New to Cost Reimbursement Contracts? Meet Your New Friends

Breakout Session #: G07 Brent Calhoon Partner Baker Tilly Shingai Mavengere Director, Government Accounting UnitedHealthcare Military & Veterans

Date: Wednesday, July 27

Time: 9:45am-11:00am

INTRODUCTIONS

Brent Calhoon • Brent joined Baker Tilly’s Government Contract Advisory practice in

2009. He has more than 20 years of experience providing consulting, accounting, auditing, and investigative services to government contractors in connection with complex cost accounting, contract pricing, and regulatory compliance matters. He advises contractors on business processes and functions critical to managing compliance and financial risks unique to government contractors.

Shingai Mavengere • Shingai Mavengere is the Director of Government Accounting for

UnitedHealthcare Military and Veterans. His portfolio includes a wide range of matters such as analyzing compliance with Government procurement regulations, including the Federal Acquisition Regulation (FAR), Cost Accounting Standards (CAS), agency supplements to the FAR and other federal government procurement regulations and guidance. Shingai also is responsible for financial reporting, cost accounting and other regulatory compliance.

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Contents

• Introductions

• Overview: Government Contract Risk Factors

• Contract Value / Volume vs. Risk Continuum

• Key Compliance Requirements and Oversight Risks

• Organizational and Operational Considerations

• The Watchdogs

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Understanding your contract risk profile • Although many factors can influence the nature and extent of

government contract oversight, five have the greatest impact.

• They are interdependent on each other, and therefore must be considered individually and in the aggregate.

• Contractor Size • Commerciality • Contract Type • Contract Size • Competition/Negotiation

• Successful contractors use these factors as a tool to understand,

anticipate, manage, and mitigate government contract compliance risk.

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Risk Factor #1: Contractor Size

• Contract requirements and exemptions vary for smaller and larger firms, as well as whether a firm is a prime contractor or a subcontractor.

• Small businesses (meeting the Small business Administration’s size standards) are exempt from some of the Government’s most onerous regulations.

• As contractors grow, they can expect more regulatory burdens and more direct government oversight

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Risk Factor #2: Product/Service Commerciality

• Commercial item means any item that is customarily used by the general public or by non-governmental entities for purposes other than governmental purposes and

o Has been sold, leased, or licensed to the general public; or o Has been offered for sale, lease or license to the general public

• Modifications are acceptable if they are customarily available in the

commercial market or do not significantly alter the function, essential physical characteristics, or purpose of an item, component, or process

• Services are “commercial items” if based on established market prices for specific tasks performed or outcomes to be achieved and under standard commercial terms and conditions

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Risk Factor #2: Product/Service Commerciality (cont’d)

• The government’s rules require it to acquire commercial products and services at reasonable prices established in the commercial marketplace, making a contractor’s production costs irrelevant.

• Accordingly, commercial item contracts are exempt from many onerous regulations and generally insulated from many (but not all) government audit and oversight activities.

• Contractors selling commercial and non-commercial items on a single contract must persuasively demonstrate commercial pricing to rebuff the Government’s ever-present desire to audit production costs (and deny reasonable/necessary commercial margins).

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Risk Factor #3: Contract Type

• Contract type is the nucleus of government contract risk.

• It is the instrument by which performance and cost risks are allocated between the parties.

• Contractors willing to accept greater performance and cost risk are rewarded with less burdensome requirements.

• As the government accepts greater performance and cost risk, contractors must accept heavier regulatory compliance and oversight burdens.

• Contractors new to cost reimbursable contracts must enter with eyes wide open and with considerable organizational preparedness for the oversight that will ultimately follow.

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Risk Factor #3: Contract Type (cont’d)

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Firm-Fixed Time & Materials/ Cost Price Labor Hour Reimbursable

Performance risks are allocated to Contractor

Labor price per unit is fixed and labor cost risk shifted to

Contractor; Government retains risk for volume and

incidental "materials"

Performance risks are allocated to Government

Cost Contractor High Low Risk Government Low High

Technical Contractor High Low Risk Government Low High

Compliance Contractor Low High Risk

Oversight Government Low High Risk

Contract Type Continuum

Risk Factor #4: Contract Size

• Contracts below the simplified acquisition threshold ($150,000) generally carry the fewest compliance requirements.

• Additional regulatory burdens accumulate as contract value grows beyond $750,000.

• Generally, a large volume of low dollar contracts will attract less direct government oversight than a small volume of large dollar contracts.

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Risk Factor #5: Competition & Negotiation

• The competitive spectrum ranges from sealed bidding to sole-source negotiation.

• Combined with the four factors above, competitively awarded fixed price contracts for commercial items offered by small businesses below $150,000 carry the least compliance and oversight risk.

• The opposite carries the most risk.

• In the absence of commercial market information and competitive forces, the government deploys its arsenal of regulations to prescribe nearly every contractor business activity.

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Cost-Type Contract Profile

• Cost reimbursable, CAS-covered contracts carry the most challenging compliance requirements o These contracts allocate all cost and performance risk to the

Government o In return for accepting this risk on behalf the contractor, the

Government allocates a wide variety of compliance requirements to the contractor. This is because the Government does not trust commercial companies to perform these contracts efficiently or effectively without specific contractual requirements for nearly every accounting and business process

o Unlike the commercial market, the Government has significant audit rights and a robust oversight and enforcement regime

• To be successful, Management teams must have a general appreciation of the requirements and what it takes to comply

• Failing to invest in compliance creates significant risks today that will go unquantified until many years later

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Contract Value/Volume vs. Risk Continuum

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Active Government Oversight &

False Claims Act Allegations

• Cost Accounting Standards (CAS)

• CAS Administration

• Contractor Business System Clause

• Cost Accounting (FAR Part 31)

• Timekeeping and Labor

Accounting

• Annual Cost Reporting

• Business System Criteria

KEY COMPLIANCE REQUIREMENTS AND OVERSIGHT RISKS

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Key Compliance requirements and Oversight Risks

Cost Accounting (FAR Part 31 Cost Principles) – • Cost Allowability –

o Specific types of cost that the Government will or won’t reimburse

o Complex rules on pricing of inter-organizational transfers o Compliance requires awareness, discipline, and consistency

throughout organization o Noncompliance may carry penalties and interest o Also governed by applicable agency FAR supplements and

unique contract terms • Cost Allocability –

o Requires logical and equitable methods o Must consistently charge costs direct vs. indirect

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Key Compliance requirements and Oversight Risks (cont’d)

Timekeeping and Labor Accounting – • Labor is generally the single largest cost charged

to contracts • Increased management oversight is necessary to

drive employee timekeeping discipline • Inconsistent labor charging across customers and

contract types (including frequent uncorrected mistakes) can become basis for false claim allegation

• Unrecorded uncompensated overtime increases risk of inequitable labor cost allocations and accounting system “significant deficiency”

• Labor accounting impacts the integrity of both the accounting and cost estimating systems

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Key Compliance Requirements and Oversight Risks (cont’d) Annual Cost Reporting (FAR 52.216-7, Allowable Cost and Payment Clause) –

• Provisional/Forward Pricing Indirect Cost Rate Proposals – o Used for interim billing/pricing of indirect costs when actual

costs not yet known o Subject to true-up after each cost accounting period (usually

fiscal year end) for cost type contracts o Established by Contracting Officer or Auditor after evaluation

of indirect rate proposal • Final Indirect Cost Rate Proposal (a.k.a. Incurred Cost

Proposal) – o Establishes final indirect cost rates; submission due no later

than six months after year end o Considered a “claim” and must exclude unallowable costs o Subject to stringent adequacy review and audit

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Key Compliance Requirements and Oversight Risks (cont’d)

Business System Criteria (DoD Contracts Only, but DOE rules coming soon) –

• Accounting – 18 criteria (internal control requirements) covering indirect and other direct costs; compensation; billing; labor accounting; and general information technology

• Cost Estimating – 17 criteria covering budgeting, planning, cost estimating methods & techniques, bases of estimates, disclosure of factual information (i.e., cost or pricing data), etc.

• Purchasing – 24 criteria covering nearly every aspect of purchasing, subcontracting, and intercompany work orders

• Government Property, Earned Value Management System (EVMS), and Material Management Accounting System (MMAS) are less common among service contractors

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Key Compliance Requirements and Oversight Risks (cont’d) Cost Accounting Standards (48 CFR 9904) – Specific requirements for measuring, assigning, and allocating costs to contracts

• Modified Coverage – Four standards apply (401, 402, 405, 406) and a CASB Disclosure Statement may be required.

o Applies when a negotiated contract initial award value exceeds $7.5 million and does not meet the requirements for full CAS coverage

• Full Coverage – All 19 standards apply and a CASB Disclosure Statement is required. Full coverage applies when:

o Single contract award ≥ $50 million; or o Multiple CAS-covered contract awards in prior fiscal year ≥ $50 million in aggregate

• Standards generally require: o Cost accounting consistency o Cost allocations using proscribed principles o Prescribed rules to accounting for specific cost types

• CAS Administration (much more complex than complying with 19 standards) o CAS applicability (when it applies, and to what extent) o Disclosure Statements (must be current, accurate, and complete) o Notifying, Measuring, and Negotiating Cost Accounting Practice Changes o Resolving CAS non-compliances o Subcontractor CAS administration

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DFARS Contractor Business System Clause (DFARS 252.242-7005) – Applies to CAS-covered DoD contracts when any of the individual system criteria apply (See Business System Criteria Section) • Significant deficiencies with any system criteria will lead to

system disapproval and billing withholds of 5% to 10% • System disapprovals create a significant competitive

disadvantage

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Key Compliance Requirements and Oversight Risks (cont’d)

Active Government Oversight – • Defense Contract Audit Agency (or other auditors) – pre/post contract

award audits; incurred cost audits; billing audits, business system audits; labor audits/floor checks; Disclosure Statement audits; CAS compliance audits; etc.

• Defense Contract Management Agency (or other admin agencies) – active contract administration, three business systems (purchasing, property, & EVMS)

• Inspectors General/Department of Justice (False Claims) • Your own employees (lucrative whistleblower rewards) • Government watchdog groups (i.e., POGO) and the mainstream media • Congress increasingly politicizing the government procurement process

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Key Compliance Requirements and Oversight Risks (cont’d)

False Claims Act (FCA) – • Establishes civil and criminal remedies for the Government if a

contractor “knowingly presents or causes to be presented, a false or fraudulent claim for payment or approval”

• Allegations can arise from many directions: employees, government employees (including auditors and contracting officers), subcontractors, higher tier contractors, or private citizens

• Mandatory Disclosure Rule – contractors are required to “timely” disclose to the Government “credible evidence” of criminal wrongdoing – contractors must have robust procedures to discover disclosable events

• Up to treble damages, plus civil penalties of $5,500 to $11,000 per false claim

• May cause significant reputational damage including suspension/debarment

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Key Compliance Requirements and Oversight Risks (cont’d)

KEY ORGANIZATIONAL AND OPERATIONAL CONSIDERATIONS

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• To effectively and profitability conduct business in an environment flush with additional requirements and oversight risks, organizational and operational considerations in the following areas must be taken into account:

o Home Office o Support Functions o Government business unit / operations

• Compliance requirements previously described will directly or indirectly

affect (or be affected by) each consideration listed in this section

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Organizational and Operational Considerations

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Organizational and Operational Considerations (cont’d)

HOME OFFICE

Business strategy

Financial reporting

Corporate compliance/ethics

Executive Management

SOX compliance

Financial performance metrics, measurement, management

Employee performance and development expectations

Risk management

Conflict identification and mitigation

Customer satisfaction

Public and government relations

Employee compensation and benefits

Delegation of authority and responsibility

Organizational structure – legal, management, accounting

Business development and investment planning

Business development resource alignment and oversight

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Organizational and Operational Considerations (cont’d)

SUPPORT FUNCTIONS

Policies, processes, and procedures (internal controls)

Information systems and data capture

Data quality (accuracy, timeliness, consistency, completeness)

Routine/non-routine activities

Administrative or clerical activities vs. analytical activities requiring professional judgment

Accounting

Pricing/Estimating

Benefits admin, employee relations, recruiting

Legal

IT Support & Security

Procurement

Contracts

Travel

Training

Employee Timekeeping

Contract compliance, audit support

IN THE AREAS OF:

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GOVERNMENT BUSINESS UNIT/

OPERATIONS

Tactical strategy and policy execution

Opportunity evaluation

Bid and proposal preparation

Project and program management

Resource optimization and resource management

Customer relationship management

Inter-organizational Support

Business partner due diligence and relationship management (such JV

partners, teaming partners, and subcontractors)

Employee performance management

Technical disciplines and expertise

Risk (legal, compliance, performance) identification, communication,

mitigation

Government property management

Government compliance awareness and discipline

Budgeting and financial management

Markets, customers, and contracts (type and size)

Organizational and Operational Considerations (cont’d)

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Government Contract Compliance Framework

Questions, Comments, Banter?

Shingai Mavengere, Director UnitedHealthcare Military & Veterans

Government Accounting

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Brent Calhoon, Partner Baker Tilly

Government Contractor Advisory Services