Redstone Government Consulting Blog (57)

On March 4, 2016, we posted a blog, “The Inherently Evil Cost-Type Contracts” which discussed the Government view of cost type contracts. More specifically, the risks to the Government when using a cost-type contract (typically cost-plus fixed-fee, but also including cost-plus incentive fee or CPIF).   From a contractor risk perspective, the evil-twin of the CPIF contract is a Fixed-Price Incentive Firm Target (FPIF) contract because of the major difference in contractor obligations to perform as a function of costs incurred.   Typically cost type contracts only require contractor performance up to the contract limitation of funds (LOF); as noted in FAR 16.307(d)(1), the completion form of a cost-type contract requires the contractor to complete and deliver the specified end product within the estimated cost (LOF). However, if the specified end product can’t be performed/delivered within the estimated cost, the government can require more effort provided the Government increases the estimated cost.  A contractor is no longer required to perform once costs incurred equal the LOF; hence, the Government assumes the risk of cost overruns if the Government wants to compel delivery of the end-product.

DCAA’s Inevitable Link with an Inadequate Accounting System

There is no specific regulatory authority that can be cited which requires work authorizations as a part of a contractor’s Labor/Timekeeping System. This argument, although accurate, is not the rationale which will be used by a DCAA auditor when “disclosing” deficiencies in a contractor’s labor system during a routine labor floor check. The auditor will ultimately render an opinion of inadequacy with respect to the accounting system citing DFARS 252.242-7006(c)(1), which states “The contractor’s system will provide for a sound internal control environment, accounting framework, and organizational structure”. You may and, probably will, ask where is there a mention of work authorizations anywhere in DFARS 252.242-7006 Accounting System Administration? The short answer; there isn’t. The DCAA answer, and the only one it thinks matters, is that the regulation it cites does not have to specifically address work authorizations but a link can be inferred within the highly general requirement for a “sound internal control environment”.

As some may have seen, on March 10, 2016, the Department of Defense (DOD) issued its 2017 regulatory proposals. However, through marginally reliable resources, we’ve located one significant regulatory deviation being sought by DOD.  We understand that DOD will make this public on April Fool’s Day, 2016.  The following is what we know about this rumored (but could be factual) DOD action.

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.

DCMA and DCAA have issued guidance on how to deal with the impact of the $487,000 rate cap that applies to contracts subject to FAR 31.2 and awarded on or after June 24, 2014. If you have not read this document, see DCAA’s MRD 16-PSP-005(R), dated February 19, 2016. It includes the DCMA guidance also. You have flexibly priced contracts that require an annual incurred cost submission. Now what, exactly, are you supposed to do with this guidance?

From the signing of the Lilly Ledbetter Fair Pay Act and the creation of the National Equal Pay Task Force and throughout Obama’s administration, we have seen a consistent push for “fair pay” (viewed from the perspective of the Federal Government). Equal Employment Opportunity Commission (EEOC) Chair Jenny Yang explained that “Since the creation of the President’s Equal Pay Task Force in 2010, the EEOC has investigated tens of thousands of charges of pay discrimination, and through our enforcement efforts, we have obtained more than $85 million in monetary relief for those who have faced pay discrimination based on sex.” Of passing interest, the amount is only shown in absolute terms/dollars because in relative terms the recovery (using annualized data) is approximately .000025% of total full-time employee compensation in the United States (annual monetary relief of $17,000,000 and total annual full-time employee compensation is approximately $6,842,500,000,000). Regardless of the statistical insignificance, in relative terms, it is clear that they mean business and that they’ve only just begun--not to be confused with the 1970’s Carpenter’s Song; “We’ve Only Just Begun”.

“A sound internal control environment, accounting framework, and organizational structure” is criteria number one in DFARS 252.242-7006 Accounting Systems. In fact, all six of the business systems identified in DFARS 252.242-7005 Contractor Business Systems, or commonly known as the “DFARS Business Systems Rule”, references adequate internal controls and the reliability of data. Even more far-reaching than DFARS is that FAR, adhered to by most, if not all US Federal Government agencies, requires adequate contractor internal controls over financial data relied upon for acquisitions. For the purposes of this blog, we shall focus primarily on the DFARS Business Systems Rule as it applies to defense contractors because of the activities of DCAA.

Although there is a “time to every purpose under heaven” (lyrics to the song Turn, Turn, Turn, by the Byrds) including a time and purpose for Cost-Type Contracts (FAR 16.3 Cost-Reimbursement Contracts), do not try to sing this song to Senator John McCain (Chairman of the Senate Armed Services Committee or SASC). In application to cost-reimbursement contracts, Senator McCain recently referred to cost-plus contracting as “an evil that has grown and grown and grown over the years, and I will not stand for it on any weapons system”.   In support of his statement, there is a long history of significant cost overruns on major weapons systems which all started with cost-reimbursable developmental contracts. Unfortunately, comparing original cost estimates with final program costs, i.e., computing the percentage of cost growth, is a very simplistic and incomplete statistic noting that developmental contracts are just that, conceptual and lacking anything approaching a well-defined statement-of-work. As such, these agreements are not exactly candidates for a firm-fixed price contract (FAR 16.2), unless the prime contractor is naïve and/or reasonably sure that its risk will be mitigated by an endless series of change orders and requests for equitable adjustment for each and every change to the statement of work.   As a point of reference explaining why a contractor should not be overly optimistic in terms of accepting a fixed-price contract with an ill-defined statement of work, one only needs to read the decision in US CoFC Nos. 13-55C, 13-97C, filed August 18, 2015.  In particular, the judge rejected the contractor claim for increased costs noting that the contractor voluntarily assumed the risk of a firm-fixed price contract, albeit with an “unusually high risk” attributed to the ill-defined statement of work.

As a small (or potential) government contractor or subcontractor, one question you will frequently encounter is if you have a “Job Cost Accounting System.” This may sound like a specific type of software, but it is not. Many different accounting software systems can provide job cost accounting if properly configured. The questions on the SF 1408, Pre-award Survey of Prospective Contractor Accounting System, are designed to discover if you have a job cost accounting system. This still doesn’t tell the non-accounting person what a job cost accounting system is or why it is important (other than to get the right answers on the SF 1408 to qualify for a government cost-reimbursable contract).

For years, DCAA has promised Congress it would get current on its incurred cost backlog. For years, it has failed to deliver on that promise. Logically, you would have expected DCAA to address the quality of their audits (or lack thereof) and eliminate the inefficiencies caused by, among other issues, (i) failure to adequately assess risk, (ii) performance of unnecessary procedures due to fears of failing the internal quality control reviews, regardless of risk, (iii) inadequate understanding and misinterpretation of regulatory requirements, and (iv) failure to have sufficient communication with the contractor to understand the issues. Unfortunately, that has not been DCAA’s approach. Instead, DCAA chose to increase the thresholds for the incurred cost submissions selected for audit, write off millions in lieu of audit, and claim victory. That strategy failed once they ran out of low hanging fruit to write off and still needed to do actual audits.