Every small business that receives a Federal Government cost reimbursable contract is expected, by the Defense Contract Audit Agency (DCAA), to have a “sound internal control environment, accounting framework, and organizational structure.”
Where Does it Say that in the Federal Acquisition Regulations (FAR)?
FAR 9.104-1 requires the contracting officer to ensure a prospective contractor has “the necessary organization, experience, accounting and operational controls.” FAR 9.106-4 refers the contracting officer to SF 1408, Preaward Survey of Prospective Contractor-Accounting System, to document this determination. Nowhere in the SF 1408 or FAR part 31, which establishes the basis of a cost accounting system, are the words “sound internal control environment, accounting framework, and organizational structure” used.
Where is This Coming From?
Defense Federal Acquisition Regulations Supplement (DFARS) 252.242-7006(c)(1) is where the words “sound internal control environment, accounting framework, and organizational structure” come from.
YES – Even if you have a single low dollar cost reimbursable contract with the DoD, you are required to comply with the requirements in this contract clause.
I Do Not Have DoD Contracts - So, I am Good, Right?
Sadly, that is not the case. Our friends at DCAA are not about to let the simple fact that the DFARS clause is not in your contract get in the way of an easy audit finding. Both the major (large contractors) and non-major (small businesses) accounting system audit programs use substantially the same wording, requiring:
CONTRACTS THAT DO NOT HAVE THE DFARS 252.242-7006 CLAUSE
Contractors that do not have DoD flexibly priced contracts are not contractually required to comply with the DFARS criteria. Nevertheless, the DFARS criteria are suitable standards to use in determining the acceptability of any Government contractor’s system for the accumulation and billing of cost under Government contracts. If this audit program is used for contractors that do not have DoD contracts, tailor the language in the audit report shell accordingly. FAOs needing assistance in tailoring the audit report should coordinate with their region and Headquarters PAC.
My Opinion
While I do not agree with DCAA’s leap of faith to simply incorporate audit criteria from a clause that is not in your contract, most of the criteria in DFARS 252.242-7006(c) come almost word for word from the SF 1408. These criteria can be tied back to requirements established by FAR part 31 and FAR part 15, so like it or not your accounting system needs to comply with these criteria. Below is a cross reference of the requirements:
|
SF 1408 |
Cross Reference |
|
1. Accounting practices in accordance with Generally Accepted Accounting Principles. |
|
|
2. a. Proper segregation of direct costs from indirect costs. |
FAR 31.202 Direct Costs |
|
2. b. Identification and accumulation of direct costs by contract. |
FAR 31.202 Direct Costs – No contract can have a direct cost charged to it, if same cost for same purpose is charged indirect. |
|
2. c. A logical and consistent method for the accumulation and allocation of indirect costs to intermediate and final cost objectives. |
|
|
2. d. Accumulation of costs under general ledger control. |
FAR 31.201-2 Determining allowability – Generally Accepted Accounting Principles and practices appropriate to the circumstances. |
|
2. e. A timekeeping system that identifies employees' labor by intermediate or final cost objectives. |
FAR 31.202 Direct Costs |
|
2. f. A labor distribution system that charges direct and indirect labor to the appropriate cost objectives. |
FAR 31.201-2 Determining allowability – Generally Accepted Accounting Principles and practices appropriate to the circumstances. |
|
2. g. Interim (at least monthly) determination of costs charged to a contract through routine posting of books of account. |
FAR 31.201-2 Determining allowability – Generally Accepted Accounting Principles and practices appropriate to the circumstances. |
|
2. h. Exclusion from costs charged to Government contracts of amounts which are not allowable in terms of Federal Acquisition Regulation (FAR) part 31, Contract Cost Principles and Procedures, and other contract provisions. |
Fixed Prices: |
|
2. i. Identification of costs by contract line item and by units (as if each unit or line item were a separate contract), if required by the contract. |
FAR 31.201-2(a)(4) Specific Contract Requirements |
|
2. j. Segregation of preproduction costs from production costs, as applicable. |
|
|
3. a. Required by contract clauses concerning limitation of cost (FAR 52.232-20 and 21) or limitation on payments (FAR 52.216-16). |
FAR 52.232-20 Limitation of Cost and FAR 52.232-22 Limitation of Funds |
|
3. b. Required to support requests for progress payments |
|
|
4. Adequate, reliable data for use in pricing follow-on acquisitions. |
The additional criteria from DFARS 252.242-7006(c) are:
(1) A sound internal control environment, accounting framework, and organizational structure;
(6) Reconciliation of subsidiary cost ledgers and cost objectives to general ledger;
(7) Approval and documentation of adjusting entries; and
(8) Management reviews or internal audits of the system to ensure compliance with the Contractor’s established policies, procedures, and accounting practices.
I totally understand the expectation that reconciliations are being done and documented. Even an accounting department of one, which is the case for many small businesses, should be performing reconciliations. My concerns come from DCAA’s expectation that all accounting departments, even at a small business, have adequate segregation of duties and robust management reviews and approvals.
Hoping that DCAA will someday realize the additional cost to the taxpayer they are driving into the contracts with small businesses is not likely our best option. While we believe that DCAA is likely to continue issuing what we think are less than significant deficiencies, we have found most administrative contracting officers (ACO) to be much more reasonable. When we say reasonable – we mean – they have not disapproved the accounting system. However, they still support DCAA in that something needs to be done to address the audit findings.
Working through corrective action plans to address these likely immaterial findings is time consuming and a resource drain – that is true. However, disregarding the issues and not making changes you may have agreed to will likely lead to the ACO ending up disapproving your accounting system – this will put a roadblock in the way of getting awarded new contracts. YES.
What Can You Do?
Here are the things you should consider:
- Review and update your policies and procedures.
- Get training for your indirect staff on Cost Accounting requirements and FAR part 31 Cost Principles.
- Have your certified public accountant (CPA) or external booker keeper perform compensating controls.
- Have an external organization perform an assessment of your accounting system before DCAA shows up to audit.
How Can Redstone Help?
Redstone GCI can assist your company in several key areas, including understanding the Federal Acquisition Regulation (FAR) requirements, drafting comprehensive policies and procedures, providing tailored training for your staff either on-site or virtually, and performing thorough assessments of your accounting system to ensure compliance and efficiency.
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