(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.)

July 2004

Chapter 2, Auditing Standards. Has been extensively revised to incorporate recent revisions to Generally Accepted Government Auditing Standards (GAGAS) included in the "Yellow Book" published in June 2003. The key revisions include (1) redefining types of audits and adding attestation functions as a separate type of audit (2) providing consistency in field work and reporting requirements and (3) strengthening the standards and clarifying the language.Chapter 4-202, Coordinated Audit Planning. The guidance alludes to the additional requirements imposed on reporting requirements of the Sarbanes-Oxley Act of 2002 (e.g. certification of certain financial and other information, management letters and independent attestation by outside auditors of internal controls) and encourages potential reliance on use of contractors’ audit efforts to lessen the scope of DCAA audit activity.Chapter 5-600, Purchasing System Internal Controls. DCAA’s General Audit Policy has been revised to address DCAA’s role and concerns in Contractor Purchasing System Reviews – usually conducted when a contractor’s non-commercial item sales to the government will exceed $25 million but the threshold can be lower if in the "best interests of the government." DCAA objectives are to be assured the contractors have adequate internal controls of its purchasing system and that it monitors these controls. The guidance calls for DCAA to conduct its own purchasing system review when it believes there is sufficient risk at a contractor but the CPSR is not conducted for some reason.Chapter 7-1403, State and Local Taxes. DCAM has added a new section addressing tax accruals and tax credits and refunds:Tax Accruals. The guidance reminds auditors that contractors sometimes account for taxes differently when estimating taxes due in accordance with local state regulations and in accordance with GAAP. Differences may occur when, for example, losses or revenue may occur under state regulations but not recognizable for GAAP purposes or method of computing depreciation may differ for tax purposes (e.g. accelerated for tax versus straight line for GAAP). Auditors are told to obtain the best possible evidence available to support allowable costs on government contracts where the best evidence is considered to be the amount of the state income or franchise tax paid. Though the contractor may consider some taxes paid to be applicable to future or prior periods, the auditor should not attempt to make this analysis. Income tax accruals designed to estimate additional taxes to be paid that are a result of a tax audit are considered unallowable contingencies while the actual amount paid related to such a tax audit is allowable.Tax Credits and Refunds. Many states follow the IRS procedures that recognize net operating loss carry backs where an operating loss can be carried back for 3 years or forward for 5 years. The DCAM is primarily interested in the carry back where the contractor receives a refund for taxes previously paid. Following the results of Hercules Inc. v. United States case (292 F.3d 1378, Fed. Cir. 2002), the method of making sure the government receives it fair share of the refund is based on the following methodology: the refund owed the government is to be based on the "same ratio as the tax payment was originally reimbursed by the government." So if the contractor receives a refund the auditor should determine the government share of the refund based upon the government reimbursement of that expense in the year the cost was originally incurred. The DCAM provides an example of a $500,000 refund paid in 2002 of a $1,000,000 state income tax expense included in the 2000 G&A pool. The government’s participation in the G&A allocation base was 65% in 2000 and 55% in 2002. The government’s share of the refund is $325,000 ($500,000 X 65%).

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