In the June 27, 2024 Federal Register, the Department of Defense (DoD) is proposing to change the Defense Federal Acquisition Regulation Supplement (DFARS) to implement a section of the National Defense Authorization Act for Fiscal Year 2021 requiring that the generally accepted auditing standards (GAAS) definition of a “material weakness” be used in place of the current definition of a “significant deficiency” when evaluating a contractor’s business system.
What Are the Two Definitions?
When the original DFARS business system clauses were put in place the term “significant deficiency” was used.
“Significant deficiency,” in the case of a contractor business system, means a shortcoming in the system that materially affects the ability of officials of the Department of Defense to rely upon information produced by the system that is needed for management purposes.
The GAAS definition of a “material weakness” has substantially different wording – however, I do not believe the intended meanings are all that different.
Material weakness means a deficiency or combination of deficiencies in the internal control over information in contractor business systems, such that there is a reasonable possibility that a material misstatement of such information will not be prevented, or detected and corrected, on a timely basis. A reasonable possibility exists when the likelihood of an event occurring is—
(1) Probable; or
(2) More than remote but less than likely.
The Defense Contract Audit Agency (DCAA) has always believed that a DFARS “significant deficiency” equated to a GAAS “material weakness.” In fact, based on my recent interactions with DCAA through our clients, DCAA auditor find few, if any, deficiencies that they do not believe rise to the level of a significant deficiency/material weakness. I do not think the change to the GAAS definition will do much for us on this front. I will say that most Administrative Contracting Officers (ACOs) are much more reasonable and focused on getting potential internal control issues fixed versus getting withholds in place.
DoD Opens the Door for Input From Small Businesses on the Impact of the Business System Rules
In addition to requesting comments on the change in the definition, “DoD will also consider comments from small entities concerning the existing regulations in subparts affected by this proposed rule in accordance with 5 U.S.C. 610. Interested parties must submit such comments separately and should cite 5 U.S.C. 610 (DFARS Case 2021–D006), in correspondence.”
I see this as an excellent opportunity for small businesses to let DoD know that the business system rules (i.e., clauses) still have a significant impact on small business even if DFARS 252.242-7005(a) limits the application of withholds to only “contracts that are subject to the Cost Accounting Standards.” Here are a few of my concerns:
- At the end of each of the DCAA audit programs for contractor business systems, DCAA discusses what it refers to as “Less Severe Significant Deficiencies.” These are clearly deficiencies which do not meet the DFARS definition of a “significant deficiency.” As a result, the withhold requirement provided for in DFARS 252.242-7005 cannot be applied, yet DCAA instructs the auditor to discuss the withhold provisions under FAR 32.503-6 with the contracting officer. See our article “DCAA Trying to Stretch FAR Yet Again.”
- To be awarded a cost reimbursable contract the contracting officer is required by FAR 16.301-3 to ensure the contractor has an adequate accounting system as outlined in the Standard Form 1408. However, upon award the DFARS 252.242-7006, Accounting System Administration, clause is included in the cost reimbursable contract which adds the additional system criteria at DFARS 252.242-7006(c) requiring:
- (1) A sound internal control environment, accounting framework, and organizational structure.
- (7) Approval and documentation of adjusting entries.
- (8) Management reviews or internal audits of the system to ensure compliance with the Contractor’s established policies, procedures, and accounting practices.
Most small businesses have, as you would think, small accounting departments of only a few employees (some have one or two employees performing the accounting function as part of their assigned duties). This makes having a sound internal control environment and levels of management review and approval (i.e., segregation of duties) simply not possible.
- The award of a cost reimbursable contract also brings with it DFARS 252.244-7001, Contractor Purchasing System Administration, and DFARS 252.242-7004, Material Management and Accounting System, these are complex systems that most small businesses cannot afford to invest the human and financial capital into supporting.
If you are a small business, take this opportunity to let DoD know the cost of these contractual requirements and the resources you must invest when dealing with DCAA system audits that provide little, if any, benefit to DoD. DCAA’s 2023 Report to Congress states that business system audits is one of its priorities. I believe, that with DCAA’s Branch Offices looking for work we are going to see many more business system audits of small businesses.
Redstone GCI plans to Submit Comments
Redstone GCI plans to submit comments that:
- We support the change in the definition.
- We recommend the definition be aligned with the Defense Contract Management Agency (DCMA) Corrective Action Request (CAR) levels – a “material weakness’ being equal to a Level III CAR.
- Also, under the 5 U.S.C. 610 request for input related to small business, we are going to recommend DoD consider a dollar threshold for the inclusion of the DFARS business system clauses when contracting with a small business.
Public Comments are Due August 26, 2024
We recommend all small business contractors submit public comments on the impact of the DFARS business system clauses on their human and financial capital investments to comply with the requirements and the benefit or lack thereof. Other contractors that have had issues with auditors or contracting officers finding minor correctable internal control issues as significant deficiencies, soon to be called material weaknesses, should submit comments as well.
Your written comments can be submitted through Federal eRulemaking Portal or by email to osd.dfars@mail.mil. Ensure you include DFARS Case 2021–D006 in any uploaded documents or the subject line of the email.
Redstone GCI assists contractors throughout the U.S. and internationally with understanding the Government’s requirements and maintaining compliance. We would be happy to be part of your team.
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