Over the past few years, the Department of Energy (DoE) has, to the unpleasant surprise of some prime contractors, quietly been inserting contract clauses in all of their management and operating contracts and some non-management and operating contracts making prime contractors responsible for not only managing their subcontracts but also for auditing their subcontracts.  More recently, the Inspector General has been conducting reviews of prime contractors for compliance with this requirement and contracting officers have been placing greater emphasis on enforcing the requirement.

The contract clause inserted under DEAR 970.5232-3 requires the management and operating contractor to either "conduct an audit of each cost-reimbursement subcontractor's costs or arrange for such an audit to be performed." The clause includes, among other requirements, for the prime contractor's audit plan to include provision for both pre-award and post-award audits of subcontracts.

In some cases, the prime contractor's contract administrators did not recognize the full implications and this requirement was not coordinated with the prime contractor's internal audit function.  As a result, these prime contractors are scrambling to implement a process for obtaining audits of the subcontractors and trying to avoid or mitigate the impact of noncompliance with the “overlooked” audit requirement on subcontracts that can no longer be easily audited, i.e., physically complete with no other active involvement with a particular subcontractor.  Most internal audit departments simply don't have either the staff or expertise needed to perform these audits. We recommend all contractors examine their DoE contracts to determine if they contain this clause. If so, ensure you have a plan for compliance to avoid a rather nasty surprise later.

In some cases, DoE contracting officers are trying to hold the internal audit staffs to a higher standard than even DCAA regarding the number of audits required. This has resulted because DCAA has never updated its contract audit manual to reflect its revised low risk incurred cost audit procedures. Redstone Government Consulting is currently assisting many prime contractors in establishing a reasonable audit plan for selecting subcontracts to be audited, based on an appropriate risk determination, as well as current guidance and performing subcontract audits at selected subcontractors.

We have seen increasing pressure on prime contractors with respect to subcontractor cost or price analysis in the award stage. For years, DCAA has classified all subcontract costs as unsupported when the prime contractor does not, in DCAA's opinion, perform adequate cost or price analysis. This includes instances where DCAA has performed a full audit of the subcontractor proposal. In a large number of cases, the contracting officer (recognizing that classifying costs as unsupported provides virtually no value for negotiating a contract) was still able to agree upon a fair and reasonable price with the prime contractor.

Unfortunately, an April 15, 2015 Department of Defense Inspector General (DoDIG) report, Report No. DODIG-2015-115, supports DCAA's position and will undoubtedly place additional pressure on contracting officers to hold the prime contractor to a higher standard related to obtaining subcontractor cost or pricing data and cost or price analysis. In its report, the DoDIG found that the contracting officer did not "obtain the required prime contractor’s subcontract cost or pricing data in accordance with Federal Acquisition Regulation (FAR) 15.403 and 15.404". DCAA had classified $240 million of the $1billion proposed as unsupported related to this issue, although some option years were removed resulting in a $576-million contract, of which approximately $75 million was considered unsupported.

The contracting officer's response was that he had relied on the contractor's approved estimating system and, on that basis, determined it was not necessary to obtain the prime contractor's cost or price analysis. The DoDIG did not accept the contracting officer's rationale. As a result, the DoDIG recommended the following:

"We recommend that the WSS Philadelphia Commander consider appropriate administrative action as a result of the contracting officer not complying with Federal Acquisition Regulation requirements for obtaining and analyzing cost or pricing data contained in Federal Acquisition Regulation 15.404, “Proposal Analysis,” and failing to document rationale for not adopting audit recommendations in accordance with Federal Acquisition Regulation 15.405, “Price Negotiation,” and Defense Federal Acquisition Regulation Supplement, Procedures, Guidance, and Information 215.406-1, “Prenegotiation Objectives.”

The contracting officer retired prior to implementation of this "administrative action". However, we can expect a significant impact from this and similar decisions on the actions of other contracting officers. Two important considerations result from this decision.

First, prime contractors can expect significantly more scrutiny of the cost or price analysis it performs on its subcontractors and other subcontract monitoring practices. Second, prime contractors will not be able to rely on the adequacy of their estimating systems to avoid government scrutiny of the prime contractor’s subcontract specific price or cost analysis.

Although it’s best described as an unintended consequence, Redstone Government Consulting is becoming more and more involved in assisting prime contractors in developing subcontract monitoring and cost or price analysis procedures and practices. In some cases, particularly those involving access to subcontractor books and records, we are directly involved with those subcontractor’s records, effectively the “firewall” between the prime contractor and subcontractor. This trend will continue as long as DOD and other Government agencies firmly believe that the real potential for significant cost savings lies with better analysis of subcontract prices and/or costs.

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Written by Robert Eldridge

Robert Eldridge Robert (Bob) Eldridge is a Director with Redstone Government Consulting Inc. He provides Government Contract Consulting services to our Government contractors primarily related to compliance with Federal Acquisition Regulations and Cost Accounting Standards, equitable adjustment claims, and business systems. Prior to joining Redstone Government Consulting, Bob served in a number of capacities with DCAA for over 32 years. Upon his retirement, Bob was a Regional Audit Manager with DCAA. Bob began his DCAA career in 1981 as an auditor-trainee with the Pratt & Whitney Resident Office in West Palm Beach, Florida. Bob served two three year tours at the Defense Contract Audit Institute teaching multiple contract audit courses including “Auditing Internal Controls”, “Technical Management of Audits”, and “Advanced Cost Accounting Standards” and writing Agency courses on Cost Accounting Standards and Equitable Adjustment Claims. He returned to the Eastern Region in 1999, holding various audit positions before ultimately becoming a Regional Audit Manager in February 2007. As Chief of the Eastern Region Quality Assurance Division, Bob was heavily involved in developing DCAA guidance related to auditor consideration of internal controls and risk assessment preparation. In 2012, Bob was assigned to the U.S. Senate Committee for Homeland Security and Governmental Affairs, serving as a subject matter expert on a wide range of federal contract and grant matters for Senator Susan Collins. During Bob’s tenure with DCAA, he had overall management responsibility for audits performed by over 200 employees. He was directly involved in conducting or managing a wide variety of compliance audits, including: forward pricing proposals, incurred cost submissions, business system internal controls, Cost Accounting Standards, claims, and defective pricing. Bob was also directly involved in complex quantitative methods applications, particularly regression analysis and improvement curve applications. Bob currently specializes in assisting clients with more complex DCAA audit issues related to business system internal controls and Disclosure Statements and with developing and maintaining government compliant accounting and estimating systems. Bob also provides expert advice on compliance with FAR cost principles and Cost Accounting Standards and assists with the more complex forward pricing proposals and equitable adjustment claims.

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: Contracts Administration, Defense Contractors