Government Contractor Business Systems and Overview of System Assessments

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1 Government Contractor Business Systems and Overview of System Assessments

2 Agenda Overview of business systems rules and environment today 3 rd party assessments Practical solutions Contractor perspective Q&A 2

3 Business Systems Overview On February 24, 2012 the final rule pertaining to contractor business systems was published, superseding the interim rule published on May 18, 2011, which was very similar in content. The genesis of the Business Systems Rule was the promulgation of FAR , Contractor Code of Business Ethics and Business, which became effective as of December 24, One key objective of the Contractor Code of Business Ethics and Conduct regulation was to establish an internal control system that would allow for timely detection of misconduct in connection with Government contracts. 3

4 Business Systems Overview Cont d The Department of Defense ( DOD ) established the Business Systems Rule, which included mandated requirements for six contractor business systems. The business systems were a furtherance of requiring internal control systems to mitigate risks to the government in certain key areas (compliance, incurred cost, pricing, etc.). Contractor Business Systems refer to DFARS Subpart for additional guidance around business systems, deficiencies, payment withholdings, and deficiency corrections. 4

5 Six Business Systems Business System Auditing/Reviewing Party DFARS Clause Accounting System DCAA Purchasing System DCMA Earned Value Management DCMA System ( EVMS ) Estimating System DCAA Material Management and DCAA Accounting System Property Management System DCMA

6 Business Systems Applicability Although DFARS has established the Business System Rule and stipulates that the requirements apply to contracts covered by the Cost Accounting Standards ( CAS ), contracts that do not contain the DFARS respective Business System Rule clauses can still be subject to business system requirements as prescribed in the Federal Acquisition Regulation ( FAR ) governed by specified dollar value thresholds or other requirements (such as the SF 1408). 6

7 Accounting System DFARS clause (a)(2) Defined as a system or systems that the contractor utilizes, which summarizes and encompasses its accounting: Methods Procedures Controls The accounting system is established for the purpose of gathering, recording, classifying, analyzing, summarizing, interpreting, and presenting accurate and timely financial data for reporting in compliance with the applicable laws and regulations. 7

8 Purchasing System DFARS clause (a) Defined as system of systems that implements: Purchasing goods and/ or services Subcontracting Within the purchasing system, the contractor shall have criteria established for: Make-or-buy decisions Selection of vendors Analysis of quoted prices Negotiation of prices with vendors Placing and administering orders Expediting delivery of materials 8

9 Estimating System DFARS clause (a) Defined as a system that includes appropriate policies, procedures and business practices for: Budgeting and planning controls Generating estimates of costs and other data included in proposals submitted to customers The Contractor s estimating system shall provide for the use of appropriate source data, utilize sound estimating techniques and good judgment, maintain a consistent approach, and adhere to established policies and procedures. 9

10 Property Management System DFARS clause (a) Defined as a system or systems for the purpose of managing and controlling Government property Criteria for an acceptable Property Management System is stipulated in in DFARS (c). Additionally, contractors must maintain a property management system in accordance with FAR (f), which requires establishing and implementing property management plans, systems, and procedures that include the basic elements of the Government property system at the contract, program, site or entity level. 10

11 Material Management and Accounting System DFARS clause (a) Defined as a system or systems designed for: Planning Controlling Accounting for the acquisition, use, issuing, and disposition of material. Material management and accounting systems may be manual or automated Additionally, they may be stand-alone systems or they may be integrated with planning, engineering, estimating, purchasing, inventory, accounting, or other systems. 11

12 Earned Value Management System (EVMS) DFARS clause (a) In general, EVMS is a system that establishes procedures in order to manage a project s: Scope Schedule Budget These management procedures are designed to provide timely, reliable and verifiable information for both the Contract Performance Report ( CPR ) and the Integrated Master Schedule ( IMS ) as required by the CPR and IMS data requirements set forth in the contract. 12

13 Business Systems Approved vs. Disapproved Contractors business systems will be deemed either approved or disapproved. As a result, opinions rendered by DCCA and DCMA will not define a business system as inadequate in part. The defining element for approved vs. disapproved business systems is determined with the new phrase significant deficiency and whether or not one or more than one exists. Significant deficiency is defined as any shortcoming in the system that materially affects the ability of officials of DOD and the contractor to rely upon information produced by the system that is needed for management purposes. A single significant deficiency in any one of the six business systems will trigger disapproval of that system and may result in withholding on invoices. 13

14 Business Systems Approved vs. Disapproved Cont d Approved business system Contractors who have approved business systems can reap the rewards that come along with it and include the following: Ability to submit proposals with the confidence of a compliant and effective business system. Deferring attention away from other potential business system audits/reviews. Disapproved business system (under DFARS rule) Contractors who do not have an approved business system will face financial difficulty and will be subject to the following: A single deficiency in one system will result in a withholding of payment at a capped five percent on affected contracts. More than one deficiency (whether in one system or across multiple systems) will result in a withholding of payment at a capped ten percent on affected contracts. 14

15 Business System Rule vs. Other System Audits/ Assessments While the repercussions of disapproved system under the DFARS Business System Rule impact only a limited number of contracts (CAS covered contracts with the DFARS clause incorporated), audits and assessments of systems under other regulatory authority (such as the FAR) is migrating towards the audit/review plan of systems under DFARS. 15

16 1408 Accounting System Review Most likely, contractors will be subject to an accounting system review when submitting a proposal for a flexibly priced contract and will be required to complete Standard Form ( SF ) 1408, Preaward Survey of Prospective Contractor Accounting System. Contractors can engage third-party consultants to conduct a 1408 accounting system assessment prior to governmental review to ensure they are meeting the compliance requirements. Primary Accounting System Requirements (summary level) SF 1408 Project cost accounting detail is maintained (direct vs. indirect costs) Indirect costs are correctly allocated to the appropriate accounts Unallowable costs are distinctly tracked and segregated Timekeeping system exists that clearly identifies employees labor by intermediate or final cost objectives Contract administration is upheld throughout contract life-cycle 16

17 DCAA and DCMA Current State Due to the publics concern regarding contractor fraud, waste, and abuse, federal agencies have realigned their focus of attention and placed increased emphasis on contractor internal controls and business systems. The Defense Contract Audit Agency ( DCAA ) and Defense Contract Management Agency ( DCMA ) have been assigned to assess internal controls and business systems of contractors. This undertaking by DCAA and DCMAA should also serve to help mitigate the publics concern of contractor fraud, waste, and abuse. 17

18 DCAA and DCMA Current State Cont d Federal agencies who rely on DCAA and DCMA to conduct field audits and reviews of contractors business systems are becoming frustrated with their: Inability to close out contracts Due to large outstanding backlog of incurred cost submissions Budget uncertainties Difficult to prioritize action items Additionally, agencies are unable to award contracts in a timely manner due to the holdup created by DCAA and DCMA. 18

19 Contractor Solution Among other things, DCAA and DCMA are tasked with reviewing and assessing contractors business systems, however, they have limited resources and a large backlog of audits in which need to be completed, making it very difficult to get either agency to review or audit a business system. Due to the large backlog of audits and nature of DCAA and DCMA s limited presence, contractors could benefit largely from engaging third-party independent consultants to assess the compliance and effectiveness of their business systems. Third-party independent consultants performing system reviews can serve several purposes, including: 1. Relieve the workload of DCAA and DCMA so that they can focus their efforts on higher priority tasks (i.e. closing out contracts). 2. Contractors can get their systems reviewed for adequacy without the delay of waiting for DCAA and DCMA. 19

20 Third Party System Assessments Though DoD COs have recently just accepted the concept of third party system assessments as a viable alternative to performing audits/assessments themselves, other civilian agency COs had already adopted the practice. For example, the Department of Energy has historically incorporated language into their RFPs allowing for third party system assessments. GSA has also allowed for third party system assessments (MOBIS). Additionally, prime contractors have historically allowed for third party system assessments. This provides prime contractors with support that they have adequately selected a subcontractor under the proper type of subcontract. 20

21 Government Audits Compliance audits performed by the government have certain restrictions that third party assessments do not, such as: The auditor must follow GAGAS A governmental audit requires the auditor express an opinion on internal controls, financial reporting, and compliance with contract/grant terms These and other restrictions produce rigidity in how assessments/audits are performed, which could be detrimental to contractors, both in terms of cost and value derived from the assessment/audit. 21

22 Process of Engaging Third Party Consultants When contractors determine they have a need to hire third-party consultants for business system reviews, contractors will typically take the following steps: 1. Define the scope of work and timeline schedule for completion; 2. Seek out prospective third-party consultants that are capable of completing the tasks and have the appropriate resources for the required completion of work; 3. Select appropriate third-party consultant and sign an engagement letter 22

23 Process of Engaging Third Party Consultants Cont d 4. Continuously provide support to third-party consultant personnel to facilitate work flow; 5. Converse with third-party consultants on findings resulting from reviews; 6. Remediate any noted deficiencies that were highlighted in the review process; 7. Establish internal controls policies and procedures for the applicable system(s) to avoid further deficiencies; and 8. Close out the engagement and ensure there is an understanding of the system compliance requirements for potential future audits 23

24 Benefits from Engaging Third Party Consultants Contractors who engage third-party independent consultants can reap several benefits, including: Competitive advantage: contractors who gain assurance that their systems are compliant are at a competitive advantage over peer firms and can assert confidence that their systems are ready for audit on a post award basis for the applicable system. Operational effectiveness of business systems: contractors with effective systems gain business advantages over peer firms that have ineffective or nonexistent systems. Some benefits that could be realized include: cost savings, more effective pricing, leaner management, etc. Additionally, should an audit be conducted, the contractor should be able to allocate fewer resources to supporting the audit. 24

25 Benefits from Engaging Third Party Consultants Cont d Identification of system gaps: Because DCAA and DCMA have become highly reluctant to identify any system deficiencies to the granularity required for effective remediation, contractors will be able to receive that missing granularity from hiring third-party independent consultants and a specific path forward for system remediation (if necessary). Mitigation of independence issues: Because of restrictions associated with government auditing standards, third-party independent consultants will not usually assess contractor systems under the framework of an attest engagement, but rather conducted through a consulting engagement. With the absence of independence issues (which emanate from attest engagements), consultants can serve in more of a business advisor capacity when compared to an auditor. Ability to correct weaknesses before audit trail exists: Before DCAA or DCMA is tasked with auditing a particular system and noting deficiencies, contractors who engage independent consultants to assess their systems can enjoy the benefit of being able to remedy any identified deficiencies before an audit trail is created. 25

26 Let s Hear from Someone Who s Been There. Done That: Introduction: Rich Matuszko, CEO, Excet, Inc. How did the issue of a 3 rd Party Review of your accounting system arise? Who handled the heaving lifting when CB performed their review? Did the CPA firm identify anything that they felt should be changed? Did the CPA firm issue a formal report? Was the report issued to your Company directly or was it provided to the DCAA or some other agency? 26

27 Let s Hear from Someone Who s Been There. Done That: Did you think the 3 rd Party Review Process was arduous? Did you ultimately get a acceptable report? Did you ultimately win the contract that prompted the review? 27

28 Questions? 28