Section 809 Panel Advisory Report – Section 2 – Contract Compliance and Audit

What was Reported?

The Section 809 Advisory Panel, established under Section 809 of the National Defense Authorization Act (NDAA) for Fiscal Year 2016, issued January 31, 2018, their Volume 1 of 3 Report of the Advisory Panel on Streamlining and Codifying Acquisition Regulations (Report). The eight-section Report addresses various aspects of the Department of Defense (DoD) acquisition process and offers several conclusions and recommendations identifying opportunities for improvement across the overall acquisition spectrum.

The focus of this paper is Section 2 – Contract Compliance and Audit. Summarized below are six selected recommendations of the total 11 recommendations identified in Section 2 of the Report. The 11 recommendations pertain to current regulatory requirements and associated business practices of the Defense Contract Audit Agency (DCAA) and Defense Contract Management Agency (DCMA) relative to current contract audit, oversight and administration activities.

Several of the findings and recommendations included in the overall 11 have been previously identified through prior fiscal years’ NDAAs and/or the DoD rule-making process and the subject of public comments, discussions, or opinions. We have selected for discussion here six of the 11 recommendations that present somewhat of a new look and offer a different perspective to effect potential improvements to the DoD acquisition process compared to other initiatives previously vetted in prior NDAAs and/or DoD rules referenced above.

– DCAA’s Annual Report to Congress (Recommendation 6) – The Report criticizes the content and metrics that the DCAA reports annually to Congress. The Report states “Congress’s reporting requirement for DCAA lacks critical metrics to adequately measure DCAA’s performance.”

Substantive findings and recommendations noted in the Report include:

  • Reduction of, as the primary emphasis, reporting of DCAA’s questioned costs, sustained costs, and return on investment as it is misleading when not reported in conjunction with other performance metrics;
  • Utilization of a balanced scorecard approach to report other aspects of DCAA’s performance, including, among other things, i) on-time performance, ii) reasons for the differences between questioned and sustained costs, iii) survey results of buying commands’ and the DCMA’s views on the timeliness, quality and effectiveness of DCAA audits performed, and iv) costs to perform audits compared to sustained costs; and
  • Amendment, by the Legislative Branch, of 10 U.S.C. §2313a requiring the DCAA to report additional key metrics.

– Statutory Time Limits for DCAA Activities (Recommendation 8) – The Report criticizes the overall timeliness of the DCAA audit activities performed and notes various activities take too long and are initiated too late. Timely receipt of audits under statutorily mandated deadlines will improve the DoD’s effectiveness of various oversight activities. The Report states, “DCAA’s work is untimely, which causes delays in contract awards, as well as other negative effects on the contract life cycle, through andincluding contract closeout.”

Substantive findings and recommendations noted in the Report include:

  • Existence of requirements for independent public accountants to submit final audit reports within required timeframes – including both audits of i) private entities under Securities Exchange Commission deadlines and ii) public agencies under Chief Financial Officers Act of 1990 deadlines;
  • Existence of requirements for contractors to submit various reports and documents to the DCAA and DCMA within required statutory timeframes;
  • Identification of 11 specific DCAA oversight activities, three on-demand and eight predictable, for which statutory deadlines should be established;
  • Establishment of these deadlines by October 1, 2019; however, the DCMA and DCAA are encouraged to establish dates sooner;
  • Extension of established dates is permissible by contracting officers within a narrow group of three categories – if the extension is due to the contractor requested or delayed category, the extension cannot be granted without the contractor’s express knowledge; and
  • Amendment, by the Legislative Branch, of 10 U.S.C. §2313b(g) to include required reporting deadlines related to the 11 specific oversight activities referenced above.

– DCAA’s use of Independent Public Accounting (IPA) Firms to meet Time Limits (Recommendation 9) – The Report asserts the DCAA cannot eliminate its backlog of incurred cost proposal audits and meet its other oversight and reporting responsibilities without use of additional resources. The Report states, “DCAA needs additional resources to get and stay current with its oversight responsibilities.”

Substantive findings and recommendations noted in the Report include:

  • Establish use of IPAs by the DCAA to eliminate the incurred cost proposal audit backlog and allow continued support of other oversight and financial services activities;
  • Request increases in appropriated funding by the DCAA to Congress to allow for the DCAA to contract with IPAs;
  • Maintain availability of increased funding to the DCAA on a yearly basis, over a five-year period and starting in fiscal year 2019;
  • Establish authority of contracting officers to request from the DCAA services of IPAs to meet contracting officers’ needs;
  • Provision, by the Legislative Branch, of additional appropriated funding beyond the current DCAA budget to allow the DCAA to retain IPAs; and
  • Modification by the Executive Branch, of DoD Directive 5105.36 to enable the DCAA’s use of IPAs.

– Replace Accounting System Administration Adequacy Criteria (DFARS 252.242-7006 with an Internal Control Audit (Recommendation 10) – The Report asserts use of the existing 18 adequacy criteria contained in DFARS 252.242-7006 for purposes of assessing the adequacy and effectiveness of contractors’ accounting systems is inadequate. Rather, as prescribed in Section 893 of the NDAA for fiscal year 2017, the DoD should accept contractors’ third-party auditor internal control audits performed using the Sarbanes-Oxley (SOX) integrated framework approach as the baseline. The Report states, “The DoD is not obtaining timely assurance that internal controls for defense contractors’ accounting systems are properly designed and functioning. Ensuring effective internal controls is one of the most efficient ways to protect the government’s interest, reduce risk, and improve performance.

Substantive findings and recommendations noted in the Report include:

  • Recognition that the accounting system is the most critical business system to ensure the government’s interests are protected;
  • Use by third-party auditors the SOX integrated audit framework as a baseline to measure contractors’ adequacy and effectiveness of internal controls to meet government contract audit objectives;
  • Revision by third-party auditors the SOX framework to address specific and unique accounting system internal control objectives and establish an internal control audit program based on objective and measurable criteria;
  • Replacement of the DFARS 18 adequacy criteria with the revised internal control audit program and conduct audits with use of third-party auditors, and
  • Revision by the Executive Branch, of DFARS 252.242-7006 to allow use of contractor performed internal audits.

– Incentivize Contractor Compliance through Robust Risk Assessment (Recommendation 14) – The Report suggests the DCAA could be more efficient with performance of their overall audit and oversight responsibilities with utilization of a more robust risk assessment program pertaining to their overall audit and workload planning. The Report states, “DCAA uses a simple risk assessment to prioritize workload. Because DCAA bears all oversight responsibilities regarding contractor costs and related business systems, DCAA needs a more robust risk assessment approach.

Substantive findings and recommendations noted in the Report include:

  • Implementation by the DCAA of a more holistic risk-based assessment approach based on assignment of numeric weightings to specific fact-based risk considerations;
  • Addition by the DCAA of ten potential additional factors (beyond auditable dollar-volume (ADV) for consideration and analysis when performing contractor risk assessments, including, among other things, i) complexity of cost accounting structure, ii) government participation in indirect expense pools, iii) status of business systems, and iv) compliance with applicable Cost Accounting Standards requirements;
  • Potential re-designation of contractors, based on the results of the numeric weightings developed from the criteria above, into high, medium and low-risk categories different than previously designated categories based on the current ADV focused approach, and
  • Definitive recommendation by the Section 809 Panel regarding the potential ten additional risk assessment factors prior to its January 2019 sunset.

– Clarify Definition of an Adequate Incurred Cost Proposal (Recommendation 15) – The Report criticizes the DCAA’s audit of direct costs as a required procedure in conjunction with the overall audit of contractors’ final indirect cost rate proposals (also frequently known as final incurred cost proposals or incurred cost submissions). The Report asserts all the schedules currently ‘required’ and included in these proposals have no bearing on meeting the sole purpose of these proposals, which is, establishment of final indirect expense rates in accordance with FAR 42.702. The Report states “Many of the required elements of an adequate final indirect cost rate proposal have no bearing on calculating, understanding, auditing, and negotiating final indirect cost rates. This collection of unnecessary data has contributed to DCAA losing its focus on the purpose and scope of contractors’ final indirect cost rate proposal and has created unnecessary work for contractors, DCAA, and especially contracting officers.

Substantive findings and recommendations noted in the Report include:

  • Clarify in the FAR that an incurred cost proposal is the same as a final indirect cost rate proposal;
  • Perform by DCAA audits of final indirect cost rate proposals in accordance with the intent of the FAR, and, exclude as a required procedure the audit of direct costs;
  • Redefinition by DCAA which schedules are required for submission in the final indirect cost rate proposal, and, designate as optional those schedules that do not relate to establishment of final indirect expense rates; and
  • Definition, by the Executive Branch, within FAR 52.216-7 that incurred cost proposal is synonymous with final indirect cost rate proposal and designate schedules I-M and O as optional.

What does this Mean?

The six recommendations discussed above make sense and offer practical and reasonable approaches to accomplishing the overall objective of the Section 809 Panel, i.e., streamline the DoD acquisition regulatory process and move to a more effective and efficient framework. Further, use of industry leading and long-established commercial business practices makes good sense.

Unfortunately, there is a twofold reality. First, as many of the recommendations can only be accomplished as a result of statutory or regulatory change, the corresponding timeline(s) associated with the legal or regulatory processes to allow implementation of these recommendations are likely, a way down the road. Second, some of the recommendations may be received as somewhat controversial and attract resistance; see, for example, recommendations 6, 8, 9, and 15. Recommendation 9 is likely the most controversial as the DCAA, based on recent public discussions and comments and congressional testimony (April 2017), clearly object to the use of IPAs for incurred cost audit purposes, let alone engaging the IPAs directly as recommendation 9 suggests.

Implementation of the above recommendations would be a welcomed change to the current government contracting state however, contractors should realize any real or substantive change will likely not be seen in the near term.