Government Contract Audit Oversight and Administration New Year Predictions and Resolutions

In 2009, we started the year with the DCAA Director proclamation of “a brave new world”.^[1] We saw and experienced an increased focus by the DCAA on contractor documentation and demonstration requirements to support system audits and proposals. As we begin 2010 we eagerly anticipate what changes we might expect to see under the direction of Patrick Fitzgerald^[2], the new Director of DCAA. This article contrasts our expectations regarding DCAA audit oversight and interaction for 2010, as compared to what we have seen contractors experience over the last year or so.

 

Continued Pressure on Access to Records and Timely Responses by Contractors

 

We predict that the tone of the auditor conversations will improve, but the results of DCAA audits and assessments^[3] will continue to be highly dependent upon Company’s actions as responsible contractors. Most of the revised approach to audits during 2009 was the result of GAO recommendations.   We do not expect Mr. Fitzgerald to materially change current auditor guidance related to obtaining timely access to records, documentation and support.  As you may have experienced, these timelines were significantly shortened during 2009.

 

Continued Significant, Negative Impacts Resulting From Audit Findings

 

Under DFAR proposed rules^[4], contractor business systems will be defined as Accounting, Estimating, Purchasing, Earned Value Management System (EVMS), Material Management and Accounting System (MMAS), and Property Management System. DCAA will report on system deficiencies with the Contracting Officer determining system adequacy. We believe that the Contracting Officers will continue to rely heavily on DCAA input when making final decisions pursuant to their authority. FAR 1.602-2 permits the Contracting Officer wide latitude to exercise business judgment after considering the advice of DCAA and other specialists, as appropriate.

 

We believe that contractors will need to be proactive in identifying and discussing with the CO any corrective action that is available to them once DCAA has issued a report on system deficiencies. This may necessitate discussions with the CO in the area of true system deficiencies, accounting, internal and compensating controls and corrective actions that may be required and implemented. However, CO’s may be more open to assessment of materiality of findings and compensating controls for any deficiencies observed and reported by the DCAA.

 

The DFAR proposed rule describes the use of withholding remedies imposed by the CO for system deficiencies. Immediate withholding for system deficiencies will be 10% of each payment, up to 50% for multiple system deficiencies. The CO may withhold up to 100% if deficiencies are highly likely to lead to improper contract payments. 

 

Contractor preparedness and actions for 2010 should be clear. Contractors should be prepared to support the Contracting Officer, surveying activity and auditors with the following actions:

Resources expended in these areas may very well preclude adverse action taken by the government for potential non-compliance and result in a competitive and financial advantage over other competing contractors.

 

Be Prepared with Major System Controls and Documentation

 

The DoD proposed consolidation of business systems reduces the Accounting System audit to the criteria contained on the SF 1408 Pre-award Survey of Prospective Contractor – Accounting System. A separate assessment will likely continue to be made by DCAA for direct billing approval. We expect the DCAA to incorporate most of its existing audit programs and control objectives for ‘legacy’ system audits (i.e. labor, indirect cost & ODC’s’, billing, etc.) into its revised Accounting System audits. As a result, contractors should be prepared to demonstrate evidence of meeting current ICAP control attributes and objectives.

 

Criteria for adequacy determinations of other systems are expected to remain unchanged.  Attributes of the other systems are described in the regulations as follows:

DCMA is expected to place increased emphasis on the CPSR due to increased use of subcontracts by the primes.

 

Enhance Compliance Function and Effectiveness of Internal Control System

 

DCAA continues to focus its resources on major contractors, pre-award proposal and system audits at the expense of smaller contractors and Incurred Cost Proposals. This is likely to have a greater adverse impact to the smaller contractors with flexibly priced contracts. Contractors should be proactive in requesting release of fee retention (FAR 52.216-8) and use of quick-closeout procedure (FAR 42.708) to minimize the potential adverse impact to working capital.

 

Regardless of company size^[5], contractors should be prepared to demonstrate results of periodic reviews and the effectiveness of internal controls for business ethics, conduct and ‘special requirements of government contracting’. The latter should include pre-assessments of contractor systems as described above. The contractor ‘gap analysis’ should serve two purposes; (1) compliance with requirements of the business ethics and conduct clause, and (2) preparation for government conducted system audits. 

 

Strengthen the Records Management and Communication Process

 

DCAA expects source documents to be available at the time certification is made for any billing, claim or proposal to the government. In the absence of documents supporting invoices, claims or proposals, DCAA has been requesting direct access to contractor personnel.

 

Contractors that have established a document tracking system have been more effective in responding to auditor requests. These systems have been as simple as spreadsheets to track the data request and response time. More formalized systems consist of extranets similar to due diligence ‘data rooms’ where requests are being logged by the DCAA and documents populated by the contractor to the data room. A robust record management system should be designed and populated with supporting documents in advance of the expected DCAA request. 

 

2010 resolutions to addressing these issues still leaves plenty of areas of contention. We expect DCAA in 2010 to continue with initiatives to seek access to internal audit work papers, ethics and hot line logs and functional personnel responsible for system elements and proposals. We also expect DCAA to continue with questioning reasonableness of employee compensation, eligibility of health and welfare benefits for claimed dependents and work product documentation of certain expenses.

 

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