fixed-price and cost-plus awards Use of senior mentors/advisors/highly qualified experts and potential conflicts of interest Requirements placed on DCAA for reports and reviews to determine if all are necessary or can be performed by others Contracting peer review process DoD policy covering contractor business systems to include reviews, approvals and surveillance Slide 8

9. Proposed DFARS RuleEffectiveness of Contractor Systems(Jan 15, 2010 DFARS Parts 215, 234, 242, 244, and 252) Allows administrative contracting officer to withhold a percentage of payment when contractor’s business system contains deficiencies Business system includes accounting system, estimating system, earned value management system, material management and accounting system, property management system, purchasing system If the ACO determines that there are one or more system deficiencies that are highly likely to lead to improper contract payments, or represent an unacceptable loss to the Government, then 100% of payments will be withheld until deficiencies are corrected Slide 9

10. Cost Allowability CasesTecom (U.S. Court of Appeals, 5/19/09, 53 CCF ¶79,109) • A lower court decision granting summary judgment in favor of Tecom, holding that defense costs and settlement payments associated with a sexual harassment suit are allowable in accordance with FAR 31.205-47, was reversed • U.S. Court of Appeals held that defense and settlement costs are allowable only if the contractor can show the lawsuit had very little likelihood of success • Requirement for the allowability of cost is that it must comply with the terms of the contract (FAR 31.201-2). An adverse judgment in a title VII suit would not be allowable under the contract, which specifically prohibited discrimination on the basis of sex Slide 10

11. Cost Allowability CasesBearing Point (ASBCA 55354 and 55555, 10/16/09, 09-2 BCA ¶34289) An appeal of disallowed labor and transportation costs was sustained when the contractor met its burden of proof on allocability: Allowable Cost and Payment clause did not require the contractor to substantiate labor costs with time sheets Audits and Records clause did not prescribe the form records or other evidence must take Documentation for Payment clause did not describe the requisite level of detail for the contractor’s books and records Contract payment and audit clauses were consistent with FAR 31.201-2(d), which refers broadly to a contractor’s responsibility to maintain documentation for claimed costs An appeal of disallowed compensation related costs was denied when the government met its burden of proof on allowability by citing specific contract limitations Slide 11

12. Cost Allowability Cases Teknowledge Corporation (U.S. Court of Federal Claims No. 06-310C, 01/07/09) Amortization of contractor’s software development costs were disallowed as not allocable to government contracts Contractor relied on GAAP (FAS 86), whereby software development costs are amortized based on current and future revenue Government relied on FAR 31.201-4, which requires that costs “benefit” the Government Fiber Materials, Inc (ABSCA No. 53616, 4/17/07). Legal defense costs in a criminal proceeding were unallocable and therefore unallowable. The legal costs were found to be too remote to satisfy the FAR benefit test (non-CAS contract) Sales commissions were allocable and allowable as indirect costs because the contractor treated sales commissions as indirect costs (G&A) consistently Patent amortization costs were expressly unallowable when not required by the contract Penalties – government bears the burden of proving expressly unallowable costs, “sufficiently colorable” claims are not expressly unallowable and penalties must be waived if the claimed expressly unallowable costs are $10k or less Slide 12

13. Future State of Compliance Controls Control systems are critical Record integrity and retention (electronically stored information) Long-standing cost accounting practices may be questioned by DCAA without a change in circumstances Continuing disputes over DCMA vs. DCAA authority New compliance and reporting obligations Slide 13

14. Contractual Compliance RequirementsWhat Does This Mean for Contractors? Higher level of scrutiny by government auditors Increased business and reputational risk More resources needed for government audits Cash flow and margin implications Financial reporting (i.e., SOX) controls may address some aspects of compliance A systematic approach is needed to increase confidence and efficiency in the compliance function

15. Rationalizing Internal Controls • Holistic framework to address internal control requirements • COSO internal controls framework used extensively to address compliance needs • COSO framework addresses five areas of internal controls • DCAA system audit objectives are within the COSO framework DCAA is focused primarily on the compliance objectives within the COSO model.

16. Compliance Effectiveness Methodology The methodology focuses on driving compliance while decreasing overall cost . It focuses on using existing technology and existing compliance efforts to achieve this goal.

17. Defining Internal Controls Optimization Efficient and systematic process to define risks Quantification of costs, process impact and validation of these controls Implement management oversight and reporting structure Establishing the right controls at the right cost Leverage higher level controls Redesign, automate or implement new controls

18. Opportunities for integration of related internal control activities Regulatory compliance Operational risk Records management IT problem management Business continuity planning Information security Credit/market risk SOX (bus and IT) Internalaudit Anti-fraud Legal

19. Question and Answer Session Slide 19