DCAA Not Auditing Small SBIR Contracts

As the Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) season ramps up we have noticed a trend when it comes to award of SBIRs and Small Business Technology Transfer (STTRs) to small businesses in regard to cost analysis as part of Phase 1 awards, as well as dealing with the administration associated with a Phase 2 cost-reimbursable awards. A significant part of the SBIR process is to educate small businesses on the process and controls required to do businesses with the U.S. Government. The cost-reimbursable nature of phase 2 awards inevitably means that small businesses will have the opportunity to undergo accounting system adequacy determination, develop provisional billing rates, and undergo incurred cost submission review or audit. These are key barriers to entry to many businesses seeking to work with the U.S. Government and the pursuit of SBIR/STTR work not only provided necessary funding for small business research and development (R&D), but also an avenue to clear necessary hurdles when it comes to the back-office compliance. At least that was the case historically.

In 2018, Defense Procurement and Acquisition Policy (DPAP) issued a class deviation memo (DPAP memo 2018-O0009 Class Deviation – Pilot Program for Streamlining Awards for Innovative Technology Projects) that essentially eliminates DCAA’s involvement in SBIR and STTR contracts, subcontracts and modifications of subcontracts valued at less than $7.5M awarded to small businesses or non-traditional defense contractors. On the surface, this makes sense from a materiality perspective as it will reduce an already overworked (by their definition) Agency responsible for the audit of roughly $800B annually. However, from a small business perspective, this approach does very little for the incredibly important small business industrial base. The audit services provided at this level are often key gateways for small businesses to larger opportunities. In particular, the accounting system and provisional billing rate approvals that were once commonplace for small businesses participating in SBIR/STTR serve as mechanisms for points used for scoring and making awards under the litany of government-wide acquisition contracts (GWACs) like OASIS, NASA SEWP and other vehicles administered by GSA. An ever-increasing share of small business dollars are being awarded using these vehicles and a small business’ ability to compete on a points score basis on these GWACs is critical for long-term company success. DCAA’s reluctance to support small business awards under the $7.5M mark effectively eliminates a path for a small business to mature and obtain government approvals for their accounting system. This is a significant impact to new entrants to the small business industrial base that will not be easy to overcome.

Additionally, we have seen first-hand how this policy shift has affected several small businesses during the award of SBIRs. Since DCAA will not offer their services to the procuring contracting officer (PCO) in the award of cost-based awards under the $7.5M mark, this inevitably means that the responsibility for accounting system and proposal adequacy determination falls to the contracting officer. This process is well within the regulation and follows existing requirements for PCO determination of responsibility in FAR Subpart 9.1, FAR Subpart 42.7 and FAR Part 16. The problem is some PCOs do not appear to be aware that this responsibility is extended to them by the Federal Acquisition Regulation, and we have seen PCOs order pre-award audits, provisional billing rate reviews, final indirect rate determinations and other services from DCAA only to be told no by DCAA which puts them in an awkward position of making a determination that they may not be equipped to make without audit support.

For small businesses working in this space who are also accustomed to having DCAA perform traditional audit services around their cost-based awards it is critical to understand the Agency’s shift in policy. Though this memo has been in place for over 4-years now, it seems to have only recently gained consistent interpretation by the DCAA offices across the U.S. During negotiation, it is advisable to consult your PCO if you do not have an adequate accounting system and potentially seek a third-party assessment of your accounting system. This type of service has become a routine occurrence for our firm around the many GWACs that allow third-party assessment of accounting systems as part of the award of points and is something that can be done rather efficiently by our team. Additionally, during performance it is worth discussing with the ACO early in the process what plans the ACO has to determine provisional billing rates and ultimately the negotiation and settlement of final indirect rates, without the support of DCAA. This is an area we can support the initial conversation, as well as be part of the solution for an independent third-party review.

Small business contractors with only Small Business Innovation Research (SBIR) type contracts for DoD that were awarded between January 9, 2018 and October 1, 2022 that are less than $7.5 million will have an issue with the Defense Contractor Audit Agency (DCAA) providing services to review or audit these SBIR contracts. DCAA will not notify you of this change. However, if the ACO request their services they will decline in a letter referencing DPAP memo 2018-O0009 Class Deviation – Pilot Program for Streamlining Awards for Innovative Technology Projects.  

This class deviation memorandum from 2018 was renewed through 2022 from the Defense Pricing/Defense Procurement and Acquisition Policy (DPAP) requiring Contracting Officers to remove the FAR 52.215-2, Audit and Records clause. The memo states that contracts, subcontracts, and modifications of contracts or subcontracts valued at less than $7.5 million awarded to a small business concern or non-traditional defense contractor pursuant to:

1. a technical, merit-based selection procedure, such as a broad agency announcement
2. Small Business Innovation Research Program
3. Small Business Technology Transfer Program

These contracts, subcontracts, and modifications are exempt from the requirements for audit and records examination under the clause FAR 52.215-2, Audit and Records – Negotiations. The term “non-traditional defense contractor” means an entity that is not currently performing and has not performed any contract or subcontract for DoD that is subject to full coverage under the Cost Accounting Standards for at least the one-year period preceding the solicitation of sources by DoD for the procurement.

This guidance is being interpreted by the Defense Contractor Audit Agency (DCAA) as a way to wash their hands of performing anything to support Small Business Innovative Research (SBIR) contracts that meet the exemption requirements mentioned above. However, this guidance and DCAA interpretation fails to consider the FAR 52.216-7, Allowable Cost and Payment clause. The process outlined in FAR 52.216-7 clause requires the Contractor to invoice with provisional billing rates and then prepare an Incurred Cost Proposal for each fiscal year a cost reimbursable type contract has incurred costs. The Incurred Cost Proposal is subject to audit and is critical in the contract closeout process for cost reimbursable contracts. This audit of the Incurred Cost Proposal ensures that unallowable costs are not claimed as well as the costs incurred are accurate, reasonable, and allocable. DCAA typically reviews the Incurred Cost Proposal to determine if it is “adequate for audit” and then eithers audits or provides a low-risk memo to Contractors.

For contractors with other types of DoD contracts, there should not be an issue with the overall review of the Incurred Cost Proposal, however, the SBIR contracts that are less than $7.5 million will not be reviewed or audited by DCAA. Phase II of the SBIR contracts are typically cost reimbursable due to the nature of the work being performed. Therefore, provisional billing rates will have to be provided for the cost reimbursable contracts and then an Incurred Cost Proposal will be required in accordance with FAR 52.216-7 to be submitted to essentially true up to actual costs incurred. Even though DCAA will decline to review these contracts, it should be included in the cost reimbursable section on your Incurred Cost Proposal. The cost reimbursable Phase II of the SBIR contract will have the indirect rate burdens that need to be settled for closeout. If DCAA will not review and audit these SBIR contracts, then who will?  

The burden of audit and validation of provisional billing rates has been passed from DCAA to the Administrative Contracting Officer (ACO). For SBIR contracts, the ACO will have the task of performing the validation steps that were traditionally performed by DCAA. Contracting Officers will be tasked with determining the risk of these small SBIR contracts as well as have to provide guidance and/or a review of the incurred cost submission to complete the contract closeout process if the Contractor only has SBIR contracts.  

Be aware, if you are a small business with only SBIR contracts, DCAA will not support you or provide services related to these contracts. Small business will have to work with the Contracting Officer to resolve any issues.