Labor Qualifications on T&M Contracts
The audit guidance alludes to earlier guidance that discussed the fact that auditors should question costs on time and material contracts related to labor hours for employees who do not meet the labor qualifications set forth in the contract. The guidance alludes to FAR 52.232.-7(a)(3) that states labor hours incurred to perform tasks for which labor qualifications were specified in the contract will not be paid to the extent the employees performing the work did not meet the qualifications specified in the contract unless specifically authorized by the Contracting Officer. The new guidance clarifies that contracting officers have the authority to approve use of non-qualifying labor both before and after the labor is provided and directs auditors to coordinate with COs before issuing audit findings in this area. Even in circumstances where the CO’s approval has not and will not be granted the guidance states the CO is not going to withhold payment of all labor costs when an employee does not meet the labor qualifications if the work delivered adequately completed the contract scope of work. In these cases, the guidance states the CO needs to modify the contract for a new rate or a contract line item to reimburse the costs. Auditors will assist the CO in arriving at a rate that “is more appropriate than the rate charged by the contractor (e.g. a rate based on the fully burdened rate of pay for the unqualified employee or the labor category where that employee truly fits).” Some comments we have seen state DCAA is not technically qualified to make an employee qualification determination.
The guidance goes further and directs the auditor to consider whether contractors’ failure to meet contract requirements constitutes weak internal controls and hence represents an inadequate accounting system where adequacy would include assurances that the contractor received CO authorization. Comments on this vulnerability to an assertion of significant deficiencies in its accounting systems have been very critical calling such prescriptions “simplistic” without considering whether the failure is material or systemic where contractors are urged to resist such auditor assertions as inconsistent with the definition of “significant deficiency” in the Business System rules (MRD 14 PPD-008(R).
Impact of Compensation Caps on Forward Pricing Audits
This guidance alerts auditors to changes to compensation limitations we discuss above and states they will affect all audits but focuses on how they will affect forward pricing audits. Theguidance alludes to (1) NDAA 2012 extension of compensation caps to all employees and (2)the Bipartisan Budget Act (BBA) cap of $487,000 for all employees on awards made after June 24, 2014. The guidance states exemptions to the caps may apply to narrowly targeted employees such as engineers and scientists. It also states that auditors are to coordinate with ACOs to decrement proposed forward pricing rate proposals or forward pricing rate agreements if the compensation caps are not incorporated. Interestingly, the guidance does not address how contractors should implement the new ceiling leading commentators to express worry that auditors may attempt to apply the $487,000 cap to awards made before June 24 (MRD No. 14-PPD-004(R).
Cancelling the Handbook on Fraud Indicators
The new guidance withdraws the DCAA handbook on fraud indicators because of the handbook’s age and the fact that scenarios set forth in the handbook are “outdated.” In place of the handbook the guidance directs auditors to “use examples of Indicators of Fraud Risk in the GAGAS Appendix Section A.10,” relevant risk factors identified in earlier DCAA guidance (dated July 31, 2013) and the DODIG Contract Audit Fraud Scenarios and Resources website (MRD. No 14-PAS003(R).
Allowability of IR&D Costs
New guidance to auditors on the Jan 2012 change to the DFARS requirement that contractors whose segments are allocated more than $11 million of IR&D costs must report anticipated Independent Research and Development projects to the Defense Technical Information Center (DTIC) to demonstrate that projects are of interest to the DOD and hence allowable under DFARS 231.205-18. The guidance (1) confirms the reporting is for anticipated IR&D projects and are not required to reconcile with actual IR&D effort (2) IR&D costs are to be treated as expressly unallowable (subject to penalties) if they have not been reported in the DTIC and (3) auditors should consider whether the failure to report to DTIC constitutes weak internal controls that may result in an accounting system deficiency. Comments on this guidance worry that DCAA involvement in DTIC reporting may lead to opinions that reporting of IR&D projects may be considered to be insufficient and hence unallowable (MRD No. 14PAC-005(R).
Alternative Procedures for Testing for the Existence and Allocation of Labor
During its floorchecks or even its incurred cost proposal (ICP) audits DCAA will verify the physical existence of labor being charged to government contracts and will often test for the existence of employees and the proper allocation of their costs. When such testing has not occurred the new guidance, with an accompanying Q&A section, provides alternative procedures to use when conducting ICP audits. The stated purpose is to ensure employees are actually at work, they are performing in their job classification and their time is being properly charged to appropriate contracts and subcontracts.
Alternative procedures used to test for the existence of the employees are (1) physically observe employees that are still employed and inquire into their start date to ensure they worked during the respective audit year (2) for employees no longer employed at the time of audit, examine personnel records (e.g. copies of drivers’ license, passport, badge, etc.) (3) validate payment of selected employees to bank statements, electronic transfer or third party payroll records (4) review other documents the employee may have created, processed or approved during the audit period (e.g. travel or expense reports, W-4s, leave requests) and (5) determine if the CO has corroborating evidence.
Alternative procedures for the allocability of employee costs may include (1) review contract requirements such as key employee, job title or labor category (2) review statement of work and work orders/authorizations to ensure labor type of employee is required on the contract (3) determine if CO has corroborating evidence showing the labor is allocable to the contract.
In conducting this real time testing the audit team must use their judgment to determine whether the evidence gathered is sufficient. In its effect on the audit opinion, the auditor should consider such factors as audit risk, significance of the labor costs and mix of contract types where “in most cases” a qualified opinion will be issued (13-PPD-012R).
Testing Incurred Cost Payments
The audit guidance references the need for compliance with the FAR clause covering cost reimbursable contracts at FAR 52.216-7 where section (b)(1) states allowable costs should be reimbursed when paid in the ordinary course of business (ordinarily within 30 days of the request for payment) and if not paid the costs should be questioned if they were never paid and considered as a fraud risk indicator.
For audit planning of an ICP audit the audit team will (1) perform testing to payments if real time testing has not occurred (2) consider the results of prior testing if it has occurred in other audits (e.g. paid vouchers, accounting/ billing system) to see if it was sufficient to support conclusions of the current ICP audit and if not, determine appropriate testing to conduct and (3) limit current testing to verification of reports (e.g. check register, bank statements, AP aging) if the team has already established the reliability of computer-based data.
For testing considerations the audit team should design appropriate tests to ensure compliance with FAR 52.216-7(b)(1) based on an understanding of the contractor’s environment, internal controls, payment process and identified risk in this area. Based upon the assessed risk the audit team will conduct either of the following procedures on all costs except for labor. If risk of non-payment is low, conduct a judgmental sample of all payments, trace to source documents (e.g. cancelled checks, electronic funds transfers, bank statements) and then perform a separate sample to test individual accounts for allowability. If risk is high, establish payment as a criterion when conducting a normal allowabililty review. When testing labor the auditor, at a minimum, should (1) reconcile payroll totals with totals of related labor cost distribution records (2) evaluate Schedule L, Reconciliation of Total Payment Per IRS Form 941 to Total Labor and (3) test quarterly taxes for evidence of payment.
In most cases the audit report will need to be qualified if testing of payments is insufficient. The incurred cost audit program is being revised to add audit procedures that address testing of payments (13-PPD-013R).
DCAA Issues “Rules of Engagement” Emphasizing Proper Communications with COs and Contractors
(Editor’s Note. The following guidance addresses one of the biggest problems contractors have when dealing with DCAA – audit findings often become identified too late to allow contractors to address them before positions become hardened. Many auditors are reluctant to raise negative points during an audit where they wait to surface their findings either at the end of an audit or in an audit report where contractors are often surprised and even shocked. This guidance should help in surfacing audit issues early so contractors can assemble facts and respond earlier to resolve problems.).
DCAA has issued guidance to “reemphasize” the importance of communicating with both its government clients and contractors being subject to audits. These so-called “rules of engagement” are considered essential to ensure audits are “fair, complete, objective, timely and comply with audit standards.” The guidance identifies several benefits from proper communication with the government and contractors including early identification of audit issues, immediate dealings with potential problems, audits become focused, efficient and timely, audit results are better understood, demand for DCAA support will increase, more audit results will be sustained and professional relationships will be enhanced. The guidance stresses that auditing standards require auditors to communicate with contracting officers and contractors where DCAM 4-100 and 4-300 are referenced and key expectations are identified:
At the beginning of the audit, auditors are to communicate the rationale for the audit procedures they plan to perform Throughout the audit, auditors should communicate potential audit findings to the contractor to ensure the auditor has and understands all relevant facts Throughout the audit, auditors should brief the COs on significant findings. When performing a pricing audit, auditors should communicate with the CO regarding the release of other than factual information. If the CO requires the auditor provide the contractor with audit conclusions and questioned costs auditors should comply with that request. (Editor’s Note. This should open the door to identify questioned costs where now contractors almost never are provided any specifics on what and how many costs are questioned.)
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