CP-121:Best Practices in Subcontractor Accounting and Administration

John Hindman, Russell Forbes, Bakertilly

Baker Tilly Virchow Krause, LLP trading as Baker Tilly is a member of the global network of Baker Tilly International Ltd., the members of which are separate and independent legal entities. © 2018 Baker Tilly Virchow

Krause, LLP

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―Understand unique subcontract administration and accounting requirements

―Identify common audit, accounting, and administrative challenges

―Understand how business system tools and applications can be leveraged to implement best practices

―Federal Subcontracting Environment

―Subcontract Administration & Accounting Requirements

―Common Challenges & Best Practices

―Deltek Subcontractor Management

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―Federal Government Marketplace

• US Government is one of the largest buyers of goods and services in the world

• $500B+ annually on contracts

• Significant prime contract awards translates into significant subcontract awards

―Primary objectives:

• Pay a fair and reasonable price for goods and services when spending tax payer dollars

• Use of responsible vendors offering quality solutions

• Support the current socio-economic and national security agenda

Overview

Rules and regulations around subcontract spend intended to:

―Protect the Government’s interest, especially under cost-reimbursement contracts

―Obtain goods and services in the conduct of normal competitive business procedure

―Flow down federal rules and regulations to prime contractor supply chains (including socio-economic requirements)

―Ensure that the Government is getting fair and reasonable prices

• FAR 31.201-3, Determining Reasonableness

“A cost is reasonable if, in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business.”

Overview

DFARS 252.242-7005, Contractor Business Systems

―Acceptable Contractor Business Systems

• “…contractor business systems that comply with the terms and conditions of the applicable business system clauses listed in the definition of "contractor business systems" in this clause.”

―Business Systems

• Purchasing; Accounting; Estimating; Property; Material Management Accounting; Earned Value Management

―Significant Deficiency

• “…a shortcoming in the system that materially affects the ability of officials of the Department of Defense to rely upon information produced by the system that is needed for management purposes.”

―Payment Withholds

• Contracting officer may withhold five percent from amounts due on contracts with system clauses for significant deficiencies (limit of ten percent for multiple systems)

Contractor Business System Requirements

Contractor Purchasing System Reviews (CPSR)

―Typically performed by the Defense Contract Management Agency (DCMA)

―FAR 52.244-2, Subcontracts, allows the government to perform a CPSR in accordance with FAR Part 44

―Review excludes subcontracts under the following prime contract types:

• Competitively awarded firm-fixed-price

• Commercial item (FAR Part 12)

―Compliance with DFARS 252.244-7001, Purchasing System Administration

• 24 defined system criteria for maintaining an acceptable system

• Potential payment withholds for system disapproval

Audit Environment

Contractor Purchasing System Reviews (CPSR)

―Review focused on:

• Purchasing system policies & Procedures

• Procurement file documentation (system output)

―30 Major Purchasing Areas (see DCMA CPSR Guidebook)

• Public law requirements

• Internal controls

• Documentation supporting source selection and prices paid

• Compliance with socioeconomic requirements

• Supply chain management practices

• Flow down of Government regulations & contract provisions

Audit Environment

Other Government Audits

―Final Indirect Cost Rate Proposal Audits

• Typically performed by DCAA or other cognizant agency auditors

• Subcontract cost summarized on required Schedule J

• Time-and-Material hours and amounts billed summarized on required Schedule K (T&M hours and labor categories often scrutinized)

―Proposal / Estimating System Audits

• Proposal and Estimating System audits typically performed by DCAA (or other agency auditors as applicable)

• Cost or price analysis of subcontractor proposals evaluated, when required (Truthful Cost or Pricing Data –“TINA”)

• Findings may lead to purchasing system deficiencies

Audit Environment

Business System Interdependencies

Purchasing System

Accounting System

Estimating System

Property Management

System

Earned Value Management

System

Material Management Accounting

System

Subcontract Administration Responsibilities

―Prime contractor is solely responsible for administration of subcontractors

―Government does not have privity (but see FAR 52.215-2, Audit and Records – Negotiation)

―FAR 42.202(e)(2)

• “The prime contractor is responsible for managing its subcontracts. The CAO’s review of subcontracts is normally limited to evaluating the prime contractor’s management of the subcontracts (see part 44). Therefore, supporting contract administration shall not be used for subcontracts unless-

(i) The Government otherwise would incur undue cost;

(ii) Successful completion of the prime contract is threatened; or

(iii) It is authorized under paragraph (f) of this section or elsewhere in this regulation.”

―FAR 42.302 identifies 71 contract administrative functions

• Important to note that these functions are not incorporated into contract clauses; however, government expectation is that prime is responsible for necessary administration activities

Requirements & Government Expectations

Subcontract Administration Responsibilities (cont’d)

― DCAA MRD 19-PIC-001(R), “The prime contractor is responsible for:

• Billing costs to the Government (FAR 52.216.7)

• Settling subcontractor amounts and rates prior to submitting the final prime contract voucher (FAR 52.216-7(d)(5))

• Providing a status of subcontractor audits to the contracting officer upon request (FAR 52.216-7(d)(5))

• Oversight and surveillance of its subcontractors (DFARS 252.244-7001)”

― FAR 52.216-7(b), Reimbursing Costs

• Subcontract costs reimbursable when payments determined due will be (1) paid in accordance with subcontract terms and conditions and (2) ordinarily within 30 days of the prime contractor’s payment request to the Government

― FAR 52.216-7(d)(5), Subcontractor Indirect Rate Negotiation

• “The prime contractor is responsible for settling subcontractor amounts and rates included in the completion invoice or voucher and providing status of subcontractor audits to the contracting officer upon request.”

Requirements & Government Expectations

Notification and Consent Requirements

―FAR 44.2 – Consent to Subcontract

―FAR 52.244-2, Subcontracts

―52.232-7, Payments under Time-and-Materials and Labor-Hour Contracts

• If the Contractor enters into any subcontract that requires consent under the clause at 52.244-2, Subcontracts, without obtaining such consent, the Government is not required to reimburse the Contractor for any costs incurred under the subcontract prior to the date the Contractor obtains the required consent. Any reimbursement of subcontract costs incurred prior to the date the consent was obtained shall be at the sole discretion of the Government.

Requirements & Government Expectations

Payment for Time-and-Materials Contracts

―FAR 52.232-7, Payments under Time-and-Materials and Labor-Hour Contracts

―Contractual hourly rates applicable to:

• Prime contractor

• Subcontractors

• Intercompany transfers

―The Contractor shall substantiate vouchers (including any subcontractor hours reimbursed at the hourly rate in the schedule) by evidence of actual payment and by

• Individual daily job timekeeping records

• Records that verify the employees meet the qualifications for the labor categories specified in the contract

Requirements & Government Expectations

Limitation on Pass-through Charges

―FAR 52.215-23, Limitations on Pass-Through Charges

―The Contractor shall notify the Contracting Officer in writing if-

• Contractor changes the amount of subcontract effort after award such that it exceeds 70 percent of the total cost of work to be performed under the contract, task order, or delivery order

• Any subcontractor changes the amount of lower-tier subcontractor effort after award such that it exceeds 70 percent of the total cost of the work to be performed under its subcontract

―Subcontract award amounts must be tracked against prime contract award amounts

―Government wants to ensure prime contractors are adding value

Requirements & Government Expectations

Subcontract Administrative Data Expectations

―Final Indirect Cost Rate Proposal: Schedule J (FAR 52.216-7)

• Listing of subcontracts awarded to companies for which the contractor is the prime or upper-tier contractor

• Information required to be included:

Prime contract number

Subcontract / PO number

Subcontract Value

Subcontract Award Type (cost-reimbursement, T&M, etc.)

Amount claimed during fiscal year

Subcontractor name, address, and point of contact information

―DCAA incurred cost proposal adequacy checklist requires inclusion of this data (may cause adequacy issues)

Requirements & Government Expectations

Subcontract Administrative Data Expectations

―CPSR Data Request Expectations (in addition to Schedule J administrative information)

• Description of goods or services

• Purchase Order date

• Award to large or small business

• Original award value, number of modifications, and current award value

• DPAS rating

• Commercial or non-commercial item

―Prime contract information used for risk assessment purposes (sales amounts excluding competitive FFP and commercial items)

Requirements & Government Expectations

Purchasing System Internal Control Considerations

―Segregation of duties between

• Purchase requisition (authorization to expend funds)

• Authority to commit (issue purchase order)

• Receiving (confirmation of goods / services received)

• Payment

―Accounts Payable Matching

• Purchase Order

• Vendor Invoice

• Receiving Report (3-way match vs. 2-way match)

Requirements & Government Expectations

Common Challenges

―Over reliance on the Government to audit subcontractor indirect rates

―No subcontract terms and conditions specifying settlement process (52.216-7 not a mandatory flowdown)

―Undefined prime contractor roles and responsibilities for “auditing”/settling rates with subs

Best Practices

―Terms and conditions defining settlement process and prime/sub responsibilities

―Defined procedures for settling with subcontractors that have minimal existing government oversight

―Establish quick close procedures

―Limit reliance on subcontractor cost data where possible (avoid cost-reimbursement unless necessary)

Final Indirect Cost Rate Negotiation

Common Challenges

―Subcontract administrative data maintained separate from financial system

―Data often required from both for reporting and/or audit support

― Incomplete data capture relative to Government requirements & audit expectations

Best Practices

―Capture as much required information as possible in financial system (e.g. Costpoint Contract Management)

―Determine key/required data fields (even admin data)

―Regularly monitor data capture for adequacy & accuracy

― If capturing data in two systems

• Designate primary key fields between systems, if necessary (e.g. purchase order number; vendor ID)

• Monitor data between the systems

Administrative Data Management

Common Challenges

―Assignment of subcontractor cost to prime contractor project structure

―Subcontractor funding management across purchase order structure

Best Practices

―Align the purchase order / subcontractor agreement / prime contract structure

• Establish purchase order structure sufficient for assignment of cost

• Adjust funding controls if necessary to manage exceptions (voucher in excess of funding on a PO line)

• Set up subcontractor time and expense charging to specific purchase order lines

―Require subcontractor cost / funding monitoring & reporting

• Include limitation of cost / limitation of funds type clauses

Subcontract Funding Management

Common Challenges

― Verification of subcontractor invoice amounts for payment

― Timely invoicing and payment of subcontractor cost

Best Practices

― Time and expense entry into prime’s system (T&M, LH, and LOE type subcontracts)

• Allows for prime contractor review and approval

• May allow for auto generation of invoice and/or support subcontract accruals

• Subcontract terms and conditions necessary to establish which system (prime or subs) governs subcontract billed hours and expense

• May require reconciliation against subcontractor invoices (unless approval possible in prime’s system)

― Other automated processes (invoice review workflows, invoice submission portals, custom image recognition solutions)

• Majority of solutions still require some level of manual review or input

• Generally, the more flexible the contract type (i.e. cost-reimbursement) the more difficult to automate

Invoice Processing & Payment

―Designed to automate the process of accumulating and billing subcontractor labor

―Key features include:

• Ability to manage subcontractor workforce

• Auto generate subcontractor invoices based on approved subcontractor time entry

• Process purchase order vouchers

• Expedite end customer billing

Subcontractor Management Overview

―Set up vendor employees in Deltek Time Collection 10

―Create work assignments for subcontractor employees

• Aligned with purchase order structure

• Control what projects subcontractor employees can charge

• Establish budgets for each work assignment

• Set work assignment period of performance

• Work assignments for expenses can be established

―Subcontractors enter time

• Signed by subcontractor personnel (same as prime contractor personnel)

• Approved by either internal or external managers

Manage Subcontractor Workforce

―Automate subcontractor invoices for labor hours

• Based on approved time entries

• Allow for suspension of labor for charges over budget or outside of performance period

• Internal or external approvals

• Expedites invoicing to end customer of subcontractor labor amounts

―Approved invoice creates purchase order voucher

• Created against purchase order lines

• Relieves purchase order commitments

―Detailed support for final customer invoices

• Print subcontractor invoices

• Labor and expense detail in supporting schedules (timesheet detail)

Subcontractor Invoices & Payment