DFARS Case 2017-D018 – Changes to DFARS Requirements for Independent Research and Development

In 2017 Congress directed through the National Defense Authorization Act (NDAA) that changes be made to the treatment of independent research and development (IR&D) costs and required the Defense Contract Audit Agency to provide as part of its annual report to Congress both independent research and development and bid and proposal (B&P) costs expended by DoD contractors. Congress intended this change to apply to indirect costs incurred on or after October 1, 2017. The Defense Acquisition Regulation (DAR) Council must have read over that part.

Summary of NDAA 2017 Section 824 Requirements

  • 2372:
    • Requires the reporting of cost incurred for independent research and development expenses independently (i.e., separately) from other allowable indirect costs.
    • Independent research and development costs shall be considered fair and reasonable, and allowable, indirect expense on Department of Defense contracts.
    • DoD provide contractors with timely and comprehensive information regarding planned or expected need for future technology and advanced capability.
    • Contractors provide DoD with information regarding progress by the contractor on independent research and development programs.
    • DoD may not include provisions that would infringe on the independence of a contractor to choose which technologies to pursue in its independent research and development program provided the chief executive officer (CEO) of the contractor determines that expenditures will advance the needs of the Department of Defense for future technology and advanced capability.
  • 2372a:
    • Require the reporting of cost incurred for bid and proposal expenses independently (i.e., separately) from other allowable indirect costs.
    • DoD must establish a goal each fiscal year limiting the amount of reimbursable bid and proposal costs paid by the DoD to an amount equal to not more than one percent of the total aggregate industry sales to the DoD. However, DoD cannot limit the payment of allowable bid and proposal costs to achieve its goal.
    • If DoD exceeds the goal, DoD must establish a panel to review laws, regulations, and practices that contribute to the expenses incurred by contractors for bids and proposals and recommend changes to such laws, regulations, and practices that may reduce expenses incurred by contractors for bids and proposals.
    • The Defense Contract Audit Agency’s annual report to Congress will include a summary of the dollars and percentage of indirect costs contractors spent on both independent research and development and bid and proposal costs for the previous fiscal year.

The DAR Council has finally issued a proposed DFARS rule to implement the congressional requirement. The Federal Register notice states:

DoD is proposing to amend the Defense Federal Acquisition Regulation Supplement (DFARS) to implement a section of the National Defense Authorization Act for Fiscal Year 2017 that makes amendments regarding the treatment of independent research and development expenditures and requires the Defense Contract Audit Agency to provide an annual report to Congress on independent research and development and bid and proposal expenditures.

The proposed rule changes language as follows:

  • Adds at DFARS 231.205–18(c)(iii)(A)(1) a requirement for CEOs determination that IR&D expenditures will advance the needs of DoD for future technology and advanced capability.
  • Adds at DFARS 231.205–18(c)(iii)(A)(2) that major contractors must include a statement in the submission to the Defense Technical Information Center (DTIC) that the CEO of the contractor has made a determination the IR&D project advances the needs of DoD for future technology and advanced capability for the cost to be allowable.
  • Removes the list of seven activities of potential interest to DoD at DFARS 231.205-18(c)(iii)(B) and the requirement at DFARS 242.771–3(a) for the ACO or CACO to determine if an activity is of potential interest to DoD.
  • Adds at DFARS 231.205–18(c)(iv) that IR&D and B&P costs will be reported independently from each other and from other incurred indirect costs.
  • Leaves unchanged the requirement to consider both IR&D and B&P costs when determining if a contractor meets the definition of a major contractor.
  • Adds at DFARS 242.771–3(c)(1) a requirement for the Under Secretary of Defense for Research and Engineering to provide on the DTIC website DoD’s future needs.
  • Adds a new contract clause at DFARS 252.242–70XX, Independent Research and Development and Bid and Proposal Incurred Costs, which requires all contractors with noncommercial awards exceeding the simplified acquisition threshold to provide an incurred cost submission of IR&D and B&P costs for the prior Government fiscal year to a website for DCAA to access.

A major contractor is a company allocating more than $11M in IR&D/B&P costs from covered segments to covered contracts. A covered segment allocates more than $1.1M to covered contracts and covered contracts are any non-firm fixed price contracts or subcontracts over the simplified acquisition threshold ($250k).

Here are a Few of Our Concerns With the Proposed Rule

While the requirement for evidence of the CEO determination to be uploaded to DTIC is limited to major contractors, the DFARS 231.205-18(c)(iii)(A)(1) requirement for a CEO determination that the IR&D project will advance the needs of DoD for future technology and advance capability is not limited to major contractors. As we have seen with many DCAA auditors this will create an audit requirement for detailed documentation with extensive rationale to support the determination by the CEO of many small businesses. BTW – many small businesses do not have a CEO position on their organization charts, so what then? Interestingly – Section VI of the proposed rules states “DoD does not have a list of other than major contractors or small entities that have IR&D programs … [however] DoD expects a minimal number of the contractors to be small entities.” We disagree with the DoD conclusion that as they do not know the number of small entities it must be a small number that incur IR&D expenses. While the need to upload evidence is limited, many small businesses will be battered by auditors’ unreasonable expectation of documentation.

The proposed language at DFARS 242.771-4 requires the inclusion of the new contract clause 252.242–70XX, Independent Research and Development and Bid and Proposal Incurred Costs, in all solicitations and contracts that exceed the simplified acquisition threshold. This wording fails to exempt FAR Part 12 commercial contracts and firm fixed price contracts which are not covered by the FAR Part 31 or DFARS Part 231 allowability requirements. As written, contractors with commercial and firm fixed price contracts would be required to submit an annual incurred cost submission for their IR&D and B&P projects.

The new contract clause 252.242–70XX, Independent Research and Development and Bid and Proposal Incurred Costs, requires a submission tied to the Government Fiscal Year (October 1 to September 30). Most contractors are not on the same fiscal year as the Government. This is going to create issues with amounts not tying to amounts included in the contractor’s incurred cost submission.

We plan to submit comments and suggest you do the same. Comments can be submitted through the Federal eRulemaking Portal. Search for “DFARS Case 2017-D018.” Select “Comment” and follow the instructions to submit a comment. Comments are due by November 29, 2021.

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Written by John C. Shire, CPA

John C. Shire, CPA John is a Director with Redstone Government Consulting, Inc. providing government contract consulting services to our clients primarily related to the DFARS business systems, CAS Disclosure Statements, and DCAA/DCMA compliance preparation, advisory, and defense. Prior to joining Redstone Government Consulting, John served in a number of capacities with DCAA/DCMA for more than 30 years. Upon his retirement, he was based in Texas as an SES-level Corporate Audit Director for DCAA, managing a staff of 300 auditors at one of the largest DOD programs. Professional Experience John began his career in the late 80s working in the Clearwater, FL audit office and over the next three decades he progressed through a number of positions within both DCAA and DCMA with career highlights as DCAA Program Manager at Ft. Belvoir, Chief of Technical Programs Division, Deputy Assistant Director-Policy, Director of the DCMA Cost and Pricing Center, the SES-level Lockheed Martin Corporate Audit Director, and Director of Integrity and Quality Assurance. John’s three decades of experience in performing and leading DCAA auditors and DCMA reviewers provides a wealth of expertise to our clients. John’s role, not only in the performance of audits, but also in the development of audit policy affords him unique insights into the defense of audit findings and the linkage of audit program steps to the underlying regulatory framework. He is an expert in FAR, DFARS, and other agency acquisition regulation, as well as a subject matter expert in the Cost Accounting Standards having reviewed and provided audit feedback on many of the largest and most complex cost accounting practices during his tenure with the DCAA. John’s tenure with DCAA and DCMA came at a critical time during each agency’s history where a number of changes were occurring such as the response to the ICS backlog, development of audit approaches to the DFARS Business Systems and implementation of new audit initiatives as a result of Congressional oversight through the NDAA process. John’s leadership at the DCMA Cost & Pricing center saw oversight of all major DOD pricing actions, leadership of should cost review teams, the Commercial Pricing group and many other areas of strategic value to our clients. His involvement in these and other Agency initiatives is of great value to our clients due to his in depth understanding of DCAA and DCMA’s internal policy directives. Education John holds a Master of Business Administration and a B.A. in Accounting from the University of South Florida. Certifications Certified Information Systems Auditor State of Alabama Certified Public Accountant

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Topics: Incurred Cost Proposal Submission (ICP/ICE), Contracts & Subcontracts Administration, DFARS Business Systems, Government Regulations