The topic of accounting system adequacy seems to be a recurring issue for many in the government contracting community. Earlier this month in the ongoing “process of elimination”, GAO weighed in again on what is NOT considered a determination of accounting system adequacy. In Shivoy B-413104.36, GAO rightfully denied a protest for unequal treatment in eliminating a proposed offeror due to lack of verification of a proposed subcontractor’s accounting system as adequate.
Financial Review Doesn’t Equal an Adequate Accounting System
The short version of events is that an adequate accounting system as required by FAR 16.301-3 was a requirement of the solicitation for the prime and all subcontractors. The proposed subcontractor submitted audited financial statements as prepared by their external CPA firm which expressed an opinion on financial statement presentation, not the adequacy of the subcontractor’s accounting system for accumulation, allocation and billing of cost under cost-reimbursable contracts. Neither GAO or the government customer was persuaded that audited financial statements provided any assurance of a contractor’s ability to manage and bill under a cost-reimbursable contract.
Financial Statement Audit vs. Accounting System Audit
As someone who has operated in this industry for many years, the distinction between a financial statement audit and a pre or post award accounting system audit would seem to be a clear one. For the sake of illustration, though, let’s unpack this a bit to show those distinctions.
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Pre/Post Award Accounting System Audit |
Financial Statement Audit |
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Purpose |
Express an opinion on the ability of a contractor’s software, policies, procedures and controls ability to accurately accumulate, report and bill costs under cost-reimbursable contracts |
Express an opinion on the presentation of the financial statements in accordance with U.S. GAAP/IFRS. |
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Requirement |
FAR 16.301—3(a)(3) A cost-reimbursement contract may be used only when…The contractor’s accounting system is adequate for determining costs applicable to the contract or order |
Company dependent; often considered a good business practice but may be required for financing or other external reporting (SEC, et al.) |
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What It Covers |
DOD: DFARS 252.242-7006(c) System Criteria Other Agencies: SF-1408 Pre-Award Survey of Prospective Contractor Accounting System If DCAA is performing the audit they will default to the DFARS criteria regardless of agency making the contemplated contract award. |
Examination of an entity’s financial statements and accompanying disclosures resulting in an attestation to the propriety of the financials presented/audited. |
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What Assurance is Offered |
Adequate; Adequate but not yet implemented; Adequate with recommendation for follow-on audit or Inadequate |
Unqualified opinion; Qualified Opinion, Adverse Opinion; Disclaimed Opinion |
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Audit Focus |
Policies, Procedures, Reporting and Income Statement expense account (cost classification: direct, indirect, unallowable; cost groupings: indirect expenses; project cost, etc.) |
Policies, Procedures other documentation (loans and other contractual agreements generating assets or liabilities) and Balance Sheet and Revenue Accounts. Financial statement auditors spend very little time evaluating expense classifications and are primarily focused on a “balance-sheet approach.” We regularly see CPAs unfamiliar with government contracting express an opinion on the financial statements without having a firm grasp on the cost accounting necessary to understand accounting system adequacy. |
Hopefully, from the above table, you can see that financial statement audits and a pre/post award accounting system audits only share the word “audit” in common. Both audits have their place in a government contractor’s business and are equally necessary, but they are not one and the same.
Redstone’s Audit Experts
At Redstone GCI we assist contractors with accounting system audit preparation and have a strong background in financial statement audits as well. Many of our staff are CPAs who spent a considerable portion of their careers in financial statement audit prior to focusing on consulting, so we are uniquely positioned to assist other CPA firms and their clients with their needs in this area. Our services do not compete as we provide no traditional CPA services (audit, tax, valuation, et al.) and are a complement and value-add to CPA firms looking to assist the government contractor community. If you are a contractor considering pursuit of cost-reimbursable contracts, or a CPA firm looking for subject matter expertise in this area, we would be happy to discuss how we may be able to assist you.
