Final Indirect Cost Rate Proposals:

Auditor Focus Areas, Trends and Best

Practices

Steven M. MasielloK. Tyler Thomas

February 14, 2017

Agenda

• Regulatory Requirements

• DCAA Audit Environment

• Recent Developments

• Statute of limitations (SOL) issues

• Reprise: Subcontractor costs

• Insufficiency of government disallowance claims

• Audit Scrutiny: Areas of Special DCAA Focus

• Commercial items price transfers between affiliates

• Travel costs

• Hazard pay

• Incentive bonuses

• Best Practices for Final Indirect Cost Rate Proposal Submissions and Facilitating the Audit Process

2

Regulatory Requirements

• FAR § 52.216-7 - Allowable Cost and Payment

• Permits billing of indirect costs based on provisional rates

• Requires submission of final indirect cost pools and allocation bases in

accordance with FAR Subpt. 42.7

• Final Indirect Cost Rate Proposals (FICRPs) must include:

• Summary of indirect expense rates, including pools, bases and calculated

indirect rates

• General and administrative expenses

• Overhead expenses

• Occupancy expenses

• Claimed allocation bases, by element of cost, used to distribute indirect costs

• Facilities capital cost of money factors computation

3

Regulatory Requirements (Cont.)

• FAR Subpt. 42.7

• Sets forth procedures for audits of FICRPs and negotiation of final rates

• Provides penalties for inclusion of expressly unallowable costs

• FAR § 52.215-2 - Audits and Records—Negotiations

• Contractors must maintain records “sufficient to reflect properly all costs

claimed to have been incurred or anticipated to be incurred directly or

indirectly in performance of this contract”

• Records must be retained and available for audit for three years after

final payment under the contract or for any shorter period specified in

Subpt. 4.7

• FAR Subpt. 4.7

• Provides additional record retention requirements

• Requirements measured according to specifications for fiscal year to

which records relate

4

DCAA’s Interpretation of Regulatory

Requirements

• FICRPs checklist

• Generally tracks the FAR requirements

• Provides detail concerning DCAA’s expectations for categories of

information identified in FAR § 52.216-7

• DCAA MRD 16-PPS-003(R) (Feb. 3, 2016): updated independent

reference review (IRR) checklist and procedures

• ICE (Incurred Cost Electronically) Models

• DCAA designed spreadsheets to provide contractors with a standard

FICRP format

• There is no legal requirement to use ICE models

• Failure to use the ICE model may result in a determination of inadequacy

• When not using the ICE model, contractors must demonstrate that its format

is responsive and complete

5

DCAA Cost Audit Manual Reorganization• In September 2016 DCAA revised and reorganized its Contract Audit Manual

• Added a separate Selected Area of Costs Guidebook to address FAR 31.205

cost principles

• Contains 75 Chapters (compared to the 46 substantive cost principles in the FAR)

• Replaces Chapter 7 of DCAA Contract Audit Manual

• Not completed - the following Chapters are still "under construction"

6

• Chapter 3 - Bad Debts

• Chapter 6 - Bonding Costs

• Chapter 10 - Compensation for Personal Services

• Chapter 12 - Contingencies

• Chapter 14 - Contract Termination Costs

• Chapter 15 - Contributions or Donations

• Chapter 18 - Cost of Money

• Chapter 22 - Economic Planning Costs

• Chapter 25 - Entertainment Costs

• Chapter 27 - Fines, Penalties & Mischarging Costs

• Chapter 28 - Gains and Losses on Disposition or

Impairment of Property or Other Capital Assets

• Chapter 29 - General Services Administration

Schedule Contracts

• Chapter 30 - Goodwill

• Chapter 35 - Interest and Other Financial

Costs

• Chapter 38 - Labor Relations Costs

• Chapter 43 - Losses on Other Contracts

• Chapter 46 - Material Costs

• Chapter 50 - Organization Costs

• Chapter 51 - Other Business Expenses

• Chapter 55 - Plan Reconversion Costs

• Chapter 56 - Post Retirement Benefits

• Chapter 57 - Pre-contract Costs

• Chapter 60 - Recruitment Costs

• Chapter 67 - Special Tooling and Special Test

Equipment

DCAA Audit Environment

• DCAA is only 18 months behind on its cost audits and can now begin

assisting non-DoD agencies with audits (MRD No. 16-PPD-008(R)

Sept. 30, 2016))

• DCAA focus continues to be on FICRPs and CAS compliance audits

• DCAA audits are not admissions on behalf of the government

• BAE Sys. S.F. Ship Repair, ASBCA No. 58809, 16-1 BCA ¶ 36,266

• Government ordered a change near the end of performance and DCAA’s audit did not

question any of the claimed costs for this change

• “[T]he DCAA audit does not constitute an admission on the part of the government but

is only one piece of evidence in determining damages”

• Tech. Sys., Inc., ASBCA No. 59577, 2017 WL 372985 (Jan. 12, 2017)

• Government's failure to challenge costs in prior audits does not bar the government

from challenging such costs in the future, instead such a waiver requires an

unequivocal statement from the government regarding allowability

7

Recent Developments: DCAA Audit Issues

• SOL

• Contracting Officer ("CO") must assert claim through final decision

within six years of claim accrual (41 U.S.C. § 7103)

• Claim accrual is the date when the government knew or should have

known of a claim (FAR § 33.201)

• Previously, the standard was government knowledge (actual or

constructive)

• CO knowledge not required (Raytheon Missile Sys., ASBCA No. 58011,

13 BCA ¶ 35,241)

• DCAA knowledge is government knowledge (id.)

• Submission of FICRPs to DCAA (not DCAA audit) triggers CDA SOL

(Raytheon Co., ASBCA No. 57576, 13 BCA ¶ 35,209)

8

Recent Developments (cont.)

• Standard sliding toward “actual knowledge” requirement

• Coherent Logix, Inc., ASBCA Nos. 59725, et al., 15-1 BCA ¶ 35,947

• Contractor submitted indirect cost rate proposals including unallowable patent

costs

• Government did not audit or discover patent costs for more than six years

• Nevertheless, the government claimed it had no reason to anticipate that

unallowable costs were included in the proposal and it requested further

support; the Board held that its claims were not barred by the SOL

• Alion Sci. & Tech. Corp., ASBCA No. 58992, 15-1 BCA ¶ 36,168

• Similar facts: government claimed it did not have enough information in the

indirect cost rate proposal and the Board agreed; SOL had not accrued

9

Recent Developments (cont.)

• Direct Costs; SOL Course Correction?

• Sparton Deleon Springs, LLC, ASBCA No. 60416, 2016 WL 7733543

(Dec. 28, 2016)

• Government questioned intra-company costs, after final indirect cost rate

agreements were executed, claiming there was no proof the costs, previously

paid by the government via interim vouchers, were billed or paid in

connection with any government contract

• Government knew or should have known of the costs when it paid such costs

pursuant to interim vouchers

• Delay of the government in auditing the paid interim vouchers did not

suspend the accrual of the claim

• SOL "claim accrual" authority remains convoluted with uncertain

boundaries

10

Recent Developments (cont.)

• Subcontractor Costs; Lockheed Martin Integrated Sys., Inc.,

ASBCA, Nos. 59508, 59509, 2016 WL 7655944 (Dec. 20, 2016)

• DCAA questioned a range of claimed subcontractor costs, claiming

those costs had not been backed by appropriate documentation

• No duty under FAR Parts 42 or 44 for a prime contractor to cause its

subcontractors to submit FICRPs directly to the prime contractor for

audit and affirmatively request audits from DCAA if the subcontractors

refuse

• Duty is reserved to DCAA and other cognizant audit agencies by FAR 42.201

11

Recent Developments (cont.)

• Insufficiency of government disallowance claims

• LMIS decision (previous slide):

• Board held the government failed to state a claim for breach of contract

because the allegations were conclusory, were based upon terms not

contained in the contracts, and were based upon the improper interpretation

of FAR clauses

• Exelis, Inc., ASBCA No. 60131, 16-1 B.C.A. ¶ 36485

• Contractor classified a building lease as an operating lease

• Government claimed it should have been classified as a capital lease and

alleged the contractor's classification was noncompliant with CAS 404

• Board held the government failed to state a claim that the contractor was

noncompliant with CAS 404 because CAS 404, by its plain language, applies

only to tangible capital assets and leases are intangible assets

12

Recent Developments (cont.)

• DCAA/DCMA Use of Decrements

• DCAA/DCMA continue to apply decrements to recover alleged

unsupported or unallowable costs

• Decrements appear loosely based upon sampling results or previous audit

findings

• Indirect costs; sampling issues

• Problems with sampling methodology

• Costs included in universe sampled do not share similar characteristics

• Sampled items generate inappropriate error rates based upon judgmental

application of criteria

13

Audit Scrutiny: Expressly Unallowable Costs

• DCAA emphasis on contractor inclusion of “expressly unallowable

costs”

• Contractors may be subject to penalties for including expressly

unallowable costs in FICRPs (see FAR § 42.709)

• Raytheon Co., ASBCA No. 57576, 15-1 BCA ¶ 36,043

• Bonus and incentive compensation for employees participating in expressly

unallowable activities are expressly unallowable under FAR § 31.205-47

• Directly contrary to recent DCAA audit alerts

• DCAA Memorandum for Regional Directors, “Audit Alert on Identifying

Expressly Unallowable Costs” (14-PAC-022(R)) (Jan. 7, 2015)

• Board states standard but applies legal interpretation of regulations to find the

costs were expressly unallowable without regard for whether the contractor's

inclusion of the costs as allowable was not reasonable under any

circumstance

14

Audit Scrutiny: Incentive Bonuses

• FAR 31.205-6(f):

• Incentive Bonuses are allowable when -

• Paid or accrued under an agreement or plan created prior to the rendering of

the services; and

• Basis of the award is supported

• DCAA focusing on whether executives are incentivized to control

costs

• Historically, DCAA questioned whether the basis of the award was

supported

• Recently, DCAA has shifted to questioning whether such costs are

reasonable

• Assertion that a prudent business person conducting a competitive

business would incentivize officers to control costs

• Effect: DCAA is questioning costs in audits in an attempt to require an

affirmative showing of allowability of incentive bonuses

15

Audit Scrutiny: Hazard Pay

• DCAA focusing on hazard pay uplifts

• Questioning amounts in excess of Department of State danger pay

allowance rates

• Rate for Afghanistan: 35%

• Issues:

• No cost principle

• Regulated by reasonableness evaluation

• In general, contractor employees are not afforded the same protections

as Department of State employees

• Inconsistent with criteria in DCAA Selected Area of Costs Guidebook

16

Audit Scrutiny: Commercial Item Transfers

• Transfers of Commercial Items Between Affiliates

• FAR 31.205-26(e) - Material Costs

• Materials sold or transferred between affiliates generally must be

transferred on the basis of costs

• May be transferred on the basis of price when:

• It is the established practice of the transferring organization to price

interorganizational transfers at other than cost for commercial work

of the contractor; and

• The item qualifies for exemption under 15.403-1(b) and the CO has

not determined the price to be unreasonable

• Permits the transfer of a commercial items between affiliates at

price

17

Audit Scrutiny: Commercial Item Transfers

• Auditors question commercial item transfers between affiliates

measured at price unless the CO has made an affirmative

determination that the item is a commercial item and the price is

reasonable

• Issues • Rule does not require CO affirmation that the item is a commercial item

• Hesitancy of COs in making commercial item determinations ("CID")

• Continues the difficulty contractors face related to commercial item

acquisitions

18

Audit Scrutiny: Commercial Item Transfers

• DoD proposed rule requires contracting officers to conduct market

research in order to make price reasonableness determinations

(81 Fed. Reg. 53,101 (Aug. 2016))

• Market research shall be used to inform price reasonableness

determinations• Market research is defined as "review of existing systems, subsystems,

capabilities, and technologies that are available or could be made available to

meet the needs of DoD in whole or in part"

• Supplies and services provided by nontraditional defense contractors

may be treated as commercial items if intended to enhance defense

innovation and create incentives for cutting-edge firms to do business

with DoD

• COs may still request "information that is sufficient to determine the

reasonableness of price"

19

Audit Scrutiny: Commercial Item Transfers

• FY 2016 NDAA

• Secretary of Defense required to:

• Establish and maintain a centralized capability with the necessary expertise

and resources to oversee the making of CIDs for the purpose of

procurements by DoD

• Provide public access to DoD CIDs

• Establish presumption that prior CIDs are sufficient for subsequent

procurements

• Ensure that CO decisions to disregard prior CIDs be reviewed by the head of

the applicable contracting agency

• Provide report to Congress containing all DoD specific requirements

applicable to commercial item procurements, with explanations and

justifications

20

Audit Scrutiny: Commercial Item Transfers

• DCMA has established its Commercial Item Centers of Excellence

• COs should adopt the practice of recognizing prior CIDs

• If a CO believes a prior CID was without foundation, or was made in

error, they should engage both their chain of command and the DCMA

Commercial Item Center of Excellence before making a determination

that deviates from prior decisions

• The Director of Defense Pricing and the DCMA’s Cost & Pricing Center

Director are supposed to work with interested companies to define,

through the use of advance agreements, the types of information

needed to support CIDs

• Thus far, lack of timely action by DCMA to make CIDs

• In fact, DCMA appears hesitant to make CIDs

• Creates issues for allowability of commercial item material transfers between

affiliates at price based upon DCAA's current stance

• May result in DCAA recommending decrements

21

Audit Scrutiny: Fly America Act

• Compliance with Travel Cost Regulations• Directly addressed by:

• FAR 31.205-46, Travel Costs

• FAR 47.4, 52.247-63 - Fly America Act

• Implicate:• General rules on allowability

• FAR 31.205-14, Entertainment Costs

• FAR 31.205-34, Recruitment Costs

• FAR 31.205-35, Relocation Costs

• FAR 31.205-43, Trade, Business, Technical and

Professional Activity Costs

• FAR 31.205-51, Alcohol Costs

22

Audit Scrutiny: Fly America Act• Basics

• FAR Part 47.4 implements the Fly America Act

• Requires FAR 52.247-63 be inserted into contracts where government-financed international air travel is possible

• Requires U.S. Government-financed international air travel be provided by U.S.-flag carrier, if “available”

• Contractors required to use U.S.-flag carrier if “available,” even though a foreign carrier may

offer lower fares or more convenient travel

• If an origin or interchange point is not served by a U.S.-flag air carrier, foreign-flag air carrier service shall be used only to the nearest interchange point

• Only applies to direct contract travel

• Exceptions

• Air Transportation Agreements - may use a foreign-flag carrier that provides transportation under an air transportation agreement with the U.S.

• Code-sharing - foreign carriers operating under a code sharing arrangement with a U.S. flag carrier are treated as U.S. carriers

• Disallowance of expenditures

• Must attach memorandum adequately explaining why U.S.-flag carrier service was not available or why it was necessary to use a foreign-flag carrier

• Focus on which airline within code-sharing arrangement the flight was booked

23

Best Practices for FICRPs Documentation,

Collection and Submission• Use advanced agreements where possible

• Document and archive the source of foundational general ledger

data

• Development and Submission of FICRPs

• Start with a clean model

• Use the FICRP adequacy checklist as a guide

• Follow your disclosed or established cost accounting practices

• Integrate your model schedules through linking

• Strategically plan your analysis to scrub unallowable costs and use

auditable methods of cost segregation

• Use explanatory notes

• Create a support binder

• Keep an exact copy of what is provided to the government

• Protect your proprietary data

• Document and archive additional information provided24

Best Practices for Facilitating the Audit Process

• During an audit • If an initiating conference is not scheduled, request one prior to

providing data

• Establish a single point of contact to ensure consistency in

communication with the auditors

• Keep auditors apprised of contractor progress

• Ensure that all requests are received in writing and appropriately

justified

• Establish the timeline needed to satisfy requests

• Keep track of everything provided to the government in support of an

audit

• After an audit • If a closing conference is not scheduled, request one

• Determine whether or not to reply to auditor findings communicated in

the closing conference or in the draft audit report

• Request a copy of the audit report from your CO/ACO

25

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