Audit Issues In Government Subcontracting

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2 Audit Issues In Government Subcontracting Breakout Session E Brent A. Calhoon, CPA, Partner, Baker Tilly Virchow Krause, LLP Janie L. Maddox, CPCM, Fellow, Thursday, March 27 1:30pm 2:45pm

3 Agenda 1. Introductions and Opening Remarks 2. Audits where Subcontracting Issues Arise 3. Top 10 Subcontract-related Audit Issues 4. Q & A 2

4 Common Audits where Subcontract-related Issues Arise Defense Contract Management Agency (DCMA) Contractor Purchasing System Reviews (CPSRs) Defense Contract Audit Agency (DCAA) Pre-award Audits (price negotiation objective) Post-award Audits (defective pricing and FAR/CAS compliance) Incurred Cost Audits (FAR/CAS compliance) Department of Labor (DOL) Prevailing Wage and Benefit Compliance 3

5 Audit Issue #1 Contractor cannot demonstrate subcontract price is fair and reasonable Arises during DCMA CPSRs and DCAA pre-award, post-award, and incurred cost audits Essential element of purchasing system criteria (DFARS ) and consent to subcontract requirements (FAR ) Issue: Contractor cannot demonstrate price/cost analysis (initial award price and/or change orders), and source selection decision Potential Consequences: Significant deficiency in purchasing system Withholding of consent to subcontract (may impact performance period) Weakened negotiation position (if pre-award audit) Cost disallowance as unreasonable (FAR ) 4

6 Audit Issue #2 Contractor cannot produce adequate supporting documents Arises during some DCAA post-award audits, but primarily during incurred cost audits Issues: FAR (d) requires contractors to maintain documents to support Costs were incurred Costs allocable to contract Costs allowable in accordance with FAR part 31 Potential Consequence: Cost disallowance as unsupported if any one or more of three criteria above not addressed 5

7 Audit Issue #3 Subcontractor labor category non-compliance Arises most often during DCAA post-award and incurred cost audits Contractor responsible for verifying subcontractor personnel meet labor category qualifications Two primary issues: Contractor cannot demonstrate compliance (documentation issue) Contractor did not verify compliance (process issue) Potential Consequence: Subcontract costs and prime contractor billings (at price) will be questioned for personnel with no demonstrated qualifications The entire cost/price for a labor category non-compliance will be questioned (even if it is clear personnel meet the quals of another labor category) Sometimes turns into False Claims Act allegation 6

8 Audit Issue #4 Contractor s procurement policies, procedures and internal controls do not comply with regulations Arises primarily during DCMA CPSRs; maybe DCAA audits An internal control design effectiveness issue if policies and procedures do not address regulatory requirements, it is unlikely contractor will meet regulatory requirements Common examples of weaknesses/shortcomings: Required Flowdowns Subcontractor responsibility determinations Prime contract flowdowns Small business plans Excluded parties Negotiation memoranda Potential Consequence: Significant deficiency in purchasing system 7

9 Audit Issue #5 Contractor does not follow consistently its procurement policies, procedures and internal controls Arises primarily during DCMA CPSRs; may arise during DCAA audits An internal control operating effectiveness issue policies and procedures provide appropriate instruction, but contractor doesn t follow them consistently Common inconsistencies: Quality of cost/price analysis Market Research Basis of award Sole source justifications Negotiation memoranda Potential Consequence: Significant deficiency in purchasing system 8

10 Audit Issue #6 Excessive pass-through charges Arises during DCAA post-award audits; may see more often when DCAA begins to audit 2008 and later incurred costs Issue: contractors must demonstrate value-add in connection with subcontracted efforts Contractor either didn t add value, or Contractor cannot demonstrate added value Potential Consequences: Disallowance of all indirect costs allocable to subcontract costs Disallowance of contractor s FEE applicable to subcontract costs 9

11 Audit Issue #7 Subcontractor does not comply with Service Contract Act or Davis Bacon Act Primarily arises during Department of Labor audits Rarely arises during DCAA audits because costs are too low Two primary issues: Contractor did not flow down required clauses in subcontract, or Contractor didn t oversee compliance and subcontractor did not comply with clauses and contractor didn t oversee compliance Consequences: Contractor responsible for subcontractor s back-pay and fringes Increased costs not recoverable on FFP and T&M contracts Increased costs likely not recoverable on cost type contracts Subcontracts should include appropriate indemnification clause 10

12 Audit Issue #8 Subcontract defective pricing Arises during DCAA post-award audits For subcontracts covered by Truth in Negotiations Act (TINA), contractors must obtain, analyze and use subcontractor cost or pricing data to establish & negotiate a fair & reasonable price Issue: DCAA performs assist audit of subcontractor proposal (post-award) and discovers defective cost or pricing data Data would have resulted in lower negotiated subcontract price Not contractor s fault, but Potential Consequence: Contractor responsible for the effect of the defective subcontract price impact on the prime contract price Subcontracts should contain appropriate indemnification 11

13 Audit Issue #9 Contractor did not administer CAS on covered subcontracts Arises during DCMA CPSRs, as well as DCAA post-award and incurred cost audits Contractors are responsible for subcontractor CAScompliance (if no Cognizant Federal Agency Official assigned) Disclosure Statement Adequacy Resolution of Cost Accounting Practice changes Resolution of non-compliances Particularly difficult with foreign concern subcontractors Common for subcontractors to deny prime access to accounting records; thus, DCAA performs assist-audit Potential Consequences: Cost impacts resulting from cost accounting practice changes or noncompliances are prime contractor s responsibility Subcontracts should include indemnity clause 12

14 Audit Issue #10 Contractor does not obtain consent to subcontract Arises primarily during DCMA CPSRs and DCAA postaward audits FAR requires contractors to obtain CO consent to subcontract if contractor does not have approved purchasing system FAR clause does not address contractor s failure to obtain DCAA audit manual instructs auditors to suspend costs despite no contractual authority to do so Potential Consequence: Significant deficiency in purchasing system Cost disallowance (but under what authority?) 13

15 Questions, Comments, & Banter Brent Calhoon, CPA Partner Baker Tilly Virchow Krause, LLP Janie Maddox, CPCM, Fellow 14

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