(Editor’s Note. The Defense Contract Audit Agency Manual (DCAM) is a two volume guide that is revised twice a year. Though it is not authoritative, the interpretations of cost and pricing regulations offered to its auditors provide useful insights into how DCAA, other audit agencies and prime contractors reviewing subcontractors will interpret the rules we all have to live with. We frequently report on significant guidance issued during the year in the GCA REPORT and the twice yearly updates incorporate both these changes as well as other changes DCAA chooses to make. In this article, we will report on the most significant changes made to both the January 2004 (our copy came late) and the July 2004 editions.)

January 2004

Chapter 5-200. An entire new section, 5-200 Section 2 has been added on revised guidance on preaward surveys at major and non-major contractors and new guidance on post contract award accounting:Preaward Survey. A preaward survey of a prospective contractor’s accounting system is an examination, as opposed to an in-depth evaluation, of the accounting system at either a major or non-major contractor before contract award. It is usually made at the request of the CO to determine the acceptability of a contractor’s accounting system for accumulating costs under a prospective government contract. The scope of audit is limited to obtaining a sufficient understanding of the accounting system to complete Form 1408, "Preaward Survey of Prospective Contractor Accounting System." (Editor’s Note. See our articles in the May-June 2004 and the March-April 2003 issues of the GCA REPORT where we discuss the basic elements of this form and encourage contractors to make sure their practices would be considered adequate before auditors conduct a preaward survey.) Auditors are told to determine acceptability of the system and to determine if the system is (1) in operation (2) set up, but not in operation (3) anticipated or (4) nonexistent.

In addition to the specific elements of Form 1408, the general guidance states specific emphasis should be placed on the following: (1) ability of the accounting system to provide specific cost information required under the anticipated contract and on inquiries that might occur (2) when appropriate, the system should be able to generate projections of costs to complete the contract (3) equity and consistency of direct charging practices as it is intended to be applied to the proposed contract (4) for cost type contracts, whether reimbursement of indirect costs will be made on an actual or negotiated basis (e.g. ceiling rates) (5) comments on any particular or unusual cost elements that should be the subject of an advance agreement or special contract clause and (6) arrangement for a follow-up post contract award review. If there is an active government contract, the auditor should discuss with the CO whether a post contract award accounting system would be more useful. Also if the CO requests a financial capability assessment that review should be set up as a separate audit.Post Contract Award Accounting System Audit. This is an examination of the accounting system at nonmajor contractors after contract award and like preaward surveys is intended to determine if the contractor’s accounting system is adequate for accumulating and billing on government contracts. It is usually performed at the request of the CO when (1) a follow-up to the preaward survey is recommended or (2) a preaward survey was not conducted prior to contract award. Sometimes, auditors will self initiate a post award audit based on "audit risk." Similar steps to the preaward survey are usually conducted but are often more comprehensive (e.g. tracing more costs to source documents such as timesheets, vendor invoices, etc.). Chapter 6-1007, Direct Billing. The guidance has added three explicit criteria for major and non-major contractors to be entitled to direct billing privileges (i.e. submission of vouchers directly to paying offices rather than DCAA). The three criteria are:

1. Have adequate internal controls over its billing system. For majors this determination usually follows a billing system and related internal controls audit while for non-majors, several criteria have been established for an adequate billing system: (a) a determination of an adequate accounting system based on a preaward survey and for billing purposes, demonstrate that billed costs are reconciled to cost records (b) billing rates are established in accordance with FAR 42.704 which basically requires that billed rates are based upon relevant information from current or recent prior audits (c) cumulative costs are accounted for to ensure billed costs do not exceed contracted amounts (d) billing rates are adjusted to reflect actual year-end allowable costs when there are significant differences between billed and actual rates determined from the year ending incurred cost computations and (e) demonstration the contractor briefs its contracts to ensure special contract limitations (e.g. capped indirect rates) are reflected in billings.

2. Submit timely indirect cost proposals in compliance with FAR 52.216-7 which calls for such submittals within the six-month period following expiration of the contractor’s fiscal year. Reasonable extensions may be requested in writing and granted by the contracting officer; auditors do not have the authority to grant such extensions.

3. In accordance with FAR 52.215-7, contractors must submit final vouchers for physically complete cost-type contracts within 120 days (or longer if approved by the CO) after settlement of the final annual indirect cost rates for all years of a physically complete contract.

Chapter 7-1004, Employee relations costs. A new section, 7-1004.8 has been added to provide a formula and an example in how to calculate tax gross-ups on employee relocation reimbursements that the FAR has recently provided as allowable costs. The Tax Gross Up Factor is x /1.0-x where x = employees tax rate. The new section provides an example, assuming a 28 percent tax rate and non-deductive moving expenses of $50,000. The gross up factor is 0.28/(1.0-0.28) = 0.3888888 or $19,444.44. The section explains that simply increasing the employee’s $50,000 payment by the 28 percent rate (i.e. $14,000) does not make the employee whole because the employee must then pay taxes on the additional $14,000 which, in turn, must be paid on all additional taxes paid to the employee.Chapter 11-200, 300 and 400, Earned Value Management (EVM) Reporting, Cost Management Reporting (CPR, C/SSR, CFSR) at non-EVM contractors and Contractor Cost Data reports. The guidance has been extensively revised to reflect recent changes to the DOD 5000 series policy. Since the changes are extensive with limited applicability to our subscribers we will not summarize the changes here but refer the interested reader to the relevant chapters. Chapter 14-907.7, Waivers to Submitting Cost and Pricing Data. The new guidance reminds auditors that an amendment to FAR 15403-1(b)(4) allows the head of a contracting activity (HCA) to waive the requirement for submission of cost of pricing data in exceptional cases. The exceptional case waiver applies when (1) the property or services cannot be obtained under the contract, subcontract or modification without the grant or waiver (2) the price can be determined to be fair and reasonable without submission of certified cost or pricing data and (3) there are demonstrated benefits to granting the waiver. The exceptional waiver provision is in addition to other exceptions to waiving cost and pricing requirements such as adequate price competition, prices set by law or regulation and commercial items.Chapter 14.909, Evaluation of Other Transaction Agreements (OTA). New thresholds have been set for DCAA audit authority for evaluating OTA contracts. For OTAs that provide for over $5 million of government payments (including options) and that are cost type (i.e. payments to contractors are based on amounts generated from contractor’s financial or cost records) either DCAA or an independent public accountant (IPA) may evaluate the costs. If the contractor or subcontractor is already performing a contract subject to the FAR cost principles or cost accounting standards, then DCAA will perform the audit; if not covered, then either DCAA or an IPA may perform the audit if stated in the audit clause of the OTA and DCAA will follow its procedures to rely on the work of others (Chapter 4-1000). The guidance recognizes that the financial management clauses of OTAs state that contractors’ accounting practices must comply with generally accepted accounting principles (GAAP) but then the guidance alerts auditors to the fact that GAAP provides "little guidance" for government contract accounting (e.g. cost allocations) and states auditors should perform "sufficient procedures on the contractor’s cost accounting system to assure themselves the accounting treatment for the OT results in a fair and equitable allocation of costs."

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