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