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Although FAR 42.202(e)(2) states that prime contractors are responsible for managing subcontracts, DCAA has launched or relaunched a strategy which presumes that prime contractors are responsible for “auditing” subcontractors.   Unfortunately, DCMA seems to have embraced this concept with respect to closing out cost-type subcontracts. Specifically DCMA Instruction 135, section 3.2.3.2 states that prime contractors are responsible for auditing subcontracts and closing subcontract using procedures similar to those used by the government.

What’s the big deal with DCAA and now DCMA’s expectations for subcontract audits (performed by prime contractors)? There simply is no regulatory requirement for “audits”. In point of fact, FAR 42.202(e)(2) only requires the prime to “manage” its subcontracts (and we cannot find any thesaurus which lists “audit” as a synonym for “manage”).   Even more confusing, DCAA recently issued an audit policy (MRD) which goes to great lengths to differentiate “audits” from other DCAA financial advisory (non-audit) services. The point, DCAA obviously understands the nuances which differentiate audits from non-audits; however, DCAA fails to consistently follow through.   Why is DCAA so inflexible in application to internal processes, yet flexible in terms of injecting “audits” in application to prime contractors vis-à-vis subcontracts?   It all depends upon the objective. In the case of internal processes, a very precise definition of audits versus non-audits opens the door for DCAA to work around Congressional action which prohibits DCAA from providing “audit support” for civilian agencies. In contrast and in application to prime contractors, substituting the word audit (for manage) opens the door for DCAA to overstate and over report questioned costs associated with incurred cost audits (after-the-fact audits of contractor direct and indirect costs).  

The obvious question, what does any of this mean to government contractors (our clients and others)?   If and when DCAA audits a prime contractor indirect cost rate proposal, DCAA is now training its auditors to focus on any and all subcontract costs on any type of flexibly priced prime contract (cost-type, fixed-price incentive, T&M). If the prime contractor cannot demonstrate that it “audited” the costs claimed by a subcontractor (cost-type) subcontract, DCAA is now questioning 100% of those subcontract costs (DCAA is not auditing the subcontract costs on behalf of the prime contractor because that is not DCAA’s responsibility).   Virtually the same end-game for T&M contracts with T&M subcontracts; if the prime did not audit the subcontractor records, 100% disallowance.   And if you think that a fixed price (FFP) subcontract mitigates prime contractor risk, not exactly if the FFP subcontract is under a cost-type prime contract.   DCAA will likely second guess the sufficiency of the prime contractor cost or price analysis leading to a DCAA assertion that the FFP subcontract is not sufficiently documented as a fair and reasonable price; hence, the entire subcontract cost (price) is unreasonable under FAR 31.201-3.

DCAA’s embellishment of FAR 42.202(e)(2) is not new; however, it’s becoming more prevalent as evidenced by a number of DCAA audit reports issued between April 1 and September 30, 2015. Millions of subcontract (direct costs) are being questioned within a number of incurred cost audits and the bases are: i) prime contractor failure to audit subcontract costs, ii) prime contractor failure to obtain competitive bids (before awarding a subcontract), and iii) various descriptions of inadequate documentation (prime contractor) supporting the allowability, allocability or reasonableness of subcontract costs (Source: DOD-IG Semi-Annual Report to Congress for the reporting period April 1, 2015 to September 30, 2015).

DCAA’s renewed emphasis on questioning subcontract costs is also evidenced by recent DCAA training on this very subject (the training materials are not on DCAA’s website; however, some of DCAA’s field staff have casually mentioned this training topic).

For those contractors who perceive this as an issue unique to DCAA and DOD contracts, there is the bad news that “subcontract management” is of growing interest across all government agencies. Whether it is sub-recipient monitoring under 2 CFR 200 (OMB Super-Circular) or managing subcontracts under civilian agency contracts subject to FAR 42.202, there is a government-wide perception that better (government) buying power depends upon better subcontract management.   Translated, prime contractors and higher tier subcontractors should be revisiting policies and procedures with respect to subcontract price analysis and/or subcontract cost management. If the prime contractor has had absolutely no historical access into subcontractor accounting records, it may be time to revisit the issue. If a subcontractor denies prime contractor access, consider a third party review which can be reasonably effective in terms of reviewing the subcontractor’s claimed costs (allowability) as well as limiting the prime contractor access to subcontractor competitive sensitive data (i.e. indirect rates). Redstone Government Consulting has been and is actively engaged in subcontractor reviews and/or audits on behalf of prime contractors, particularly for civilian agency prime contracts.  In any case, prime contractors cannot overlook the requirements of FAR 52.216-7(d)(5) which requires the prime to settle subcontractor amounts and rates (ultimately) included in the prime contractor completion voucher.

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Written by Michael Steen

Michael Steen Mike Steen is a Emeritus Advisor with Redstone Government Consulting, Inc. and a specialist in complex compliance issues to include major contractor cost accounting & business system regulations, financial compliance, resolution of DCAA audit issues, Cost Accounting Standards application, litigation support, and claims preparation. Prior to joining Redstone Government Consulting, Mike served in a number of capacities with DCAA for over thirty years, and upon his retirement, he was one of the top seven senior executives with DCAA. Mike Served as a Regional Director for two DCAA regions, and during that time was responsible for audits of approximately $25B and 800 employees. In October 2001, he was selected for the Senior Executive Service and in 2006 he received the Presidential Rank Award. During Mike’s tenure with DCAA, he was involved in conducting or managing a variety of compliance audits, to include cost proposals, billing systems, Cost Accounting Standards, claims, defective pricing, and then-evolving programs such as restructuring, financial capability and agreed-upon procedures. He directly supported the government litigation team on significant contract disputes and has prepared and presented various lectures and seminars to DCAA staff and business community leaders. Since joining Redstone Government Consulting in June 2007, Mike has developed and presented training and seminars on Government Contracts Compliance to NCMA, Federal Publications Seminars and various clients. Mike also is a prolific contributor of written articles to government contracting publications, as well as to our own Government Insights Newsletter. Mike also serves as the director of our training service offerings, with responsibilities for preparing and developing course content as well as instructing our seminars to clients and general audiences throughout the U.S. Mike also serves as a faculty instructor for the Federal Publications Seminars organization. Education Mike has a BS Degree in Business Administration from Wichita State University. He is also a graduate of the DCAA Director’s Fellowship Program in Management, and has a Masters Degree in Administration from Central Michigan University. Mr. Steen also completed a number of OPM’s management and executive development courses.

About Redstone GCI

Redstone Government Consultants are a team of the most senior industry veterans and the brightest new talent in the industry. Many have held senior government positions including leadership roles in the DCAA. Our new talents bring significant accounting and software experience along with fresh perspectives, inspiration and energy to our team. Through our leadership and combined experience, we provide a unique perspective, bringing both government and contractor proficiencies to bear and ensuring rock-solid government compliance for our clients.

Topics: Defense Contractors, DCAA Audit Support