By: Curt Smith, Manager and John Ford, Senior Consultant
Many contractors deal only with the Defense Contract Audit Agency (“DCAA”) on audit matters. For several years, we have presented a webinar on the latest developments concerning DCAA. 2018 was a slow year for DCAA with few new matters arising. However, a substantial number of contractors do business with other agencies who conduct contract audits. Further, many contractors also receive grants or cooperative agreements from various agencies that have audit requirements in them.
In January 2019, Cherry Bekaert presented our annual “Hot Buttons” webinar where we addressed issues with audits by other agencies and audits of grants and cooperative agreements. Below is a summary of the information presented.
A. Congress in Section 803 of the fiscal year (“FY”) 2018 National Defense Authorization Act (“NDAA”) added a new section – 2313b Performance of Incurred Cost Audits – to title 10 of the U.S. Code.
- The Secretary of Defense shall use qualified private auditors to perform a sufficient number of incurred cost audits of contracts of the Department of Defense to:
- eliminate, by October 1, 2020, any backlog of incurred cost audits of the Defense Contract Audit Agency; and
- ensure that incurred cost audits are completed not later than one year after the date of receipt of a qualified incurred cost submission.
- Not later than April 1, 2019, the Secretary of Defense . . . shall award a contract or issue a task order under an existing contract to two or more qualified private auditors to perform incurred cost audits of costs associated with contracts of the Department of Defense (See DFARS 237.270, Enclosure 15 to DoDM 7600.07 and Enclosure 3 to DoDI 7600.02 for guidance on contracting for audit services.).
- The Secretary of Defense shall notify a contractor of the Department of Defense within 60 days after receipt of an incurred cost submission from the contractor whether the
submission is a qualified incurred cost submission (FAR uses the term “adequate”).
- With respect to qualified incurred cost submissions received on or after the date of the enactment of this section (December 12, 2017), audit findings shall be issued . . . not later than one year after the date of receipt, not the date of determination of adequacy, of such qualified incurred cost submission.
- Not later than October 1, 2020, if audit findings are not issued within one year after the date of receipt of a qualified incurred cost submission, the audit shall be considered to be complete and no additional audit work shall be conducted.
Comments: 1) There appears to be a gap between the date of enactment of December 12, 2017, and October 1, 2020, in which DCAA will not be required to submit audit findings within one year from the date of receipt of a qualified incurred cost submission without consequences. Note that it is only after October 1, 2020, that an audit will be considered complete if it is not completed within one year after an adequate submission is received. However, the NDAA requires audits of adequate submissions submitted after December 12, 2017, to be completed within one year after submission, but no consequences are provided for a failure to meet the one-year requirement until October 1, 2020. Congress may have provided this window as a grace period for DCAA to come to grips with the one-year audit timeframe. It is important to note that the one-year period for audit of a qualified submission is shortened by the time it takes DCAA to determine adequacy. For example, if DCAA took two months to determine adequacy, then DCAA would have only 10 months to conduct the audit.
2) The one-year – or less – timeframe to conduct audits of major contractor submissions could force significant change upon DCAA’s audit practices. At the least, DCAA will have to change its risk assessment practices to focus only on areas of greatest risk such as large cost – typically labor, material, and subcontracts – or those where a contractor has historically had large findings. DCAA will not be able to audit to the same level of detail as it has previously for many contractors.
3) We have not seen the Department of Defense (“DoD”) release a request for proposal or solicitation for audit services of incurred cost submissions to date. DoD may choose qualified auditors from the General Services Administration (“GSA”) Schedule instead.
B. MRD 18-PIC-001(R) Audit Alert on 2018 NDAA Section 803 Timeliness Requirement for Incurred Cost Adequacy Reviews and Audits (January 29, 2018)
- For any incurred cost submission received since December 12, 2017, the audit team must complete the adequacy review and notify the contractor of the results of the adequacy review within 60 days.
- Another important aspect of the NDAA requirement is completing incurred cost assignments within 12 months of receiving a qualified submission after the date of enactment (December 12, 2017).
Comments: We find DCAA’s lack of communication concerning this sea change in regulation interesting. Perhaps DCAA is developing guidance and appropriate responses internally before releasing them publically. Generally, DCAA released very little guidance publically in 2018, which continues the downward trend of previous years.
C. FAR 42.705-1
The procedures for determining the adequacy of contractor incurred cost submissions is found in Federal Acquisition Regulation (“FAR”) 42.705-1.
- Upon receipt of the proposal:
- (A) The cognizant auditor will review the adequacy of the contractor’s proposal for audit in support of negotiating final indirect cost rates and will provide a written description of any inadequacies to the contractor and contracting officer.
- (B) If the auditor and contractor are unable to resolve the proposal’s inadequacies identified by the auditor, the auditor will elevate the issue to the contracting officer to resolve the inadequacies.
Comments: As noted above, as currently written the time DCAA spends conducting adequacy determinations is deducted from the one-year period for audit. If DCAA elevates issues concerning adequacy to the contracting office, determination could take months thereby shortening the period for audit considerably if the contracting officer considers the proposal adequate. In addition, DCAA may be forced to audit submissions it considers inadequate due to the decision of the contracting officer (“CO”).
D. FAR 52.216-7, Allowable Cost and Payment clause
FAR 52.216-7 is the only FAR clause that requires a contractor to establish final indirect cost rates. The clause is used in all cost reimbursement and T&M FAR contracts, except those for commercial items.
- 216-7(d)(2)(iii) identifies the information that must be included in a proposal to establish final indirect cost rates “unless otherwise specified by the cognizant Federal agency official.”
- 216-7(d)(2)(iv) identifies information that may be requested during the conduct of an audit, but is not necessary to determine if a proposal is adequate.
Comments: DCAA often requests information that “may be requested” during its determination of adequacy and has refused to proceed with audit of a submission without the requested information because it considers the submission inadequate without it. Upon refusal by the contractor to provide the requested information elevation to the CO, DCAA may end up auditing submissions it considers inadequate although the proposal meets the FAR criteria for adequacy.
E. Cognizant Federal Agency
“Cognizant Federal agency” is defined by in FAR 2.101 and means the Federal agency that, on behalf of all Federal agencies, is responsible for establishing final indirect cost rates and forward pricing rates, if applicable, and administering cost accounting standards for all contracts in a business unit.
- For contractors other than educational institutions and nonprofit organizations, the cognizant Federal agency normally will be the agency with the largest dollar amount of negotiated contracts, including options. (FAR 42.003)
- For educational institutions and nonprofit organizations, the cognizant Federal agency for indirect costs is established according to the OMB Uniform Guidance at 2 CFR part 200, appendices III and IV, respectively. (FAR 42.003)
- Once a Federal agency assumes cognizance for a contractor, it should remain cognizant for at least five (5) years to ensure continuity and ease of administration. However, if circumstances warrant it and the affected agencies agree, cognizance may transfer prior to the expiration of the five-year period.
Directory of Federal Contract Audit Offices
- DCAA maintains and distributes the Directory of Federal Contract Audit Offices. The directory identifies cognizant audit offices and the contractors over which they have cognizance.
- A copy of the directory or information concerning cognizant audit offices may be obtained by contacting DCAA at the following address: Defense Contract Audit Agency, ATTN: CMO Publications Officer, 8725 John J. Kingman Road, Suite 2135, Fort Belvoir, VA 22060-6219.
F. Federal Contract Audit Offices
- DCAA has memoranda of understanding with most Federal agencies to perform audits of incurred cost submissions provided to those agencies. The time limits for the conduct of incurred cost audits contained in the NDAA do not apply to DCAA when it is conducting an audit for another agency. Further, the NDAA time limits do not apply when another agency conducts the audit.
However, some agencies perform their own contract auditing, at least for some contracts, and include:
- Department of Veterans Affairs (DVA)
- Health and Human Services (HHS)
- The Financial Management Services, Division of Cost Allocation, Program Support Center, establishes indirect cost rates, and, as necessary, fringe benefits, and other special costing rates for use in contracts awarded to State and local governments, colleges and universities, hospitals, and other nonprofit organizations.
- The National Institute of Health (NIH), Division of Financial Advisory Services, establishes indirect cost rates and similar rates for use in contracts awarded to for profit organizations.
- General Services Administration (GSA)
Comment: DCAA does not discriminate, in favor of or against, requests from other agencies to audit incurred cost submissions. All requests for audit are generally addressed equally. In other words, all requests are placed on the same slow boat for response.
G. Audit Requirements for Grants and Cooperative Agreements
The FAR only applies to procurement contracts. It does not apply to grants and cooperative agreements.
Guidance on the award and administration of grants and cooperative agreements is provided by OMB’s Uniform Administrative Requirements, Cost Principles, and Audit Requirements for Federal Awards (2 CFR 200), commonly referred to as the Uniform Guidance. The Uniform Guidance is not a regulation and agencies are required to use it as a basis for their regulations on grants and cooperative agreements.
The Uniform Guidance contains multiple terms regarding indirect cost oversight and audit.
Cognizant agency for indirect costs means the Federal agency responsible for reviewing, negotiating, and approving cost allocation plans or indirect cost proposals on behalf of all Federal agencies. The cognizant agency for indirect cost is not necessarily the same as the cognizant agency for audit.
- For institutions of higher education (IHE), cognizance is assigned to the Department of Health and Human Services (“HHS”) or the Department of Defense’s Office of Naval Research (“DOD”), normally depending on which of the two agencies (HHS or DOD) provides more funds to the educational institution for the most recent three years. (Where ONR is the cognizant agency, DCAA will conduct audits necessary to establish final indirect cost rates.)
- The Federal agency with the largest dollar value of Federal awards with a nonprofit organization will be designated as the cognizant agency for the negotiation and approval of indirect cost rates and, where necessary, other rates such as fringe benefit and computer charge-out rates. Once an agency is assigned cognizance for a particular nonprofit, the assignment will not be changed unless there is a shift in the dollar volume of the Federal awards to the organization for at least three years.
- For indirect cost rates and departmental indirect cost allocation plans of state and local governments, the cognizant agency is the Federal agency with the largest dollar value of direct Federal awards with a governmental unit or component, as appropriate. Once designated as the cognizant agency for indirect costs, the Federal agency must remain so for a period of five (5) years.
- In addition, various agencies are designated as the cognizant agency for determining indirect cost rates for specific state governmental entities. For example, the Department of Education is responsible for establishing indirect cost rates for school districts and state educational agencies.
“Cognizant agency for audit” means the Federal agency designated to carry out the responsibilities described in §200.513 Responsibilities, paragraph (a).
- A non-Federal entity expending more than $50 million a year in Federal awards must have a cognizant agency for audit. The designated cognizant agency for audit must be the Federal awarding agency that provides the predominant amount of direct funding to a non-Federal entity unless OMB designates a specific cognizant agency for audit.
- “Oversight agency for audit” means the Federal awarding agency that provides the predominant amount of funding directly to a non-Federal entity not assigned a cognizant agency for audit.
Comment: The Oversight Agency for Audit guidance applies to non-Federal entities expending less than $50 million a year in Federal awards. The cognizant agency for audit and oversight agency for audit do not conduct audits, but monitor and comment on audits that recipients are required to have performed.
H. Cost Principles for Grants and Cooperative Agreements
The Uniform Guidance provides separate cost principles for state and local governments, educational institutions, and nonprofits. These same cost principles are adopted by the FAR for use in contracts awarded to these entities (see FAR 31.3, 31.6 and 31.7).
- The Uniform Guidance does not address grants or cooperative agreements awarded to for-profit organizations. Individual agencies can do so in their implementation of the Uniform Guidance.
- HHS permits awarding agencies to apply the grant rules, including the various categories of cost principles, to for-profit organizations.
Comment: From the above discussion, it is evident that it is not always clear which cost principles apply in every situation. Sometimes, even grants officers are confused. We suggest that if there is any question, parties should carefully study the Uniform Guidance along with agency regulation and inquire with the grants officer for a ruling.
I. Indirect Cost Rates for Grants and Cooperative Agreements
Non-Federal entities as defined in the Uniform Guidance that receive cost reimbursement contracts under the FAR must use the format prescribed by FAR 52.216-7 for indirect cost rate proposals.
Where DHHS is the cognizant agency for establishing final indirect cost rates, NIH DFAS requires commercial entities that receive both grants and contracts to use the FAR/DCAA format. However, if a commercial entity receives only grants, it must use a template provided by NIH DFAS to submit its proposal.
J. Indirect Cost Rate Proposals for Grants and Cooperative Agreements
Proposals to establish final indirect cost rates submitted by IHEs, nonprofits, and state and local governments must be certified (see Appendix IV to Part 200 Section D). However, the certification for grants and cooperative agreements is different from the certification found in FAR 52.242-4. Further, there is no penalty similar to that found in FAR 52.242-3 to be assessed against a recipient if the proposal contains unallowable costs.
Neither the FAR or Uniform Guidance addresses the possibility of dual submissions or the possibility of separate agencies for establishment of final indirect cost rates.
Comment: For those contractors who may be subject to providing two incurred cost submissions to two different agencies for the same period of costs, we suggest the contractor contact both agencies to determine if they will accept a single submission. The agency with the largest amount of awards to the contractor may emphasize its status and request that its preferred format prevail.
K. Record Retention Periods for Grants and Cooperative Agreements
The Uniform Guidance has records retention periods that are different from the records retention periods stated in FAR 4.7.
Financial records, supporting documents, statistical records, and all other non-Federal entity records pertinent to a Federal award must be retained for a period of three years from the date of submission of the final expenditure report except:
- If any litigation, claim, or audit is started before the expiration of the three-year period, the records must be retained until all litigation, claims, or audit findings involving the records have been resolved and final action taken.
- When the non-Federal entity is notified in writing by the Federal awarding agency, cognizant agency for audit, oversight agency for audit, or cognizant agency for indirect costs, to extend the retention period.
For the following types of documents and their supporting records, the three-year retention period for supporting records starts from the date of the submission if the proposal, plan, or other computation is required to be submitted to the Federal government to form the basis for negotiation of the rate:
- indirect cost rate computations or proposals;
- cost allocation plans; and
- any similar accounting computations of the rate at which a particular group of costs is chargeable (such as computer usage chargeback rates or composite fringe benefit rates).
L. Government Access to Records for Grants and Cooperative Agreements
FAR 52.215-2 requires a contractor to “make available at its office at all reasonable times the records, materials, and other evidence described this clause, for examination, audit, or reproduction, until 3 years after final payment under this contract or for any shorter period specified in subpart 4.7, of the FAR, or for any longer period required by statute or by other clauses of this contract.”
Section 200.336 of the Uniform Guidance states that the Federal awarding agency, the Comptroller General, or any of their authorized representatives, have the right of access to any documents, papers, or other records which are pertinent to the Federal award, in order to make audits, examinations, excerpts, and transcripts. The right also includes timely and reasonable access to the non-Federal entity’s personnel for the purpose of interview and discussion related to such documents. The rights of access in this section are not limited to the required retention period but last as long as the records are retained.
Comment: Because the FAR 52.215-2 does not include access to personnel in its language, DCAA has sometimes received pushback from contractors who deny DCAA access to personnel. DCAA objects to this denial of access but under the FAR regulation has no recourse. In this regard, while DCAA can subpoena contractor records, it cannot subpoena contractor personnel.