One question we always get is how to account for uncompensated overtime. Almost every small business has at least one employee working gazillion hours over a standard 40-hour work week. The DCAA considers these hours "at work labor." They want these hours captured in the name of treating all contractors accounting and pricing systems equitably and consistently.

Not addressing this issue successfully now poses a huge risk since DCAA auditors have no wiggle room in overlooking it as a minor problem. Any deficiency in your accounting system will likely lead to a failing grade, according to the latest DCAA guidance to its auditors (see previous article). This could prevent you from obtaining lucrative flexibly-priced contracts or fixed price contracts financed through progress payments.

The DCAA way
The basic DCAA audit guidance for addressing uncompensated overtime is very simple and straight-forward. They will divide your yearly salary by all the hours you worked and used for personal time off. This results in your "effective" billing rate. The DCAA expects you to adjust your rate in your accounting system each pay period to reflect this effective rate. The drawback to this system is contractors have to make these adjustments in their accounting system every pay period. It also artificially reduces your hourly rate. The DCAA will use this lower rate when evaluating any proposal you have submitted to the government or a prime.

A better way
The DCAA guidance does recognize other methods as being suitably fair and consistent. One approach lets you use your existing timekeeping system to segregate your "extra effort" hours, dollarize those hours, and direct those dollars to the appropriate place on your balance sheet as a liability, similar to how you might already treat regular accrued wages. Periodically, you can bring those dollars back to the income statement as a credit expense in an indirect pool. This reduces your pool costs, which gives the government credit for your extra work. You also won't have to adjust your billing rates in your accounting system or for proposals.

Everyone's happy, even the DCAA. That's what life's all about for government contractors, right?

Provisional Rates

Over the last year or so the DCAA has focused attention on larger government contractors.  Many smaller businesses may feel left out since they have not been visited by the DCAA.  More likely, they may feel that everything is "ok" since for most of us "no news is good news".  Our Account Managers here have been hearing bits of news from various sources that this might change in 2012.  First, the DCAA is apparently going to focus more on completing Incurred Cost Proposal audits in 2012, especially from smaller contractors.  The backlog of Incurred Cost audits was estimated to have quadrupled over the last 10 years but even DCAA Director Fitzgerald didn't know the exact number in a meeting with Senators Brown (R-MA) & McCaskill (D-MO) in  February last year.  Rest assured the number is huge.  We have recently seen clients that have received letters from the DCAA that demand the Provisional Billing Rates for Jan. 1, 2012 thru Dec. 31, 2012 be completed and turned in to the DCAA by February 1, 2012.  So we are seeing focus not only on the provisional rates (Ref Far 42.704(b)) but we expect to see a focus on cleaning up the backlog of Incurred Cost Proposals.  Both of these efforts will affect small business contractors.  The Provisional rates affect your ability to bill the government in the near future.  Once the DCAA audits the Incurred Cost Proposals the provisional rates become final rates.  The government is bound to payment based on the final indirect rates so these are very important numbers.  If your final indirect cost rates are lower than your provisional indirect cost rates, then the contractor could be liable for repayment to the government.  The important message for all government contractors is twofold: 1) it is important that your provisional rates are calculated correctly so that they come as close as possible to the final rates and 2) it is important that your Incurred Cost Reports are correctly done and accurate.  We envision spending a lot of time on those two areas this year.  It would be wise for all government contractors to do the same.

There may be a perfect storm brewing in the government contracting world that will make it harder to do business with the federal government.  It started in July of 2008 when the Government Accountability Office (GAO) issued a report that 3 of 3 DCAA audits showed inadequacies in the DCAA's performance of the audits.  This was followed up with another GAO investigation in September of 2009 that indicated a widespread problem within the DCAA organization.  As a result the DCAA went through 3 directors in a little over a year.  Major reform was announced and the DCAA is performing audits strictly to the book now, with only a "pass/fail" grade issued.  But even with this increasing dose of compliance issues for contractors, there continues to be problems.  Does it seem to you that we are hearing more about federal contractor fraud cases lately?  And then how about the case where government contractor executives are paid excessive salaries?  Many contracts suffer from cost overruns and late deliveries.  Combine all of this with the current economic crisis and the emphasis on cutting the federal budget and we have a perfect storm focused on government contractors.  What does this mean?  I think it will mean more scrutiny on government contractors, more emphasis for compliance and certainly more emphasis on performance.  There will be more difficulty for firms to survive in the government marketplace that do not meet all he compliance issues and/or that don't perform on-time and either on budget or under budget.  The contractors that can do this will be rewarded.  The contractors that cannot perform to this new standard will be rapidly pared from the market.  Companies that have an experienced staff to respond to all the government's compliance issues will prosper.  Companies that do not have significant experience in this area need to shore up that weakness.  Outsourcing this function can strengthen a company and assure survival.  Tech BizSolutions staff has the experience to offer to these companies in need of this service.  Call us today if you need to address a weakness or potential weakness.  We can help.

In helping a client recently with some contract closures, it became quickly apparent that the DCAA was way behind in getting to the audit of the system to close out this contract.  It became quickly apparent that there are several risk factors for this happening.  First the contract work will be in the distant rear-view mirror by the time the audit takes place.  The chance of misplaced records and forgotten tasks becomes much greater as more time passes.  Such omissions could result in the government disallowing costs that would change the indirect rates.  This could end up costing the company money.  To mitigate this risk, it can be in a contractor's best interest to try to have the government perform what is called the quick closeout procedure.  This is described in FAR 42.708.  This clause allows the Contracting Officer (CO) to negotiate the settlement of indirect costs for a specific contract.  There are a couple of requirements to be able to use this clause.  First the contract must be complete.  Then the contract's unsettled cost must be relatively insignificant.  For the government, insignificant usually means unsettled indirect costs of less than a million dollars for one contract.  There are provisions for restrictions to not exceed 15% of the estimated total unsettled indirect costs allocable to cost-type contracts for that year too.  It is worthwhile to talk with your CO to see if an agreement could be reached to close out the contract so you don't have to wait for the DCAA to "wade" through their backlog and get to your specific contract.  By the time they get to it, you could end up with a penalty that you didn't anticipate.

Over the years we have had many inquiries from government contractors about evaluating their accounting systems for adequacy before they actually undergo a DCAA audit.  This actually makes sense in today's environment.  The risks associated with failing a DCAA audit are greater today than they were even 5 years ago.  The DCAA is also less forgiving today than it was 5 years ago and the combination can have a disastrous impact on a small government contractor.  (Actually it can have a bad impact on a large government contractor too).  The risks of failing the audit include delayed payments (cash flow problems can be the "kiss of death for a small business"), reduced  contract opportunities and even barred from further contracting with the government.  So it makes sense to evaluate your system prior to the DCAA evaluating the system, identify gaps in compliance and then fixing these gaps.  Then you can feel confident that when the DCAA does come in to audit the system that it will pass.  Any system evaluation (we call this an Adequacy Audit) should include a look not only at the accounting system but also a look at the written policies and procedures, the timekeeping system, the purchasing system, indirect rate determinating system and the invoicing system.  This simple evaluation and resulting corrective actions could save many government contractors the pain and problems of failing a DCAA audit.  Visit the Tech Biz Adequacy Audit page to learn more.

Many of our clients have noticed a "different" DCAA recently.  Other clients have noticed that there is a difference in their subcontracts with major primes.  All of them don't understand how they could have been doing the same type of contracting in the past without this type of scrutiny and why has that changed?  Well, we have to go back about 18 months.  The DCAA was audited by the Government Accountability Office (GAO) and found to have errors in their audits.  A second review by the GAO disclosed further and more widespread problems.  Then the Senate got involved (Homeland Security and Government Affairs Committee) and the DCAA came under close scrutiny.  Shortly thereafter, the head of the DCAA was dismissed.  To make a long story short, the DCAA has come under intense scrutiny and criticism over the last 18 months.  Many changes have been implemented at the suggestion of everyone in authority.  Ok, but what does that mean?  It means that the DCAA's reaction is also severe.  The DCAA is following all the regulations (FAR, CAM, GAGAS, and more) to the letter.  As a matter of fact, some of the GAO criticism and Senate committee criticism centered on the fact that DCAA supervisors over-rode auditor findings and recommendations.  Other findings centered on audits being done too fast without focusing on the quality of the audits.  The DCAA response is obviously to hire more auditors so that they won't fall further behind, while doing more thorough audits.  The other obvious change is that DCAA audit supervisors are resistant to over-ride an auditor's finding.  Well, if the auditor is not using common sense or is just "off-base", it is not getting thrown out like before.  Likewise, previously the DCAA auditor would provide an audit report that "passed with some recommendations".  Today the contrator either passes or fails the audit, no more intermediate grades.  This means compliance is harder, especially for smaller businesses.  This trend is likely to continue for some time.  Contractors will find it more difficult to comply with all the rules, especially if they are not fully accustom to the government regulations.  Government contracting is becoming more difficult.  Most contractors either need to have an "expert" on staff or they need to outsource expertise to insure compliance.  

In the previous two articles in this series we looked at what is required for a DCAA timekeeping system and what types of systems will meet these requirements.  Today I want to look at how the DCAA monitors these systems and what you, as a government contractor, might expect to be compliant. I think you can fairly assume that any time the government comes to your facility to do an audit (pre-award audit, system audit, or other) that they will be interested in looking at your timekeeping system.  But there are also other types of ways that they will check up on contractors timekeeping systems.  This is usually called a Labor Floor Check.  This is where a DCAA auditor shows up at your facility unannounced and randomly samples a few employees and checks for their understanding of the system and how they fill out their timesheets.  They have a detailed audit program that they follow from their Contract Audit Manual and it could be worth while to familiarize yourself with exactly what they might be looking for.  They will be looking for standard stuff like is the employee actually at work, do they know what to charge their labor to, are they recording their labor times daily, do they know the company procedure for timekeeping and are they following it.  There are also guidelines for the auditor to follow if you have remote employees or "work at home" employees.  These two areas are possible areas of misuse and of keen interest to the auditor.  You can be certain that if the auditor finds dicrepancies that your contracting officer will hear about it.  If you cannot resolve these findings with the auditor and/or contracting officer, there can be serious consequences.  All the more reason to make sure your timekeeping system is a good system and you have trained employees to use it properly.