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TRANSCRIPT
Final Indirect Cost Rate Proposals:
Auditor Focus Areas, Trends and Best
Practices
Steven M. MasielloK. Tyler Thomas
February 14, 2017
Agenda
• Regulatory Requirements
• DCAA Audit Environment
• Recent Developments
• Statute of limitations (SOL) issues
• Reprise: Subcontractor costs
• Insufficiency of government disallowance claims
• Audit Scrutiny: Areas of Special DCAA Focus
• Commercial items price transfers between affiliates
• Travel costs
• Hazard pay
• Incentive bonuses
• Best Practices for Final Indirect Cost Rate Proposal Submissions and Facilitating the Audit Process
2
Regulatory Requirements
• FAR § 52.216-7 - Allowable Cost and Payment
• Permits billing of indirect costs based on provisional rates
• Requires submission of final indirect cost pools and allocation bases in
accordance with FAR Subpt. 42.7
• Final Indirect Cost Rate Proposals (FICRPs) must include:
• Summary of indirect expense rates, including pools, bases and calculated
indirect rates
• General and administrative expenses
• Overhead expenses
• Occupancy expenses
• Claimed allocation bases, by element of cost, used to distribute indirect costs
• Facilities capital cost of money factors computation
3
Regulatory Requirements (Cont.)
• FAR Subpt. 42.7
• Sets forth procedures for audits of FICRPs and negotiation of final rates
• Provides penalties for inclusion of expressly unallowable costs
• FAR § 52.215-2 - Audits and Records—Negotiations
• Contractors must maintain records “sufficient to reflect properly all costs
claimed to have been incurred or anticipated to be incurred directly or
indirectly in performance of this contract”
• Records must be retained and available for audit for three years after
final payment under the contract or for any shorter period specified in
Subpt. 4.7
• FAR Subpt. 4.7
• Provides additional record retention requirements
• Requirements measured according to specifications for fiscal year to
which records relate
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DCAA’s Interpretation of Regulatory
Requirements
• FICRPs checklist
• Generally tracks the FAR requirements
• Provides detail concerning DCAA’s expectations for categories of
information identified in FAR § 52.216-7
• DCAA MRD 16-PPS-003(R) (Feb. 3, 2016): updated independent
reference review (IRR) checklist and procedures
• ICE (Incurred Cost Electronically) Models
• DCAA designed spreadsheets to provide contractors with a standard
FICRP format
• There is no legal requirement to use ICE models
• Failure to use the ICE model may result in a determination of inadequacy
• When not using the ICE model, contractors must demonstrate that its format
is responsive and complete
5
DCAA Cost Audit Manual Reorganization• In September 2016 DCAA revised and reorganized its Contract Audit Manual
• Added a separate Selected Area of Costs Guidebook to address FAR 31.205
cost principles
• Contains 75 Chapters (compared to the 46 substantive cost principles in the FAR)
• Replaces Chapter 7 of DCAA Contract Audit Manual
• Not completed - the following Chapters are still "under construction"
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• Chapter 3 - Bad Debts
• Chapter 6 - Bonding Costs
• Chapter 10 - Compensation for Personal Services
• Chapter 12 - Contingencies
• Chapter 14 - Contract Termination Costs
• Chapter 15 - Contributions or Donations
• Chapter 18 - Cost of Money
• Chapter 22 - Economic Planning Costs
• Chapter 25 - Entertainment Costs
• Chapter 27 - Fines, Penalties & Mischarging Costs
• Chapter 28 - Gains and Losses on Disposition or
Impairment of Property or Other Capital Assets
• Chapter 29 - General Services Administration
Schedule Contracts
• Chapter 30 - Goodwill
• Chapter 35 - Interest and Other Financial
Costs
• Chapter 38 - Labor Relations Costs
• Chapter 43 - Losses on Other Contracts
• Chapter 46 - Material Costs
• Chapter 50 - Organization Costs
• Chapter 51 - Other Business Expenses
• Chapter 55 - Plan Reconversion Costs
• Chapter 56 - Post Retirement Benefits
• Chapter 57 - Pre-contract Costs
• Chapter 60 - Recruitment Costs
• Chapter 67 - Special Tooling and Special Test
Equipment
DCAA Audit Environment
• DCAA is only 18 months behind on its cost audits and can now begin
assisting non-DoD agencies with audits (MRD No. 16-PPD-008(R)
Sept. 30, 2016))
• DCAA focus continues to be on FICRPs and CAS compliance audits
• DCAA audits are not admissions on behalf of the government
• BAE Sys. S.F. Ship Repair, ASBCA No. 58809, 16-1 BCA ¶ 36,266
• Government ordered a change near the end of performance and DCAA’s audit did not
question any of the claimed costs for this change
• “[T]he DCAA audit does not constitute an admission on the part of the government but
is only one piece of evidence in determining damages”
• Tech. Sys., Inc., ASBCA No. 59577, 2017 WL 372985 (Jan. 12, 2017)
• Government's failure to challenge costs in prior audits does not bar the government
from challenging such costs in the future, instead such a waiver requires an
unequivocal statement from the government regarding allowability
7
Recent Developments: DCAA Audit Issues
• SOL
• Contracting Officer ("CO") must assert claim through final decision
within six years of claim accrual (41 U.S.C. § 7103)
• Claim accrual is the date when the government knew or should have
known of a claim (FAR § 33.201)
• Previously, the standard was government knowledge (actual or
constructive)
• CO knowledge not required (Raytheon Missile Sys., ASBCA No. 58011,
13 BCA ¶ 35,241)
• DCAA knowledge is government knowledge (id.)
• Submission of FICRPs to DCAA (not DCAA audit) triggers CDA SOL
(Raytheon Co., ASBCA No. 57576, 13 BCA ¶ 35,209)
8
Recent Developments (cont.)
• Standard sliding toward “actual knowledge” requirement
• Coherent Logix, Inc., ASBCA Nos. 59725, et al., 15-1 BCA ¶ 35,947
• Contractor submitted indirect cost rate proposals including unallowable patent
costs
• Government did not audit or discover patent costs for more than six years
• Nevertheless, the government claimed it had no reason to anticipate that
unallowable costs were included in the proposal and it requested further
support; the Board held that its claims were not barred by the SOL
• Alion Sci. & Tech. Corp., ASBCA No. 58992, 15-1 BCA ¶ 36,168
• Similar facts: government claimed it did not have enough information in the
indirect cost rate proposal and the Board agreed; SOL had not accrued
9
Recent Developments (cont.)
• Direct Costs; SOL Course Correction?
• Sparton Deleon Springs, LLC, ASBCA No. 60416, 2016 WL 7733543
(Dec. 28, 2016)
• Government questioned intra-company costs, after final indirect cost rate
agreements were executed, claiming there was no proof the costs, previously
paid by the government via interim vouchers, were billed or paid in
connection with any government contract
• Government knew or should have known of the costs when it paid such costs
pursuant to interim vouchers
• Delay of the government in auditing the paid interim vouchers did not
suspend the accrual of the claim
• SOL "claim accrual" authority remains convoluted with uncertain
boundaries
10
Recent Developments (cont.)
• Subcontractor Costs; Lockheed Martin Integrated Sys., Inc.,
ASBCA, Nos. 59508, 59509, 2016 WL 7655944 (Dec. 20, 2016)
• DCAA questioned a range of claimed subcontractor costs, claiming
those costs had not been backed by appropriate documentation
• No duty under FAR Parts 42 or 44 for a prime contractor to cause its
subcontractors to submit FICRPs directly to the prime contractor for
audit and affirmatively request audits from DCAA if the subcontractors
refuse
• Duty is reserved to DCAA and other cognizant audit agencies by FAR 42.201
11
Recent Developments (cont.)
• Insufficiency of government disallowance claims
• LMIS decision (previous slide):
• Board held the government failed to state a claim for breach of contract
because the allegations were conclusory, were based upon terms not
contained in the contracts, and were based upon the improper interpretation
of FAR clauses
• Exelis, Inc., ASBCA No. 60131, 16-1 B.C.A. ¶ 36485
• Contractor classified a building lease as an operating lease
• Government claimed it should have been classified as a capital lease and
alleged the contractor's classification was noncompliant with CAS 404
• Board held the government failed to state a claim that the contractor was
noncompliant with CAS 404 because CAS 404, by its plain language, applies
only to tangible capital assets and leases are intangible assets
12
Recent Developments (cont.)
• DCAA/DCMA Use of Decrements
• DCAA/DCMA continue to apply decrements to recover alleged
unsupported or unallowable costs
• Decrements appear loosely based upon sampling results or previous audit
findings
• Indirect costs; sampling issues
• Problems with sampling methodology
• Costs included in universe sampled do not share similar characteristics
• Sampled items generate inappropriate error rates based upon judgmental
application of criteria
13
Audit Scrutiny: Expressly Unallowable Costs
• DCAA emphasis on contractor inclusion of “expressly unallowable
costs”
• Contractors may be subject to penalties for including expressly
unallowable costs in FICRPs (see FAR § 42.709)
• Raytheon Co., ASBCA No. 57576, 15-1 BCA ¶ 36,043
• Bonus and incentive compensation for employees participating in expressly
unallowable activities are expressly unallowable under FAR § 31.205-47
• Directly contrary to recent DCAA audit alerts
• DCAA Memorandum for Regional Directors, “Audit Alert on Identifying
Expressly Unallowable Costs” (14-PAC-022(R)) (Jan. 7, 2015)
• Board states standard but applies legal interpretation of regulations to find the
costs were expressly unallowable without regard for whether the contractor's
inclusion of the costs as allowable was not reasonable under any
circumstance
14
Audit Scrutiny: Incentive Bonuses
• FAR 31.205-6(f):
• Incentive Bonuses are allowable when -
• Paid or accrued under an agreement or plan created prior to the rendering of
the services; and
• Basis of the award is supported
• DCAA focusing on whether executives are incentivized to control
costs
• Historically, DCAA questioned whether the basis of the award was
supported
• Recently, DCAA has shifted to questioning whether such costs are
reasonable
• Assertion that a prudent business person conducting a competitive
business would incentivize officers to control costs
• Effect: DCAA is questioning costs in audits in an attempt to require an
affirmative showing of allowability of incentive bonuses
15
Audit Scrutiny: Hazard Pay
• DCAA focusing on hazard pay uplifts
• Questioning amounts in excess of Department of State danger pay
allowance rates
• Rate for Afghanistan: 35%
• Issues:
• No cost principle
• Regulated by reasonableness evaluation
• In general, contractor employees are not afforded the same protections
as Department of State employees
• Inconsistent with criteria in DCAA Selected Area of Costs Guidebook
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Audit Scrutiny: Commercial Item Transfers
• Transfers of Commercial Items Between Affiliates
• FAR 31.205-26(e) - Material Costs
• Materials sold or transferred between affiliates generally must be
transferred on the basis of costs
• May be transferred on the basis of price when:
• It is the established practice of the transferring organization to price
interorganizational transfers at other than cost for commercial work
of the contractor; and
• The item qualifies for exemption under 15.403-1(b) and the CO has
not determined the price to be unreasonable
• Permits the transfer of a commercial items between affiliates at
price
17
Audit Scrutiny: Commercial Item Transfers
• Auditors question commercial item transfers between affiliates
measured at price unless the CO has made an affirmative
determination that the item is a commercial item and the price is
reasonable
• Issues • Rule does not require CO affirmation that the item is a commercial item
• Hesitancy of COs in making commercial item determinations ("CID")
• Continues the difficulty contractors face related to commercial item
acquisitions
18
Audit Scrutiny: Commercial Item Transfers
• DoD proposed rule requires contracting officers to conduct market
research in order to make price reasonableness determinations
(81 Fed. Reg. 53,101 (Aug. 2016))
• Market research shall be used to inform price reasonableness
determinations• Market research is defined as "review of existing systems, subsystems,
capabilities, and technologies that are available or could be made available to
meet the needs of DoD in whole or in part"
• Supplies and services provided by nontraditional defense contractors
may be treated as commercial items if intended to enhance defense
innovation and create incentives for cutting-edge firms to do business
with DoD
• COs may still request "information that is sufficient to determine the
reasonableness of price"
19
Audit Scrutiny: Commercial Item Transfers
• FY 2016 NDAA
• Secretary of Defense required to:
• Establish and maintain a centralized capability with the necessary expertise
and resources to oversee the making of CIDs for the purpose of
procurements by DoD
• Provide public access to DoD CIDs
• Establish presumption that prior CIDs are sufficient for subsequent
procurements
• Ensure that CO decisions to disregard prior CIDs be reviewed by the head of
the applicable contracting agency
• Provide report to Congress containing all DoD specific requirements
applicable to commercial item procurements, with explanations and
justifications
20
Audit Scrutiny: Commercial Item Transfers
• DCMA has established its Commercial Item Centers of Excellence
• COs should adopt the practice of recognizing prior CIDs
• If a CO believes a prior CID was without foundation, or was made in
error, they should engage both their chain of command and the DCMA
Commercial Item Center of Excellence before making a determination
that deviates from prior decisions
• The Director of Defense Pricing and the DCMA’s Cost & Pricing Center
Director are supposed to work with interested companies to define,
through the use of advance agreements, the types of information
needed to support CIDs
• Thus far, lack of timely action by DCMA to make CIDs
• In fact, DCMA appears hesitant to make CIDs
• Creates issues for allowability of commercial item material transfers between
affiliates at price based upon DCAA's current stance
• May result in DCAA recommending decrements
21
Audit Scrutiny: Fly America Act
• Compliance with Travel Cost Regulations• Directly addressed by:
• FAR 31.205-46, Travel Costs
• FAR 47.4, 52.247-63 - Fly America Act
• Implicate:• General rules on allowability
• FAR 31.205-14, Entertainment Costs
• FAR 31.205-34, Recruitment Costs
• FAR 31.205-35, Relocation Costs
• FAR 31.205-43, Trade, Business, Technical and
Professional Activity Costs
• FAR 31.205-51, Alcohol Costs
22
Audit Scrutiny: Fly America Act• Basics
• FAR Part 47.4 implements the Fly America Act
• Requires FAR 52.247-63 be inserted into contracts where government-financed international air travel is possible
• Requires U.S. Government-financed international air travel be provided by U.S.-flag carrier, if “available”
• Contractors required to use U.S.-flag carrier if “available,” even though a foreign carrier may
offer lower fares or more convenient travel
• If an origin or interchange point is not served by a U.S.-flag air carrier, foreign-flag air carrier service shall be used only to the nearest interchange point
• Only applies to direct contract travel
• Exceptions
• Air Transportation Agreements - may use a foreign-flag carrier that provides transportation under an air transportation agreement with the U.S.
• Code-sharing - foreign carriers operating under a code sharing arrangement with a U.S. flag carrier are treated as U.S. carriers
• Disallowance of expenditures
• Must attach memorandum adequately explaining why U.S.-flag carrier service was not available or why it was necessary to use a foreign-flag carrier
• Focus on which airline within code-sharing arrangement the flight was booked
23
Best Practices for FICRPs Documentation,
Collection and Submission• Use advanced agreements where possible
• Document and archive the source of foundational general ledger
data
• Development and Submission of FICRPs
• Start with a clean model
• Use the FICRP adequacy checklist as a guide
• Follow your disclosed or established cost accounting practices
• Integrate your model schedules through linking
• Strategically plan your analysis to scrub unallowable costs and use
auditable methods of cost segregation
• Use explanatory notes
• Create a support binder
• Keep an exact copy of what is provided to the government
• Protect your proprietary data
• Document and archive additional information provided24
Best Practices for Facilitating the Audit Process
• During an audit • If an initiating conference is not scheduled, request one prior to
providing data
• Establish a single point of contact to ensure consistency in
communication with the auditors
• Keep auditors apprised of contractor progress
• Ensure that all requests are received in writing and appropriately
justified
• Establish the timeline needed to satisfy requests
• Keep track of everything provided to the government in support of an
audit
• After an audit • If a closing conference is not scheduled, request one
• Determine whether or not to reply to auditor findings communicated in
the closing conference or in the draft audit report
• Request a copy of the audit report from your CO/ACO
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