recent trends in government contract cost recovery and dcaa audit issues
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Effective Management of DCAA Audits ----------------------
Cost and Pricing Update
NCMA Pikes Peak Chapter
January 21, 2010
Steven M. MasielloTaylor M. Menlove
McKenna Long & Aldridge LLP
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Agenda
• DCAA Audit Policy Update– GAO criticisms / new audit policies– Discussion of selected audit policies
• Recommendations for working with DCAA
• Resolving Audit Disputes
• Cost and Pricing Update (Case Law/Regulatory)
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DCAA Audit Policy Update
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Background
• July 2008 GAO report criticized DCAA audit execution:– Audit work insufficient to support opinions
– Work papers do not support opinions
– DCAA supervisors drop findings and change opinions without adequate evidence
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Background (cont.)
• July 2008 GAO report surfaced two issues: – Some DCAA auditors are not fully qualified (e.g., not
certified public accountants) and have limited supervision
– Issues not being resolved by DCAA in a timely manner
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Background (cont.)
• DCAA reaction to July 2008 GAO report– DCAA issued Policy memoranda in December 2008
aggressively targeting: • Access to contractor records• Internal control audit opinions
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Background (cont.)
• September 2009 GAO audit report again criticized DCAA audit execution– Findings
• 65 of 69 audits contained significant deficiencies, and remaining 4 failed to comply with GAGAS
• Failure to protect public interest
– Recommendations• Establish DCAA internal review organization• Review audit policies, including DCAA Contract Audit
Manual (“DCAM”)
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Access to Contractor Records
• Old DCAM procedures for obtaining documentation required that auditor:– Verbally request documentation during normal course
of business with contractor
– Discuss with contractor the basis for the request
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Access (cont.)
• December 2008 Policy changed audit access approach:– Policy states data “should be readily available” (e.g.,
same day unless off-site or analysis required)
– Policy requires auditors obtain data “directly from person responsible for the information” and disapprove contractor use of “liaisons” as justification for delays
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Access (cont.)
• When contractor fails to provide documentation, Policy requires auditor to:– Follow new denial of access to records “procedures”– Question unsupported costs in audit– Issue Form 1 to suspend or withhold unsupported
costs billed, until data received and cost allowability determination made
– Follow policy even if contractor concurs with questioned costs (because penalties may apply)
– Consider whether internal control deficiency exists
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Access (cont.)
• New “fast track” procedures to obtain information when late and no explanation provided– Auditor makes written request to management within 5
days– If contractor fails to provide information or explanation
within 1 week, auditor notifies Contractor of formal denial of records
– After additional efforts by CO or DCAA, DCAA may issue subpoena under 10 U.S.C § 2313(b) contract audit authority
– DoD IG also may issue subpoena under “broad” subpoena authority in 5 U.S.C. App. § 8 for fraud-related issues
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Access (cont.)
• Contractors and DCMA should know:– Audit clause limits DCAA’s examination to “records
and other evidence sufficient to reflect” costs, and at “reasonable times”
• Audit clause does not provide DCAA right to interview employees
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Access (cont.)
• Contractors and DCMA should know (cont.):– CO “may” reduce or suspend payments if CO finds:
• Unallowable costs; or • “Substantial evidence” of a failure to comply with
contract “material requirement,” but DCAA not permitted to withhold costs pursuant to a policy
– No contract provision authorizes “penalty” for lack of access
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Access (cont.)
• Contractors and DCMA should know (cont.):– Policy ignores relevant case law
• Failure to reimburse costs based upon a denial of access to records is improper, absent cost and record relationship
• DCAA subpoena power does not authorize access to all records that might relate directly or indirectly to a contract (e.g., does not extend to internal audit reports)
– Contractors properly may resist improper records requests
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Access (cont.)
• Contractors and DCMA should know (cont.):– FAR and DFAR Councils issued a Final Rule that
modifies audit clause to allow GAO to interview “any current” employees (74 Fed. Reg. 52,851 (Oct 17, 2009))
• Implements FY 2009 DoD Authorization Act• Inconsistent with case law that only permits limited
access to inspect those items directly pertinent to cost and pricing
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Internal Control Audits
• December 2008 Policy changes audit reporting approach:– Policy purports to “clarify” definition of “significant
deficiency/material weakness”
– Audits on internal controls that report “any significant deficiencies/material weaknesses” for any control element now will include an opinion that the overall system is inadequate (e.g., no “inadequate in part”)
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Internal Control Audits (cont.)
• Policy builds on prior concept that a “failure to accomplish any control objective. . . could result in unallowable costs”– DCAA claims it only audits major contractor systems,
so any internal control (e.g., ethics control objective) deficiency is material
– No direct relationship to cost required for DCAA to report “a significant deficiency/material weakness”
– Policy states “[i]t is not necessary to demonstrate actual questioned cost to report a significant deficiency/material weakness”
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Internal Control Audits (cont.)
• Policy now requires:– DCAA issuance of a Form 1 even when no
disagreement exists or system is inadequate in part
– Audits identify affected system and recommend• CO disapprove system, and • Pursue suspension of a percentage of progress
payments or reimbursement of costs (Form 1)
– Internal control audits not to contain suggestions to improve system (apparently to avoid confusion)
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Internal Control Audits (cont.)
• Contractors and DCMA should know:– DCAA’s internal control position contrary to current
standards regarding “material” deficiency
– Previous policy consistent with SOX where material deficiency relates to controls adversely affecting ability to record, process, summarize and report financial data
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Internal Control Audits (cont.)
• Contractors and DCMA should know (cont.):– DCAA’s conclusion that any deficiency supports
reductions in progress payments and cost reimbursements is wrong
• Disallowance improper unless relates to specific costs• Progress payments clause requires payment absent a
CO finding of a failure to maintain an “adequate” accounting system, not a “perfect” system
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Other DCAA Reactions
• Integrated Product Team / SSEB participation prohibition
• Interim billing review procedures• Direct billing suspension standards
• New DCAA Director (Nov. 9, 2009)
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Results of DCAA Reactions
• Overbroad demands for access to employees and records
• Widespread suspensions of contractor direct billing authority
• Approved internal control systems now deemed “inadequate”
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Results of DCAA Reactions toCriticism (cont.)
• Key audits delayed• Increased Form 1 and other disallowance activity• CO indecision / emerging disputes
– DCAA will not discuss issues
– COs reluctant to reject DCAA conclusion
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Suggestions for Working
with DCAA
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General Suggestions
• Engage local auditors early, even before draft reports written
• Be engaged in the audit process• React decisively to DCAA overreaching; do not
create pattern of acquiescence
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Specific Actions
• React quickly and decisively to any DCAA internal control systems audit challenge– Work with CO concerning any audit findings
– Submit rebuttal and corrective action plan immediately
– Draft solicitation requirements to maximize competition
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Specific Actions (cont.)
• Ensure DCAA access requests are appropriate
• Respond promptly to questioned costs• Understand relevant dispute / litigation
options
Resolving Audit (Cost) Disputes
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Resolving Disputes
• When costs questioned initially, DCAA and contractor required to confer to ensure understanding of issues– DCAA provides contractor preliminary findings
– Contractor permitted 30 days to provide rebuttal for inclusion in audit
– Exit conference may include CO, and provide contractor with opportunity to submit additional information within 30 days
– DCAA given 30 days to audit additional information
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Resolving Disputes (cont.)
• When DCAA and contractor agree, agreement documented and contractor:– Excludes costs from vouchers, or
– Credits cost in next voucher submitted
• When DCAA and contractor disagree, DCAA issues Form 1, and contractor may:– Request CO pay costs, or
– File a Claim
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Resolving Disputes (cont.)
• Form 1 also prompts CO to consider:– Recouping any disapproved costs paid when no
future billings– Issuing Final Decision with a demand for payment,
and/or– Authorizing DCAA disapprove costs on separate
contract if no payment in 30 days
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Resolving Disputes (cont.)
• Demand Payment Letter– Request for Deferrel
• Contractor Certified Claim/CO Written Decision
• Contractor Appeal
Cost and Pricing Update
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No Required Formula to Support Incurred Costs
• BearingPoint, 09-2 B.C.A. ¶ 37,289– Subcontractor provided security in Iraq for
BearingPoint to provide financial services; lost timesheets
– Government argued contractor required to produce all “hard” documents and maintain “nice neat little files” to support costs
– Board found costs could be supported in a variety of ways, including use of “other evidence” (e.g., witness testimony)
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Gov. Defective Pricing Claim Time-Barred
• McDonnell Douglas, ASBCA No. 56568, 2009 WL 4774620– DCAA issued preliminary audit findings more than 6
years before government asserted defective pricing claim, but DCAA issued final audit findings (with increased amount) less than 6 years before
– Government defective pricing claim time-barred under CDA statute of limitations
• “[N]o requirement that a sum certain be established” to begin tolling of 6-year period
• Statute applies equally to government and contractor claims
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Airfare Costs
• New rule, effective January 11, 2010, clarifies that “lowest customary standard, coach, or equivalent airfare” means lowest priced airfare available to the contractor– 74 Fed. Reg. 65,612 (December 10, 2009)
• When contractors obtain discounted airfare prices not available to the general public, airfare only is allowable for the discounted prices
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Business Systems/Withholds
• Proposed DFARS rule– 75 Fed. Reg. 2,457 (Jan. 15, 2010)
• Procedures for government withholds based on deficiencies in contractor “business systems”– “Business systems” defined broadly
• Administrative requirements– Timekeeping (Accounting System)
• Ambiguous requirements– Maintain “complete history files” (Estimating System)
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Conclusions / Questions
Steven M. Masiellosmasiello@mckennalong.com
Taylor M. Menlove
tmenlove@mckennalong.com
1400 Wewatta St, Suite 700Denver, CO 80202
(303) 634-4000
DN 32165298
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