GOVERNMENT CONTRACTING MICROSOFT DYNAMICS AX AND

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1 GOVERNMENT CONTRACTING AND MICROSOFT DYNAMICS AX White paper on Government Contracting requirements and considerations in planning for a Dynamics AX implementation. 1 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

2 Microsoft Preface To deliver products and services to the United States federal government, particularly under cost-plus contracts, providers need to ensure compliance with all applicable regulatory and administrative requirements. However, compliance can be difficult to plan and achieve because requirements vary with the portfolio of work that a contractor does for the government, as well as the way in which that provider organizes and runs its business. Larger companies and professional services firms that do business with both private and public sector organizations, arguably face the most complex challenge because they typically have to form separate legal entities to manage government work but also need flexibility to borrow and loan resources across private and public sector projects. Manufacturers of machinery that also install and service their products face challenges with intercompany transfer of lots of components to support field service operations. Common scenarios like these can often lead to indirect cost accounting headaches for project managers, finance teams, and compliance officers. Unfortunately, highly specialized enterprise resource planning (ERP) software in use by government contracting business units today typically enforce each publisher s prescribed approach to compliance, without leaving enough room for industry-specific and company-specific variations in practice and procedure. In an age of change marked by budget sequestration, proliferation of public-private partnerships, and ever more grueling competition, government contractors require higher levels of business agility. They need to be able to leverage experience and assets widely, adjust or adapt operational processes on the fly, and innovate with new business models. In short, they need both compliance and agility. To strike the right balance, business and finance leaders need a clear and factual understanding of the range of compliance requirements they must address based on respective business profiles and both current and target contract portfolios. They then need to be able to compare the compliance and agility benefits and tradeoffs of systems of compliance that use different ERP offerings available in the market. Microsoft is committed to helping customers meet their business objectives by making the right investments in and getting the most out of our technologies. To this end, we engaged experts in government contracting from the respected accounting firm of McGladrey to develop the white paper that follows. The document includes both a guide to regulatory compliance and a gap-fit assessment of Microsoft Dynamics AX, our multi-industry ERP offering for larger businesses serving both public and private sector customers. We hope this material will help foster an open, transparent and factbased discussion of compliance requirements, related software capability needs, and solution selection and implementation considerations. 2 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

3 McGladrey Foreword McGladrey is committed to helping customers that are federal contractors achieve compliance with regulations applicable to such organizations, while controlling their costs and without compromising efficiencies, by best aligning IT elements, processes and people. With this goal in mind, we believe this material will advance the knowledge and understanding of the interdependencies of the major elements of an organization s business systems when it relates to compliance and thus help make the right decisions when it comes to this important mix of business assets, and more importantly, compliance. While there is widespread agreement that compliance is paramount, especially when it comes to applicable government regulations, the path to achieving compliance is not always well understood. And there are multiple reasons for that regulations vary from contract to contract; contractors processes and people skills are different and they may at times operate in very different manners. Further, as it will be demonstrated, regulations apply to a wide area of business processes and the contractors are responsible for compliance of multiple business systems, which the regulator (US Federal Government) defines as system or systems for accounting methods, procedures, and controls established to gather, record, classify, analyze, summarize, interpret, and present accurate and timely financial data. Given these circumstances, understanding how an organization can approach compliance via available options for software, processes and controls is obviously a major input in making the right decisions. Using the right IT elements, processes and skilled workforce can make a substantial difference not only in deploying and maintaining adequate business systems, but more importantly, in doing so efficiently and while creating the base for achieving or maintaining competitive advantage. Ultimately, our goal is to help demystify the requirements related to contracting with agencies and show that when an organization is equipped with knowledge about these regulations, it has a wider variety of options available to it and does not have to choose between compliance and efficiency. 3 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

4 Contents Government contractor s guide to regulatory compliance and requirements for an Enterprise Resource Planning solution 5 1 Introduction Can an out-of-the-box Enterprise Resource Planning (ERP) system be compliant? 5 2 Applicable regulatory documents and references Federal Acquisition Regulation (FAR) Defense Federal Acquisition Regulation Supplement (DFARS) Cost Accounting Standards (CAS) Other Regulations or Agency Documents that Apply What are the potential consequences of non-compliance? 10 3 High level review of requirements and capabilities to enable compliance Accounting System Other contractor systems Cost Accounting Standards Other Guidance 19 4 Acceptable business systems and why an ERP cannot cover all requirements It is virtually impossible at present to achieve 100% compliance with any ERP software Even contractors that have ERP software commonly thought of as compliant still experience determinations of inadequacy 22 Baseline gap-fit assessment of Microsoft Dynamics AX as an ERP for government contracting 23 5 Gaps that require customization or independent software vendor (ISV) extension Accounting system Other contractor systems functionalities User Expectations (de-facto industry standards) 27 6 Considerations in selection of an ERP for government contracting 29 7 The case for multi-industry ERP in government contracting 30 4 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

5 Government contractor s guide to regulatory compliance and requirements for an Enterprise Resource Planning solution 1 Introduction Doing business with the United States federal government is complex and guided by its own set of regulations and standards across a multitude of scenarios. The documentation, compliance and audit requirements for a government contractor are significantly more intricate than that of a traditional commercial company. As a result, government contractors are required to dedicate more time to managing the unique challenges and complexities associated with government procurement. Staying on top of these ever-evolving regulations and remaining compliant can be daunting. While an Enterprise Resource Planning (ERP) system is the key to managing compliance, a software system alone is not sufficient. A comprehensive system involving technology, people and processes that supports operations and regulatory challenges is absolutely necessary. This white paper will examine the full spectrum of requirements that a federal contractor must consider when selecting an ERP business solution. 1.1 Can an out-of-the-box Enterprise Resource Planning (ERP) system be compliant? Defining ERP There are myriad definitions of ERP. One of them from PC Magazine defines it as an integrated information system that serves all departments within an enterprise. Evolving out of the manufacturing industry, ERP implies the use of packaged software rather than proprietary software written by or for one customer. ERP modules may interface with an organization's own software with varying degrees of effort, and, depending on the software, ERP modules may be alterable via the vendor's proprietary tools, as well as proprietary or standard programming languages. An ERP system can include software for manufacturing, order entry, accounts receivable and payable, general ledger, purchasing, warehousing, transportation and human resources. 1 Important conclusions can be made from analyzing the above definition. For instance, the system must span across the enterprise. It must encompass all or the majority of the systems a company has implemented. In addition, in most cases, a number of processes, policies and procedures are needed to identify data entry responsibility, how data integrity is maintained, and how controls are established and operated to ensure accuracy, reliability, timeliness, completeness and availability of the data Beyond the software System, as commonly defined in regulatory documents, consists of software, processes, policies and controls. This is supported by the existing regulatory documents applicable to government Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

6 contracting. Most pronounced in this regard are definitions in the Defense Federal Acquisition Regulation Supplement (DFARS): Definition of system, (Department of Defense [DoD] acquisition regulations, Accounting System Administration) is defined as an accounting system or systems for accounting methods, procedures, and controls established to gather, record, classify, analyze, summarize, interpret, and present accurate and timely financial data for reporting in compliance with applicable laws, regulations, and management decisions, and may include subsystems for specific areas such as indirect and other direct costs, compensation, billing, labor, and general information technology. Therefore a system is the software plus the people that operate it and the processes that have been employed to operate the software. This is not in line with the commonly encountered suggestion that software alone can secure compliance. As we shall further discuss and establish, the applicable requirements are rooted in a large number of regulatory documents. A common misunderstanding of the applicable requirements relates to the role of the Defense Contract Audit Agency (DCAA), which reviews (such reviews are often referred to as audits) contractors systems, inclusive of the software, people and processes. DCAA provides guidance to its auditors and the contractor community and offers audit programs that are helpful in establishing an understanding of compliance requirements, but the agency does not review and/or certify the compliance of any vendor software. Despite the above points, contractors often hear representations about accounting software that is compliant with or otherwise meets either DCAA or other government contractor requirements. Thus, the importance of just the software product tends to be overemphasized and the systemic (i.e. software, policies, procedures, controls) nature of compliance requirements is overlooked. These sales and marketing tactics implicitly suggest that software products, other than one specifically designed for the purpose, cannot be used by government contractors. Yet, in practice, contractors use a wide variety of software depending on their size and industry, and have been able to configure or customize a variety of software products to meet their needs and the requirements applicable to government contracts Compliant system Then, what is a compliant system? As we discussed already, a system is a combination of policies, procedures, controls and supportive software. Thus, in short, a compliant system is a combination of policies, procedures, controls and supportive software and not an off-the-shelf software product. This applies equally to accounting and other systems employed by government contractors. It is important to make this distinction in order to demonstrate the notion behind the use of the word compliant hereafter. 2 Applicable regulatory documents and references Regulatory documents distinguish between several different business systems, all of which are often collectively referred to as an ERP system. In order to describe those systems and requirements, we need first to identify the regulatory documents and the types of business systems 6 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

7 for which they provide requirements. In subsequent sections, we ll provide a more detailed account for the requirements and how software, people or processes are designed (software), organized (people), and defined (processes and controls) in order to meet those requirements. 2.1 Federal Acquisition Regulation (FAR) The FAR provides uniform policies and procedures for U.S. federal government executive agency procurement of supplies or services via contract using appropriated funds. The FAR contains regulation surrounding requirements for various elements of an ERP as explored below Accounting system FAR requires A cost-reimbursement contract may be used only when the contractor s accounting system is adequate for determining costs applicable to the contract. FAR (e) states that a contractor must have the necessary accounting and operational controls. FAR (b)(2) requires that a contracting office must obtain from auditors proof of adequacy of prospective contractors accounting systems and [the] systems suitability for use in administering the proposed type of contract. FAR (a) determines the required review or survey of a contractor s accounting system related to cost reimbursable contracts - SF 1408, Pre-award Survey of Prospective Contractor Accounting System Other contractor systems Certain other contractor business systems are required to be complaint either for specific types of contracts or by certain agencies. An example of type of contract would be a major acquisition (i.e., over specific dollar amount). While an example of by agency would be acquisition by the Department of Defense (DoD) under the specific for this agency regulatory supplement see further discussion on DoD specific regulations. Another example are the Cost Accounting Standards (CAS) that regulate contracts over certain size. FAR have specific requirements for other contractor systems, namely their cost estimating system, earned value management system (EVMS), property management system and purchasing system. Estimating system EVMS FAR (a) states, Using an acceptable estimating system for proposal preparation benefits both the Government and the contractor by increasing the accuracy and reliability of individual proposals. FAR and the related clause require an EVMS system to comply with American National Standards Institute / Electronics Industries (ANSI/EIA) Standard-748, Earned Value Management Systems. 7 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

8 Purchasing system FAR prescribes that if a contractor handles high volume, complexity or dollar value of subcontracts (over $25M of certain contract types in a future period) the government may determine that a contractor purchasing system review is necessary and the contractor s purchasing system must meet certain requirements. Property management system FAR and the related require the contractor to have a system of internal controls to manage (control, use, preserve, protect, repair and maintain) government property in its possession. Basically, the contractor s system should be able to distinguish between types of property (government and contractor furnished), keep records of government property and provide data related to name, type, part number, quantity, acquisition cost (if acquired by the contractor) and location. 2.2 Defense Federal Acquisition Regulation Supplement (DFARS) DFARS presents an additional layer of regulation for contractors doing business with the DoD. As the most active buyer of major systems without equivalents in the market, compared to other government agencies, DoD predominantly uses reimbursable contracts as its acquisition vehicle. Since cost reimbursable contracts provide the highest risk to the buyer compared to other contract types, DFARS has been continuously updated and expanded to include a multitude of rules related to systems used by manufacturers or suppliers Accounting system Beyond the applicability of SF 1408, Pre-award Survey of Prospective Contractor Accounting System as prescribed in the FAR, for an accounting system to meet DFARS compliance requirements it must also satisfy requirements related to controls, approvals, and internal review among other areas. These additional requirements are defined in DFARS Other contractor systems Compliance requirements for other contractor systems are likewise expanded beyond the FAR to include, among other things, provisions related to management procedures, policy, and documentation. These principles, once again, illustrate that software alone cannot guarantee compliance. Estimating systems In addition to the requirements prescribed in FAR, an acceptable estimating system means an estimating system that complies with the system criteria in DFARS (d). The system should be maintained, reliable, and consistently applied. It should produce verifiable, supportable, documented, and timely cost estimates. EVMS In addition to compliance with ANSI/EIA-748 guidelines, DFARS (2) prescribes that for a system to meet EVMS compliance requirements it must include management procedures that 8 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

9 provide for generation of timely, reliable and verifiable information for the Contract Performance Report (CPR) and the Integrated Master Schedule (IMS) required by the CPR and IMS data items in a contract. Purchasing system A significant deficiency in a contractor s purchasing system materially affects the ability of offices of the DoD to rely upon information produced by the system that is needed for management purposes. DFARS (c) prescribes the list of criteria needed in order for a system to be considered acceptable. Property management system The requirements for property management systems for DoD contractors places increased scrutiny on supply management and control. Contractors must apply standards for inventory procedures, expand record data and include reporting requirements among other things as defined in DFARS Material management and accounting system (MMAS) A MMAS is the system or systems for planning, controlling and accounting for the acquisition, use, issuance and disposition of material. An adequate MMAS should provide accurate, timely and consistent information about the materials and their associate costs. The contractor should have controls in place to ensure that the information produced is free of material misstatements and prevent overcharging to the federal government. 2.3 Cost Accounting Standards (CAS) CAS are a set of 19 standards applicable to certain DoD contractors, depending on the size of contract awards and other criteria. These standards were established to achieve uniformity and consistency in the cost accounting principles followed by contractors and subcontractors and to establish regulations to require contractors and subcontractors to disclose in writing their cost accounting practices. CAS is applicable in full or modified coverage depending on the size of the awards obtained by the contractor. In some cases, contractors may be exempt from CAS applicability based on bid type, contract award size, contractor business type and other defining criteria outlined in 48 CFR 9903 and CAS standards contained in 48 CFR Other Regulations or Agency Documents that Apply Contractors Audit Manual (CAM) 2 DCAA makes public the CAM, an official publication that prescribes auditing policies, procedures and guidance in auditing techniques. For example, Chapter 8 of the CAM provides audit guidance for the evaluation of the contractor's disclosure statement and the practices used for estimating, accumulating and reporting costs on contracts. Currently DCAA is charged with reviews and audits of the contractor s accounting system, estimating system and MMAS Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

10 2.4.2 Defense Contract Management Agency (DCMA) The DCMA works with government contractors in support of DoD to maintain the integrity of federal acquisitions. DCMA is involved in the contractor selection process prior to contract award and in the monitoring of contractor performance and compliance post contract award. As such DCMA conducts initial and ongoing reviews of the contractor s EVMS, Property Management System, and Purchasing System. The guidelines used by DCMA were designed to ensure that the mentioned contractor s systems are in compliance with FAR and DFAR Who audits, reviews and determines systems adequacy? The government has established a number of structures, from offices often affiliated with the inspector general (IG) to entire agencies as in the case of DCAA, that audit contractors and recipients of federal assistance. 3 FAR requires one contracting officer (CO) to administer contractorrelated issues including assignment of the auditor that will assess contractors and their business systems. This CO is referred to as the cognizant officer and is assigned based on agency participation in a contractor s portfolio as determined by contract award dollar value. Once assigned, the CO retains cognizance, providing consistency, until circumstances change or the government agency initiates a change. The cognizant CO uses the auditing arm of the agency that the CO belongs to (i.e. DCAA for any COs within DoD 4 ) to administer audits including those related to cost and business systems. 2.5 What are the potential consequences of non-compliance? Dependent on circumstances, the regulations impose a substantial number of administrative actions, and civil and criminal penalties related to non-compliance. Generally speaking the majority of non-compliance cases are related to material liabilities from a contractor s perspective. These may include: Inability to collect payments or delays in payments, usually related to billing systems, but in a number of cases having provenance in issues with timekeeping, labor charging, etc. These consequences have direct effect on the contractor s cash flows and cost of doing business as they often drive the need for relatively expensive operating loans. Loan covenants and other binding agreements are often dependent on these metrics. Penalties, restitutions, interest, which can be related to any element of the system or contractor s process such as charging of unallowable costs, not paying vendors in a timely manner, or not applying credits that are applicable to the contract and price reductions. These may affect the ability to continue working for the government or win future business. 3 Recipient of federal assistance are subject to similar, but relative to the requirements discussed herein, less stringent requirements, which are not subject to this review (see Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards). In general, systems meeting the requirements discussed herein, would be complaint with the requirements applicable to recipients of federal assistance. 4 Within DoD the contract officers responsible for managing contracts are generally from the Defense Contracts Management Agency or DCMA. 10 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

11 Terminations - the contracts with the federal government include mandatory clauses that allow the CO to terminate a contract both for default and for convenience, giving the government the option at its discretion to terminate practically every contract in case the contractor does not perform as expected, including if its financial, accounting and other business systems are not compliant with applicable requirements. Loss of ability to propose on future work, which is a major concern for contractors as it can cause a disruption in their business strategy, loss of lucrative work and large clients, and prevents the contractor from delivering on expected results with a variety of possible negative consequences depending on the company. Contractors under modified or full CAS coverage are at risk related to clauses requiring price adjustments. Price adjustments would be necessary in cases where there is a voluntary change to cost accounting practices; and in cases where the contractor is non-compliant with one or more standards or fails to follow their disclosed practices. Price adjustments present a significant challenge related to the amount of effort to the contractor, which must develop and submit a cost impact proposal, usually within 60 days after the accounting practice change or after the non-compliance is found. In addition to any overage in payment, the federal government is also entitled to recover interest on any overpayments made to the contractor. 3 High level review of requirements and capabilities to enable compliance Expanding on the definitions of each regulatory document and body in the previous section, in this section we provide a more detailed account of the specific requirements for business systems as detailed in those documents. The guidelines presented should help formulate a clear understanding of the major capabilities required to enable compliance. Further they will lay a foundation for making informed decisions around selection of systems for support of government contracts requirements. 3.1 Accounting System Having an adequate accounting system is a significant concern in government contracting given the variety of contract types that can be used in acquisition. Several contract types rely heavily on the accounting system to supply accurate, timely and reliable data that determine contract payments, and in the case of cost reimbursable contracts, the contract price. For example, in time and materials (T&M) contracts, actual hours incurred by contractor workers with specific skills determine amounts to be paid for work done by the contractor since hourly rates for types of skills are pre-negotiated. The FAR requires that an accounting system properly segregate direct from indirect costs and track costs to the proper cost objectives and accounts. The system should be able to accumulate and identify direct costs by contract and have a logical and consistent method for the allocation of indirect costs to intermediate and final cost objectives as well as the ability to track allocation of indirect costs to intermediate and final cost pools. Further, the system should accumulate costs 11 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

12 under general ledger control. Contractor s job cost ledger and other books of account should be reconcilable and posted to the general ledger control accounts, at least monthly. The timekeeping function of a contractor s accounting system is a critical element. The timekeeping system should identify employees labor by intermediate and final cost objectives and display hours recorded to the correct direct or indirect project. The information is to be recorded on a paper or electronic timekeeping document that is completed and signed by the employee and approved by the employee s supervisor. Further, the corresponding labor distribution should charge direct and indirect labor to the appropriate cost objectives and the accounting system should be capable of generating reports showing project codes, units, quantity, individual names, amounts, account codes and payroll items. From a reporting perspective, the accounting system should be capable of providing accurate and reliable financial data that can be used for financial reporting. As required by contract clauses concerning limitation of cost (FAR and 21) or limitation of payments (FAR ), the accounting system shall be able to set contract and funding ceilings at the contract or other required level. To successfully pass an accounting system review an accounting system must also satisfy the following areas: Have methods in place to identify and exclude unallowable costs as prescribed in FAR 31, Contract Cost Principles and Procedures, or other contract provisions. Be capable of identifying costs, not only by project, but also by contract line item and further itemization if required by the contract. Segregate pre-production costs from production costs. Segregate allowable costs that are not directly related to contracts and do not constitute indirect costs; for example, bid and proposal costs, or independent research and development costs which have to be identified separately and then allocated through the G&A cost pool. Ability to support requests for progress payments. DFARS delineates further requirements for contractors providing products and services to the DoD. While the regulation presents software requirements, there are also people and process components to the compliance determination. In addition to the basic FAR requirements, an adequate accounting system shall be capable of reconciliation of subsidiary cost ledgers and cost objectives to the general ledger. Interim indirect expense rates shall be readily calculated from the books of account and routinely monitored. Compliance requires that billings can be reconciled to the cost accounts for both current and cumulative amounts claimed and that they comply with contract terms. Finally, the system shall be able to provide adequate and reliable data for use in pricing follow-on acquisitions. From a people and process perspective DFARS compliance requires that an organization s accounting system provide for a sound internal control environment, accounting framework and organizational structure. To demonstrate a reliable accounting framework, the contractor shall 12 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

13 carry out regular management reviews or internal audits of the system to ensure compliance with the contractor s established policies, procedures and accounting practices. The regulation emphasizes requirements for approvals and proper documentation for processing adjusting entries. Accounting practices should be compliant with the Cost Accounting Standards, if applicable, otherwise, Generally Accepted Accounting Principles. 3.2 Other contractor systems Estimating systems An adequate estimating system must consistently produce well-supported proposals that are acceptable as a basis for negotiation of fair and reasonable prices. Given that an estimating system must handle a substantial amount of various data types as the basis for reliable estimates, the ERP system becomes subject to a number of requirements necessary to satisfy this need. An acceptable estimating system must establish clear responsibility and provide written description of the organization and duties for preparation, review and approval of cost estimates and budgets. Relevant personnel must have sufficient training, experience and guidance to perform estimating and budgeting tasks. Sources of data and the estimating methods and rationale used in developing cost estimates and budgets must be identified. Adequate supervision and consistent techniques are needed for the estimating and budgeting process. Controls must exist for detection and timely correction of errors, and for protection against cost duplication and omissions. The system must capture historical experience (including historical vendor pricing data) for use with appropriate analytical estimation methods, and it needs to be able to integrate data and information available from other management systems. Similar to the accounting system, management review is required to ensure compliance with the company's estimating and budgeting policies, procedures and practices Regulations require that the company conduct internal review of the acceptability of the estimating system (budgetary data supporting direct cost estimate, projected vs. actual results, variance analysis). Throughout the negotiation process, the procedures to update cost estimates need to be provided to the CO in a timely manner. The system needs to provide estimating and budgeting practices that consistently generate sound proposals that are a match with the provisions of the solicitation and are adequate to serve as a basis to reach a fair and reasonable price. It is required to have adequate system description, including policies, procedures and estimating and budgeting practices that comply with the FAR and DFARS Purchasing systems Elevated level of responsibility and accountability is placed on the contractor when spending government funds and an adequate purchasing system helps to demonstrates cost-effective spending and subcontractor management. The administrative CO is responsible to determine if the purchasing system review is required. If so, the cognizant CO office will conduct a contractor purchasing system review (CPSR) and further review the system every three years. 13 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

14 An adequate purchasing system must include documented policies, procedures and purchasing practices. The contractor should maintain an organization plan that shows the hierarchy of purchasing authority and responsibility (i.e., an approval matrix). All purchases must be based on authorized requisitions including a complete and accurate history of purchase transactions to support vendor selected and price paid. Subcontract and purchase order files must be clearly documented and are subject to government review. The contractor must perform adequate price or cost analysis on purchasing actions and technical evaluation for each subcontractor or supplier to ensure fair and reasonable prices. They should seek, take and document economically feasible purchase discounts. The make-or-buy policy needs to be in the government s best interest including use of competitive sources to the maximum extent practicable should also ensure that debarred or suspended contractors are excluded from contract award. Subcontractor s performance should be closely monitored to ensure timely delivery of an acceptable product and procedure. The government should be notified of any subcontractor problems that may impact delivery, quantity, and/or price. The contractor must have policies and procedures to ensure purchase orders and subcontracts contain mandatory and applicable flow down clauses and the federal government should be notified of all subcontracts affected by those clauses. To ensure system integrity, the contractor should conduct internal audits, management reviews and training. Policies and procedures should be maintained including enforcement of policies regarding conflicts of interest, gifts and gratuities Property management system Government property means all property owned or leased by the government. Government property includes both government-furnished property and contractor-acquired property. The contractor is responsible to have an adequate Property Management System in place. In doing so, the contractor needs to initiate and maintain the processes, systems, procedures, records and methodologies necessary for effective control of government property, consistent with voluntary consensus standards and industry-leading practices and standards for government property management except where inconsistent with law or regulation. 5 Any significant changes to a property management system need to be disclosed prior to implementation. The contractor is required to document and record all required information for acquisition of properties and receipt of government properties 6 and needs to periodically perform, record and disclose physical inventory results. With some exceptions, a final physical inventory should be performed upon contract completion or termination. Government properties are assigned to authorized contracts. The system should be capable of generating discrepancy reports and maintain government accounting source data, as required by contract, particularly in the areas of recognition of acquisitions and dispositions of material and equipment. 5 FAR Refer to FAR (f)(1)(iii)(a) for a specific list of required information. 14 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

15 3.2.4 Material Management System The MMAS is expected to forecast material requirements and ensure that costs of purchased and fabricated material charged/allocated to a contract are based on valid time-phased requirements, while maintaining a consistent, equitable, and unbiased logic for costing of material transactions. The contractor, as with other systems, is expected to have policies, procedures, and operating instructions that adequately describe its MMAS. Conducting internal reviews to ensure compliance with established MMAS policies, procedures, and operating instructions is also required. Upon request, the contractor needs to provide the results to the Administrative Contracting Officer (ACO). Any significant changes to MMAS are to be disclosed to the ACO at least 30 days prior to implementation. An adequate MMAS system is required also to provide a mechanism to identify, report and resolve system control weaknesses and manual overrides and identify operational exceptions, such as excess/residual inventory, as soon as known. The system must provide audit trails and maintain records that allow evaluation of system logic and verification of transactions. Adequate levels of record accuracy should be maintained, including reconciliation of recorded inventory quantities to physical inventory by part number on a periodic basis. Contractor policies should include detailed descriptions of circumstances that will result in manual or system generated transfers of parts and a consistent, equitable, and unbiased logic for costing of material transactions. They should include controls for cases where allocations from common inventory accounts are used or for physically commingled inventories EVMS Earned value management is a widely accepted industry best practice for project management. It is the use of integrated management that coordinates the work scope, schedule and cost goals of a program or contract, and objectively measures progress toward these goals. The purpose and objectives of EVMS criteria are for contractors to be able to provide the government with accurate, valid, reliable, timely and auditable data for determining contract status. An EVMS is required for major acquisitions for development, in accordance with OMB Circular A- 11. The system must meet the American National Standards Institute /Electronics Industries (ANSI/EIA) Standard-748. When contractors first encounter such requirement they are allowed to present a comprehensive plan for compliance with these EVM standards. In addition to the FAR requirements, the contractor needs to establish procedures that provide for generation of timely, reliable and verifiable information for the Contract Performance Report (CPR) and the Integrated Master Schedule (IMS) required by the CPR and IMS data items of applicable contracts. 3.3 Cost Accounting Standards CAS sets forth principles, defining practices, procedures and policies for contractors. Many of these principles have a direct impact on the contractor s ERP solution. Contractors with an award over $7.5 million are covered by modified CAS, with some exceptions. Modified applicability defines 15 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

16 requirements for the contractor business systems contained in CAS 401, 402, 405 and 406 see CAS outline below. Contractors with award(s) over $50 million are subject to full CAS coverage, with some exceptions. These contractors must abide by the requirements of modified CAS coverage and in addition their business systems must be suitable to meet the required CAS 403, 404, and 420 see CAS outline below. The brief descriptions below are based on the DCAA s CAM (see above) and are intended to provide a high level outline of the standards goals and requirements Cost Accounting Standard Consistency in estimating, accumulating and reporting costs The purposes of this standard are to achieve consistency in the cost accounting practices used in estimating costs for contractor proposals with the practices used in accumulating and reporting costs during contract performance, and to provide a basis for comparing such costs. As used in the standard, "Reporting of Costs" refers to the data presented in reports required by the contract, such as budget and management reports, for cost control purposes and the data contained on public vouchers or any other request for payment. Major consideration is establishing whether the accounting practices for selecting indirect cost pools and methods of distributing the indirect costs used to determine the amounts on those reports are consistent with those used for estimating (on proposal) and accumulating (accounting entries) Cost Accounting Standard Consistency in allocating costs incurred for the same purpose The purpose of this standard is to ensure that each type of cost is allocated only once and on only one basis to any contract or other cost objective. The fundamental requirement is that all costs incurred for the same purpose, in like circumstances, are either direct costs only or indirect costs only with respect to final cost objectives Cost Accounting Standard Allocation of home office expenses to segments The purpose of this standard is to establish criteria for allocation of home office expenses to the segments of the organization on the basis of a beneficial or causal relationship. Appropriately implementing this standard will limit the amount of home office expenses classified as residual to the expenses of managing the organization as a whole. The contractor and Government personnel have a specific, authoritative accounting rule prescribing criteria for allocating home office and group office expenses to segments of an organization. The basic concept of the standard recognizes that some home office expenses incurred for specific segments can be assigned directly. Other expenses, not incurred for specific segments, have a clear relationship (i.e., measurable with reasonable objectivity) to two or more segments. Lastly, the standard recognizes a third type of home office expense (i.e., residual) which possesses no readily measurable relationship to segments Cost Accounting Standard Capitalization of tangible assets This standard establishes criteria for determining the acquisition costs of tangible assets which are to be capitalized. The standard requires contractors to capitalize the acquisition cost of tangible assets in accordance with a written policy that is reasonable and consistently applied. 16 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

17 The policy shall include minimum service life criterion (2 yr), minimum acquisition cost criterion ($5,000), and identification of asset accountability units Cost Accounting Standard Accounting for unallowable costs This standard contains guidelines on identification of costs specifically described as unallowable and the cost accounting treatment to be accorded such identified unallowable costs. For example, costs expressly unallowable or mutually agreed to be unallowable, including costs mutually agreed to be unallowable directly associated costs, shall be identified and excluded from any billing, claim or proposal applicable to a Government contract Cost Accounting Standard Cost accounting period The purpose of this standard is to provide criteria for selecting the time periods to be used as cost accounting periods for contract cost estimating, accumulating, and reporting, and to reduce the effects of variations in the flow of costs within each cost accounting period Cost Accounting Standard Use of standard costs for direct material and direct labor The purpose of this standard is to provide criteria under which standard costs may be used for estimating accumulating, and reporting costs of direct material and direct labor. Use of a standard cost accounting system to cost government contracts is permitted only when it meets criteria such as entering of standard costs into the books of account and properly computing variance, accounting for standard costs and related variances at the level of the production unit, and stating in writing and consistently following practices with respect to the setting and revising of standards, use of standard costs, and disposition of variances Cost Accounting Standard Accounting for costs of compensated personal absence The purpose of this standard is to establish criteria for measuring and allocating the costs of compensated personal absences to final cost objectives. These costs include compensation paid by contractors to their employees for such benefits as vacation, sick leave, holiday, military leave, etc. The standard sets forth detailed guidelines as they relate to period assignment of compensated time that has been earned and used or remains unused Cost Accounting Standard Depreciation of tangible capital assets This standard provides criteria for assigning costs of tangible capital assets to cost accounting periods and should enhance objectivity and consistency in their allocation. The standard sets depreciation guidelines as it relates to residual value, service life, selection of depreciation methods, accounting for depreciation as an indirect vs. direct cost Cost Accounting Standard Allocation of business unit general and administrative expenses to final cost objectives This standard provides criteria for the allocation of general and administrative (G&A) expenses to final cost objectives and furnishes guidelines for the type of expense that should be included in the G&A expense pool. It also establishes that G&A expense shall be allocated on a cost input base which represents total activity. The provisions of this standard define what shall be included in the 17 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

18 G&A expense pool, allocation of G&A to unallowable costs, treatment of selling costs as G&A expenses, home office allocation base, and other allocation based guidelines Cost Accounting Standard Accounting for acquisition costs of material This standard provides criteria for the accounting of acquisition costs of material, provides guidance on using inventory costing methods, and improves the measurement and assignment of costs to cost objectives. The standard defines accumulation and allocation of materials and treatment of materials as direct vs. indirect Cost Accounting Standard Composition and measurement of pension costs This standard establishes the composition of pension costs, the basis of measurement, and the criteria for assigning pension costs to cost accounting periods. Per FAR (j)(1), it is applicable to all contracts, even contracts which are not CAS-covered or subject only to modified CAS-coverage Cost Accounting Standard Adjustment and allocation of pension cost This standard establishes criteria for assigning actuarial gains and losses to cost accounting periods, valuing pension fund assets, and allocating pension costs to segments Cost Accounting Standard Cost of money as an element of the cost of facilities capital The standard recognizes the cost of facilities capital as a contract cost. It provides criteria for measuring and allocating an appropriate share of the cost of money which can be identified with the facilities employed in a business Cost Accounting Standard Accounting for the cost of deferred compensation The purpose of this standard is to provide criteria for measuring deferred compensation costs and assigning those costs to cost accounting periods. It applies to all deferred compensation costs except for compensated absences and pension costs covered in CAS 408 and CAS Cost Accounting Standard Accounting for insurance cost CAS 416 provides criteria for the measurement of insurance costs, the assignment of such costs to cost accounting periods, and their allocation to cost objectives. The standard covers accounting for purchased insurance, self-insurance, and payments to a trustee of an insurance fund Cost Accounting Standard Cost of money as an element of the cost of capital assets under construction This standard establishes criteria for the measurement of the cost of money attributable to capital assets under construction, fabrication, or development as an element of the cost of those assets. Per FAR , it is applicable to all contracts, even contracts that are not CAS-covered or subject only to modified CAS-coverage. 18 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

19 Cost Accounting Standard Allocation of direct and indirect costs CAS 418 requires the consistent classification of costs as direct or indirect, establishes criteria for accumulating indirect costs in indirect cost pools, and provides guidance on allocating indirect cost pools. The standard requires consistently applied written statement of accounting policies and practices for classifying costs as direct or indirect, accumulating indirect costs in indirect cost pools which are homogeneous, and for pooled costs to be allocated to cost objectives in reasonable proportion to the beneficial or causal relationships to such cost objectives. While the CAS and the FAR are similar with regard to the conceptual basis, the standard goes beyond the requirements of the FAR and provides more definitive guidance for allocation base selection Cost Accounting Standard Accounting for independent research and development costs and bid and proposal costs (IR&D and B&P) This standard provides criteria for the accumulation of IR&D/B&P costs and for the allocation of such costs to cost objectives. According to FAR , it is partially applicable to all contracts, even contracts which are not CAS-covered or subject only to modified CAS-coverage. 3.4 Other Guidance DCAA GUIDANCE Accounting system DCAA s audit program reviews the accounting system for adequacy based on the FAR and DFAR regulation but has individual validations that extend the compliance requirements further. In addition to having a system that properly identifies direct costs by contract, the contractor should have controls in place to preclude mischarging costs from one contract to another. Likewise, in addition to a system that provides for a timekeeping system identifying labor by intermediate or final cost objective, the contractor should also have segregation of duties and responsibilities throughout the timekeeping system. Other contractor systems Estimating system DCAA s audit program delves into the specifics surrounding a contractor s policies, procedures, and methods for estimating. The program scrutinizes specific proposal elements such as direct labor rates, direct labor hours, interdivisional work orders, direct materials, indirect expenses and the supporting budget development and budget process functions, other direct costs, subcontractor costs, cost of money, and specific estimating techniques such as parametric estimating. The program seeks to verify clear assignment of responsibilities throughout the estimating process including preparation, review and approvals. The contractor should be able to present sufficient documentation for basis of estimates, evidence of considerations for historical data, and rationale for any significant departures from relevant history. Estimates should present fair and reasonable prices, be completed under adequate supervision, and should also prove sound and compliant in accordance with the contractor s established policies and procedures. 19 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

20 Material Management and Accounting System (MMAS) Review for an adequate MMAS per the DCAA audit program is preceded by the contractor s organizational control environment. A sound control environment is evidenced by ethical values, management philosophy and operating style as well as organizational structure among other elements. Assessment of the overall control environment is the first step in evaluating adequacy of all systems including MMAS. Further, the contractor should be able to demonstrate adequate processes for risk identification, assessment, and management. As it specifically relates to the MMAS system, the contractor must exhibit methods established to record, process, summarize, and report contract cost data including appropriate manual and computerized controls that check for accuracy, completeness, proper authorization of material related transactions, and timely assessments of the internal control environment and any necessary corrective actions. The contractor should maintain 95 percent inventory record accuracy in order to assure that the recorded inventory quantities reconcile to the physical inventory DCMA guidance Property Management System When required by a contract, property administration is performed by DCMA. Its representative is charged with establishing compliance with the FAR and DFARS criteria and requirements. In doing so it follows the Contract Receipt and Review instruction. 7 Purchasing System If the DCAM Administrative Contracting Officer (ACO) determines that a Contractor Purchasing System Review (CPSR) is required, DCAM will plan and conduct such review. This includes an entrance conference with the contractor, policies and procedures review, purchasing system health check, and exit conference. DCMA will determine the final results based on the findings of deficiencies (if any) based on the 24 criteria found in DFARS (c) and issue a report to the ACO for approval/agreement, who in turn, if the review results are positive, will issue an initial determination letter. EVMS The DoD has recognized the 32 EVMS guidelines in the American National Standards Institute/Electronics Industries (ANSI/EIA)-748 Standard and the DCMA continues to use the ANSI/EIA-748 EVMS guidelines as the basis for determining initial and ongoing compliance of contractor management systems. The EVMS compliance review consists of a 16-step process. 8 7 See for more detail information. 8 See for more detail information. 20 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

21 4 Acceptable business systems and why an ERP cannot cover all requirements 4.1 It is virtually impossible at present to achieve 100% compliance with any ERP software As discussed, the regulations define requirements related to a number of contractor business systems, sometimes beyond the accepted definitions of ERP (see Defining ERP). To be acceptable, a business system must pass certain procedures conducted by government agencies and to do so, they must meet all requirements. A number of requirements are fairly easy to meet. These include project accounting, segregation of costs using chart of accounts structure, and some of the requirements related to time recording and expense recording directly to projects. Various ERP products are capable of meeting these requirements without any or with minor effort, typically during set-up. However, a number of requirements cannot be met by ERP software functionalities right out of the box or even with ERP-based controls. While certain ERP software can, either through built-in functionalities or through customizations and extension, meet a large number of requirements, 9 no ERP software is capable of meeting all requirements. This is driven by a number of factors related to the need for analytical evaluation of accounting transactions prior to determination of accounting treatment, as well as the multiplicity of business scenarios that vary by industry, contractor size, differences in contractors operations, organizational structure, and personnel skills. Examples of such requirements and related controls are treatment of unallowable costs and segregation of pre-production from post-production costs. Also the limitations of software systems are particularly evident with regard to CAS requirements, where a number of functions and controls are not easily implemented within systems or require extensive efforts to meet requirements. A number of other system requirements related to purchasing and estimating also explain why the need for added processes and controls, due to the implied need for analysis, approvals, reviews and other actions, prevent full automation at the present level of technology development. 10 An area where ERP systems most often come up short in meeting requirements is around policies. As defined, government contractors systems include applicable policies and related procedures. While policies are more often than not similar for most contractors, derived procedures are dependent on available ERP software functionality and set-up, as well as on variables pertaining to the individual contractor s specific industry, organizational structure, business processes, etc. Thus a contractor-specific set of policies and procedures is required, which, after being evaluated by the government s authorized reviewers together with the deployed controls, will provide the basis for assessment of the system s adequacy. Further, a number of controls must be designed and implemented to meet the full range of requirements. Key controls include time and expense charging (requiring reviews by personnel who 9 In some cases ERP that have been designed to meet government contracting requirements provide a large number of required functionalities and controls, yet they still require design and implementation of additional processes and controls. 10 Certain new technologies such as automation of knowledge work may allow ERP to further expand functionalities that support compliance with regulations. 21 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

22 are knowledgeable of the specific contract and of direct charges), unallowable cost determination and segregation (controls of accounting entries, but also controls spanning various operational and functional areas of the company for example, Human Resource systems and practices have a direct relation to reasonableness of compensation), purchasing/procurement controls (controls needed to establish that policies related to competitive procurement process are followed with consistency), estimation process controls (for example, appropriate evaluation of make vs. buy options) and many others. The number of controls, how they operate, and how efficient they are, depend largely on the company, and therefore, although some controls can be automated via use of workflows, a number of controls will remain outside the ERP. This preceding discussion explains why no government auditor or agency specifies or certifies software or ERP packages as compliant (see Compliant system). As indicated in Other Guidance, regulatory documents include for mandatory consideration specific elements that are outside of today s ERP software systems and that vary by contractor, industry, etc. 4.2 Even contractors that have ERP software commonly thought of as compliant still experience determinations of inadequacy Contractors that are not fully aware of non-software elements required for compliance often fail to develop the policies, manual procedures, and software-enabled controls that are necessary to bridge gaps in ERP software capabilities and functionalities. Our experience over many years indicates that such organizations are at risk for reviews that conclude with determinations of inadequacy. 22 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

23 Baseline gap-fit assessment of Microsoft Dynamics AX as an ERP for government contracting 5 Gaps that require customization or independent software vendor (ISV) extension In order to understand an ERP system s adequacy to address compliance requirements, it is important to identify areas where it may not be able to meet those requirements right out of the box. 11 As discussed in prior sections, such shortages are expected to be inherent in every ERP software offering, due to regulatory definitions of compliance and systems. Various software systems can meet requirements to a certain degree, but it is unlikely that any will be fully compliant for any but very simplistic business scenario without adding policies, processes and controls or, if applicable, customizations and extensions. Depending on contract types performed and the industry in which a contractor is active, certain requirements may or may not be applicable. Therefore a given ERP system may be perceived to be less or more adequate depending on the contractor situation, and may need more or less customization or extension to meet requirements. To identify the degree to which an ERP system enables compliance requires an analysis of areas where requirements are not met and where there is a need to customize the ERP system or incorporate ISV extensions (herein referred to as gaps ). This analysis is an important step in ERP system evaluation and selection, and has substantial implications for implementation planning. The following review of Microsoft Dynamics AX 2012 R3 edition and comparison to regulatory requirements focuses on identifying functional gaps. Although the review does discuss certain areas where Microsoft Dynamics AX meets requirements, it does not attempt to cover all such areas or to discuss how requirement would or could be met. Consequently, if a gap has not been identified, the implication in general is that the Microsoft Dynamics AX ERP system can meet the requirements. 5.1 Accounting system Detailed review of all requirements related to adequate accounting system vs Microsoft Dynamics AX ERP 2012 R3 (herein referred to as Microsoft Dynamics AX or system ) FAR Segregation of direct and indirect costs Microsoft Dynamics AX allows such segregation. Identification and accumulation of direct costs by contract: 11 It is assumed,for the purpose of the discussion that follows, that any ERP system would require certain work to set it up. Such set-up needs are considered to be normal system implementation work and, where required, are not considered as gaps. 23 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

24 Microsoft Dynamics AX has a project accounting module to identify and accumulate direct costs by contract. Indirect Cost Allocation Requirements: Accumulation of costs under general ledger control Microsoft Dynamics AX can retain project codes, units, quantities and etc. using dimensions. Microsoft Dynamics AX also has the capability of reporting by organization/tax ID with multiple country setups using a dimensional structure. Gaps: Costs can be allocated based on multiple criteria such as cost, revenue, and accounts. However, system currently does not perform multi-tier allocation nor does it retain results of allocations, for example, within the existing project ledger. Customization: System does not have pre-built processes to apply provisional indirect rates nor does it automatically generate a Statement of Indirect Costs based on actuals and apply this to projects. While capable of capturing the required data elements and performing certain allocations, an automated allocation process consistent with requirements is not provided in the system and it does not enforce consistent grouping of costs into defined cost pools, other than through a chart of accounts structure. This gap has derivative implications in other areas where requirements apply in such areas the gap will be referred to as the indirect cost feature gap. A timekeeping system that identifies employees labor by intermediate and final cost objectives: Microsoft Dynamics AX meets this requirement as it has the following capabilities: i. Able to retain audit trail ii. iii. iv. Multiple approval capabilities Able to prevent people from entering time in advance Able to track entries and produce reports (audit trail) v. Able to require reasoning for any changes made vi. Can associate time with projects Labor distribution system that charges direct and indirect labor to the appropriate cost objectives: Microsoft Dynamics AX has an effective rate feature (i.e., re-calculation of salary rates based on actual time worked) that only addresses a weekly or bi-weekly payroll scenario. It is able to pull a labor distribution report that allows to see individual labor costs allocated to projects. Gaps: 24 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

25 Effective rate feature does not work automatically when timesheets are semi-monthly, monthly, etc. In those cases the salary must be converted into an hourly rate manually to achieve the effective rate. Microsoft Dynamics AX does automatically adjust for overtime. Interim (at least monthly) determination of costs charged to a contract through routine posting of books of account: Gaps: This is derivative of the indirect cost feature gap, in that automatic allocations to contracts are not performed. However, Microsoft Dynamics AX has the necessary data fields in the Project Ledger (PL). Exclusions of cost not allowed in regulations (FAR Part 31, CAS) and in contracts. This is not usually ERP system functionality with the exception of updates and management of certain travel costs. Microsoft Dynamics AX allows identifying cost that needs to be excluded from charging to contracts or indirect cost pools. Segregation of pre-production cost from production costs: Gaps: Derivative of the indirect cost feature gap, there is no allocation mechanism for indirect costs. Therefore, system does not fully identify pre-production costs and segregate from production costs (indirect costs would not be segregated by the system). Ceilings on costs and/or revenue recognition in terms of projects: Microsoft Dynamics AX has a funding limit mechanism that handles cost limitation. Ceilings can be established at all levels, i.e. project, task, etc. Gaps: System does not have built-in recognition for a contract ceiling. Consequently, billing limitation or limitation of payments functionality is inadequate, derivative of the indirect cost feature gap. Revenue recognition: Revenue is recognized on the cost side. Microsoft Dynamics AX has the capability to perform Estimate at Completion, including milestone billing, production billing, and T&M. Project Categories are used as labor categories and automatic billing can be created based on rates. Rates can be setup at the project, task, or activity level. Gaps: Revenue recognition is not done on the billing side and therefore without the recognition of a ceiling (see prior note) it is possible to recognize revenue in excess of the contract ceiling. System does not have an allocation methodology for indirect cost, derivative of the indirect cost feature gap. As such, it does not calculate indirect cost pool and base allocations as required for cost reimbursable contracts, and so the related revenue recognition functions for such contracts are inadequate. 25 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

26 DFARS Progress Payments: Microsoft Dynamics AX meets the requirements to perform progress payments. In addition to the FAR criteria, the following requirements must be met under 48 CFR Accounting system administration (c) System criteria. Cost accounting information, as required to readily calculate indirect cost rates from the books of accounts. Gap: Microsoft Dynamics AX has an allocation feature allowing calculation of indirect rates, but the system does not post those rates. Therefore, total cost is not reconciled between the general and project ledger. See indirect cost feature gap discussion above. 5.2 Other contractor systems functionalities Review of Microsoft Dynamics AX functionalities that support other business systems requirements EVMS and Estimating system There is a quoting/estimation feature in the Microsoft Dynamics AX project module and partial support for EVM calculation and reporting. System does not send detail allowing EVM calculations to Microsoft Project or other EVMS. Gaps: System does not offer full support for earned value reporting. The quoting/estimation feature falls short related to requirements, due to lack of support for distinction of indirect and direct cost elements, derivative of the indirect cost feature gap. Purchasing system Microsoft Dynamics AX generally meets the requirements. It maintains historical data on purchases and supplier relations and supports reporting and analytics, plus has the capability to perform the following: i. Can create purchase orders ii. iii. iv. Can have approval flow Can create a subcontractor purchase order including units of measure Can associate purchase orders with projects v. Breaks out labor categories Other areas indicative of system gaps Contracts: Estimating system does not support use of forward pricing rates 26 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

27 Estimating does not provide for breakdown by fiscal period Supply Chain related to MMAS: Certain typical functions for government contractors engaged in manufacturing are not currently supported, such as: Project pegging Accurate product costing (derivative of the indirect cost feature gap) Complex purchase agreement structures Inventory borrow/payback Product Costing: System does not offer built-in Purchase Order for subcontractors that invoice using milestone, progress, or cost-plus contract types System does not have a feature for pushing flow-down clauses to subcontractors System does not support liquidations billing for firm-price DD250 shipments Property Management Systems: Certain functions for government contractors engaged in manufacturing related to Government Furnished Equipment/Government Furnished Materials, like zero cost DD1662 are not provided and need customizations. 5.3 User Expectations (de-facto industry standards) Although not specifically required (i.e., are not gaps related to regulations) the functionalities or features discussed below are generally expected to be available as they increase worker efficiency and reduce error/risk levels for government contractors. Out-of-the-box support and configurability of Microsoft Dynamics AX varies by feature and function Accounts Payable Efficient AP management methods for employees of subcontractors Note: Currently, users would need to devise a methodology to create a timesheet comparison and reconcile with the subcontractor invoices Expensing and expense reports Microsoft Dynamics AX has a robust expense module that includes approvals, uses a consistent workflow mechanism across modules, and supports pre-set per diem rates. However, the system is not designed out of the box to enable update of approved per diem rates automatically (would require manual update of rate tables) Payroll/HR System may fall short in determining the proper labor rate to use; i.e., Contract Rate vs. Davis Bacon Act Rate. 27 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

28 Microsoft Dynamics AX has a skill-based rate table for labor. However, the system does not support the application of Davis Bacon Act; i.e., it does not recognize and match labor rates to specific skills/competencies. The base product does not offer a built-in integration for reconciliation to payroll providers (ADP, Paychex, etc.) Project Setup and Tracking Microsoft Dynamics AX allows the user to set ceilings on hours, dollars, and fees to establish cost limitations through project and funding levels; different project types can also be specified [fixed fee, time and materials (T&M), T&M with mark-up (Cost Plus in Microsoft Dynamics AX), etc.]. However, indirect cost ceilings are not supported due to the indirect cost feature gap. For T&M project variants in Microsoft Dynamics AX, a cap on labor cost and expenses can be set. Indirect cost limitation is approximated based on direct costs a provisional mark-up approach. The gap can be filled by journalizing or doing a manual adjustment outside of the system. Configuration: Within Microsoft Dynamics AX, limitations on cost elements at contract (billing level) can be expanded through association of multiple projects to one contract. A hierarchy of subprojects can also be set up to create various levels with associated activities at the lowest level. Any of these levels can have restrictions by type of cost and restrictions may be imposed across branches in the hierarchy. Budgeting and forecasting can also be done at any level. T&M with markup ( Cost Plus ) cost limitation budget plans in Microsoft Dynamics AX can offer soft warnings or hard stops when spending is about to exceed the set limitation. A customization is required to set up IDIQ/GSA schedules within the system. A Project Status Report (PSR) can be generated through customization for what will need to be displayed on the report. Gap: Data level adjustments can only be performed by an administrator, not an end user AR Billing Billing cap capabilities in Microsoft Dynamics AX may be applied to any charges against the project categorized by activities or items (i.e., labor, other direct costs, travel, and mark-up). As the system does not have a built-in indirect cost allocation mechanism, it cannot automatically generate invoices for cost reimbursable contracts. Allowing the user to automatically calculate indirect costs based on direct costs and including those costs in the invoice would increase efficiency and reduce the need for manual entries. Additional billing features such as the following would improve system usability: 28 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

29 i. Displaying YTD, cumulative, contract to date costs ii. Automatically calculate and display amount in excess of contract iii. Ability to break down project for billing by task iv. Ability to set up a fixed fee based upon different contracts or scenarios. Currently fee is based on totals. Customization: Billing can be done at the project level by design. Billing by sub-project or by type of transaction can be done manually. Customization can set billing to a lower level of granularity (i.e. ACRN or CLIN level) in the system. 6 Considerations in selection of an ERP for government contracting When making an ERP selection, contractors and prospective contractors should consider two routes: rely on a specialized ERP, one developed specifically for government contractors, or choose to use a multi-industry ERP that requires customization. Software that has been developed with the goal of providing maximum compliance features provide certain key controls and software-based rules that implement the requirements discussed earlier. Specifically (and this is not a full review), such products provide features and controls, such as indirect cost calculations and allocations to projects, detailed project set-up with multiple project attributes and project reporting typical for government contractors, limitations of cost, and funding audit trails for timekeeping and expenses, some automated updates related to travel expense limitations, and a multitude of other useful features and controls. Certainly, this provides the basis for deployment of a highly automated system that, combined with policies, procedures and controls that may not be system-based, can pass reviews and be deemed adequate. It also may increase the contractors confidence that the implemented ERP will pass adequacy reviews. Typically, these built-in features and controls are customizable (in order to allow contractors to approximate their business model). However, such customizations are not always constrained within the boundaries of the requirements. As a result, depending on initial set-up or subsequent mode of use, these features and controls may or may not be entirely adequate or may only partially meet adequacy requirements, even though they are implemented within an ERP developed specifically for government contractors. Since specialized ERPs are designed around federal requirements, their set-up often limits the degree to which process flows may vary to meet contractor-specific business practices. Thus contractors are faced with a choice either to modify the way they do business or to use ancillary systems to compensate for the limitations of the specialized ERP and develop interfaces, reconciliations, controls, etc. to feed data into and out of the ERP, which in turn drives costs and reduces integrity. In other words, the specialized ERP may enforce a number of rules that may force contractors to change successful proprietary business processes and potentially forsake unique efficiencies and competitive advantages. 29 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

30 Other considerations include the costs of specialized staff, over-reliance on ERP to ensure requirements are met, and costs of hiring outside consultants to fix errors or make changes that support unique organizational structures or processes. Last but not least, any specialized ERP will still need development of policies, procedures and controls (not hard-coded into the software) in order to be deemed adequate so costs associated with gap analysis and subsequent work to bridge those remaining gaps will always be part of a successful deployment. In fairness, however, it is important to recognize that such work may be less extensive than bridging gaps in a multiindustry ERP. 7 The case for multi-industry ERP in government contracting As became clear in the preceding analysis of Microsoft Dynamics AX, multi-industry ERP does have certain gaps that require customizations or ISV extensions to meet requirements. When properly identified and planned for in advance, such gaps can be successfully bridged. Provided the contractor develops, as in the case with any specialized ERP, the necessary policies, procedures and designs and implements proper controls, an multi-industry ERP would be able to pass adequacy reviews. Practice shows that many such systems do in fact pass adequacy reviews with varying degrees of preparatory work. In general, the cost of bridging gaps remaining after customizations and ISV extensions, especially until they are sufficiently tested and updated based on user experiences and feedback, may still remain higher than the comparable cost of a specialized ERP. However, multi-industry ERP can provide specific advantages to contractors in allowing better adaptation to a large variety of processes and business models without the inherent constraints of a specialized ERP. This simply means that contractors need not alter successful proprietary business processes or forsake efficiencies and competitive advantages in order to achieve compliance. This observation is especially valid for new entrants into the government contracting space who may have already successfully deployed a multi-industry ERP that is adequate for their business model and processes. In such case, having the compliance requirements met through customizations and/or ISV extensions may be a distinct advantage to the contractor and the overall cost could be lower since the implementation cost would be already sunk cost. This scenario is a typical dilemma that has to be resolved by numerous companies. In conclusion, no ERP software is compliant out-of-the-box, and depending on the situation, multiindustry ERP can be a viable alternative. Compliance is not optional, but there are many ways to deploy an adequate ERP and contractors and prospective contractors have multiple choices to achieve compliance and successfully pass the applicable business system reviews. The ERP selection decision should not be based only on the degree of compliance an ERP provides, but also on factors related to an ERP s ability to best fit contractor s business needs and support efficient operations while being able to meet compliance requirements. 30 Government Contracting and Microsoft Dynamics AX v1.0 Microsoft

31 Microsoft Microsoft members successfully deliver Microsoft Dynamics solutions that help customers pass DCAA audits, elevate project management and accounting capabilities, and improve capture management processes. Through the, government contractors can access solution providers that strike a better balance between the regulatory mandate for compliance and the business imperative for flexibility and agility. United States and Canada toll free: (888) Worldwide: +1 (701) Microsoft Corporation. All rights reserved. This document is provided "as-is." Information and views expressed in this document, including URL and other Internet Web site references, may change without notice. You bear the risk of using it. This document does not provide you with any legal rights to any intellectual property in any Microsoft product. You may copy and use this document for your internal, reference purposes.

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