2016 Incurred Cost Proposals: A Year In Review Ryan Koenitzer, CPA March 8, 2017 RKI (USG Contracts Practice)

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2016 Incurred Cost Proposals: A Year In Review

What do we want to learn from this presentation. https://www. youtube What do we want to learn from this presentation? https://www.youtube.com/watch?v=ux9HEjDCb38 Not This

Why Changes in USG ICP Process are Significant DCAA Backlog AGENDA Why Changes in USG ICP Process are Significant DCAA Backlog Changes to ICE Model and Adequacy Checklist Unallowable Costs Compensation Limits Changes in Audit Focus

WHY CHANGES IN USG ICP PROCESS ARE SIGNIFICANT U.S. Government, like a company, is an evolving organization Changes in their people, process, or technology have both an internal and external impact Monitoring of changes is essential to ensuring: Compliance; Optimizing recovery of allowable costs Having a common understanding with USG customers/auditors for healthy dialogue 2016 was a busy year with regards to Incurred Cost Proposals Focus on what each change means to the ICP process

DCAA BACKLOG Stated in DCAA’s 2015 Report to Congress as the “top priority” 2015 highlights heading into 2016: A reduced employee count of 278 (of a total of approx. 4,300 Completed 1,925 ICP audit reports Closed 9,400 incurred cost years DCAA prohibited from performing non-DoD audits (superseded 9/30/16) 2016 report typically released in March

So What? DCAA BACKLOG Your auditor may be different: DOE and NASA have engaged private CPA firms; others potentially to follow You may be de-risked! If you are delinquent, you must submit or wind up in a total contract cost decrement circumstance (up to 16.4%) DCAA is catching up – Other audit focus likely: ROI audits (Estimating and Forward Pricing) DFARS Business Systems - 675 required, 22 occurring

Changes to ICE Model and Adequacy Checklist Recent history of changes to ICE Model: October 2016: Heading change to supplemental schedule C December 2015: Additional Schedule J information required including: DUNS numbers for subcontractors Prime contract value to which subcontract pertains

Changes to ICE Model and Adequacy Checklist Recent history of changes to Adequacy Checklist: June 2016: Addition of Advance Agreements for Exec Comp August 2015: Clarifying some of the checklist items related to inter-schedule tie-outs Adding a tie-out between Schedule H and Schedule J for subcontract costs Adding a final overall determination of adequacy section

Changes to ICE Model and Adequacy Checklist So What? Use the current version of the ICE Model (v. 2.0.1f October 2016) if you want a happy DCAA auditor Always evaluate your proposal against the current version of the DCAA Adequacy Checklist - they change

Unallowable costs Expressly Unallowable Costs DCAA issued two MRDs clarifying their interpretation of expressly unallowable costs: 12/14 1/15 These MRDs were used by auditors in FY2016 audits

Unallowable costs Definition (1/15 MRD): Expressly Unallowable Costs “In order for a cost to be expressly unallowable, the Government must show that it was unreasonable under all the circumstances for a person in the contractor’s position to conclude that the costs were allowable. Thus, a cost principle makes costs expressly unallowable if: 1. It states in direct terms that the costs are unallowable, or leaves little room for differences of opinion as to whether the particular cost meets the allowability criteria; and 2. It identifies the specific cost or type of costs in a way that leaves little room for interpretation”

Unallowable costs Expressly Unallowable Costs “In summary, a cost can be expressly unallowable even though the cost principle does not explicitly state that the cost is unallowable or not allowable.” “The Government must establish that it was “unreasonable under all the circumstances for a person in the contractor’s position to conclude that the costs were allowable.” Defined 110 expressly unallowable cost principle references Perhaps more than industry has previously interpreted

Unallowable costs Expressly Unallowable Costs Penalties apply to contracts covered for costs expressly unallowable under a cost principle in the FAR: Amount of the disallowance plus interest on the paid portion Two-times the Costs if previously determined to be unallowable in a prior proposal Waiver of Penalty (709-5) Proposal withdrawn before the audit entrance conference or Government provides written notice of audit Amount of unallowable costs subject to penalty is $10K or less Contractor has established policies, internal controls & training Unallowable costs were inadvertently included (Error)

Unallowable costs DCAA Selected Areas of Cost Guidebook Penalties apply to contracts covered for costs expressly unallowable under a cost principle in the FAR: DCAA recently released on their website new audit guidance related to cost allowability (FAR Subpart 31.2) The new guidance is evolving and is in process; however, 13 areas of cost have been revised from the prior guidance in Chapter 7 of the CAM Of note, the guidance related to professional and consultant service costs stresses the need for auditor judgment when assessing if the three requirements for allowability exist - agreement, sufficient invoice and evidence of work performed Link: http://www.dcaa.mil/SelectAreasCost.htm l

Unallowable costs So What? Potential fines and penalties for DCAA defined “expressly” unallowable costs Questioned costs due to insufficient documentation regarding consultants and professional services Incorporate current DCAA interpretations into your internal unallowable cost guidance Be prepared to have a healthy exchange with DCAA based on published guidance

Compensation limits Compensation Limits Bipartisan Budget Act of 2013 Removed authority of the Office of Management and Budget, Office of Federal Procurement Policy (OFPP) to establish executive compensation limits Congress now sets the compensation limits applicable to ALL employees of contractors doing business with ANY Government agency Changed the applicability of the caps from fiscal year to year of contract award, significantly increasing the complexity of cost reporting (ICS) requirements

Compensation limits Compensation Limits

Compensation limits Compensation Limits Defense Procurement and Acquisition Policy Memo Recognized the challenges associated with applying multiple compensation caps emerging as a result of the Bipartisan Budget Act…attempted to find a solution Recommended a “blended rate” solution: Weighted average based on contract volume before and after June 24, 2014. Contractors aren’t required to use the approach. The memo actually suggests that contractors are free to apply the $487,000 cap to ALL contracts regardless of award date! Contractor use of the recommended “blended rate” method requires an Advance Agreement with the contracting officer. (MRD: http://www.dcaa.mil/mmr/16-PSP-005.pdf)

Compensation limits Compensation Limits Executive compensation review alone is not enough to support allowability of compensation – reasonableness criteria still must be evidenced Evolving space – contractors have experienced an increased standard on compensation surveys, and similar, to substantiate compensation beneath exec comp thresholds Be mindful of national blended salary surveys unadjusted for location and cost of living – one size does not fit all Costs are being questioned if a formal, documented Compensation plan with associated policies/procedures cannot be demonstrated

Compensation limits So What? If you have employees over $487,000, you must evaluate your contracting profile for a blended rate approach No advance agreement = inadequacy Too simplistic an approach may leave cost recovery on the table Questioned compensation costs if you don’t have: Market data supporting fair and reasonable comp Policies/procedures on compensation process, including all eligible bonus plans

Changes in audit focus Increased Focus on Direct Costs DCAA marked increased in the sampling of direct costs Accounting system deficiencies citing lack of adequate direct cost sampling in unallowable cost policies/procedures

Changes in audit focus Labor Qualifications On T&M Contracts 5/22/14 MRD: http://www.dcaa.mil/mmr/14-PPD-008.pdf During ICP audits, DCAA reviewing invoiced labor under T&M contracts for proof of labor qualifications Without acceptable proof, typically a resume, costs – sometimes in their entirety – are questioned Contractors may be in an untenable negotiating position

Changes in audit focus Auditing of Cost-Type Subs According to DCMA-INST 135 (IPC-1), released March 4, 2015, Section 3.2.3.2. Subcontract Costs describes “The prime contractor is responsible for auditing subcontractors… DCAA may issue a qualified indirect cost audit report indicating that audit of certain subcontract costs has not been completed…” DEAR 970.5232-3 “Accounts, Records, and Inspection”, sub-section (c) explicitly requires contractors to audit their subcontractors incurred cost proposals A number of DCAA audit reports have found that millions of subcontract (direct costs) were questioned within a number of incurred cost audits

Changes in audit focus So What? Potential Increased questioned costs surrounding: Direct costs Invoiced T&M labor Cost-type subs Potentially significant variances with subs affecting prime funding and financial accounting reserves Delays in closing contracts due to unsettled subcontractor costs DFARS Accounting system deficiencies

Wrap up 2016 was a busy year for incurred cost proposals These things affect questioned costs and your bottom line if there is not a common understanding of expectations 2017 expectations: Further reduction backlog to get current DCAA demonstration of value through: Evolving questioned cost interpretations ROI Audits Linkage to business system audits and audit leads New audit programs and new auditors

Wrap up Questions?

Thank you Ryan Koenitzer, CPA Managing Principal RKI USG Contracts rkoenitzer@rkiaccounting.com (617) 413-5438 www.rkiaccounting.com